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SEE-2 - Business Entities and Considerations - Section 1.3

Apply C corporation formation and taxation rules, including the Section 351 nonrecognition rule, the flat corporate tax rate, and dividend and earnings-and-profits treatment.

Apply the Section 351 rule that property transferred to a controlled corporation (80% control immediately after) is generally tax-free, and compute corporate taxable income at the flat 21% rate on Form 1120. Recognise that distributions to shareholders are dividends to the extent of earnings and profits, that C corporation income is taxed twice, and how the dividends-received deduction reduces tax on inter-corporate dividends.

Form 1120Section 351Earnings and profitsDividends-received deductionDouble taxation

Practice question for this objective

Free sampleBusiness Entities and Considerationshard

Caldermoor Fabrication Inc, a calendar-year C corporation, computes its 2024 results as follows: taxable income before any charitable contribution deduction is 200,000 dollars, and during the year it made 30,000 dollars of qualifying cash charitable contributions. It has no dividends-received deduction, no net operating loss carryover, and no contribution carryover. After applying the corporate charitable contribution limit and the flat corporate rate for 2024, what is the corporation's regular federal income tax before credits?

  • A42,000 dollars, applying the 21 percent rate to the 200,000 dollars of income before contributions, on the basis that charitable gifts are not deductible by a corporation.
  • B35,700 dollars, applying the 21 percent rate to 170,000 dollars after deducting the full 30,000 dollar contribution without regard to any percentage limitation.
  • C61,200 dollars, applying the former 34 percent graduated corporate rate to the 180,000 dollars of taxable income after the limited charitable deduction.
  • D37,800 dollars, applying the 21 percent rate to 180,000 dollars after allowing the charitable deduction limited to 10 percent of the 200,000 dollar base. Correct
A corporation applies the flat 21 percent rate to taxable income computed after the charitable deduction, which is limited to 10 percent of taxable income before that deduction. A C corporation may deduct charitable contributions, but the deduction is limited to 10 percent of taxable income computed without the contribution deduction and certain other items. Here the base is 200,000 dollars, so the limit is 20,000 dollars and the remaining 10,000 dollars carries over. Taxable income becomes 200,000 minus 20,000, or 180,000 dollars. The corporate tax is then a single flat 21 percent under Section 11, so 180,000 multiplied by 0.21 equals 37,800 dollars. The old graduated rates no longer apply.

Why A is wrong: Corporations may deduct charitable contributions within the limit, so ignoring the deduction overstates taxable income; the deductible 20,000 dollars must reduce income before the rate is applied.

Why B is wrong: The corporate charitable deduction is capped at 10 percent of taxable income computed before the contribution, so only 20,000 dollars is deductible; deducting the full 30,000 dollars understates taxable income and the tax.

Why C is wrong: The 34 percent rate comes from the repealed graduated schedule; corporations now pay a single flat 21 percent rate, so applying 34 percent overstates the tax even though the 180,000 dollar income figure is correct.

Why D is correct: The charitable deduction is limited to 10 percent of 200,000, or 20,000 dollars, so taxable income is 180,000 dollars and the flat 21 percent rate gives 180,000 multiplied by 0.21, which is 37,800 dollars.

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