Chapter 15 — Entities Overview

Legal Entities & Liability Protection

Tax law starts with a legal classification, then layers on a tax classification via the check-the-box regulations. Liability protection is a nontax characteristic but drives entity choice.

Check-the-Box Regulations

Eligible entities (non-corporations) may elect their tax classification on Form 8832. A corporation by state law (Inc., Corp.) is per se a corporation and cannot elect out.

Double Taxation — C Corporations

• Layer 1: C corp pays 21% flat tax on taxable income.
• Layer 2: Shareholders pay tax on dividends at 0/15/20% qualified dividend rates (individuals), plus potential 3.8% NIIT if modified AGI > $250K MFJ / $200K single.
• Flow-through entities do NOT pay entity-level tax — owners pay once on their allocable share.

★ Strategies to Mitigate Double Taxation ★

These come up every exam. The C corp deducts these payments (reducing corporate-level tax), and the shareholder is taxed only once on receipt:

• Pay salaries to shareholder-employees (deductible to corp, ordinary income to SH — must be "reasonable compensation" to survive IRS scrutiny)
• Lease property from shareholders (rent deduction to corp, rental income to SH)
• Loan money to the corporation (interest deduction to corp, interest income to SH)
• Retain earnings (defer layer 2 indefinitely — watch out for §531 accumulated earnings tax)
• Elect S corp status (eliminate layer 1 entirely)

Qualified Business Income (QBI) Deduction — §199A

• 20% deduction of QBI allocated from flow-through entities (from-AGI deduction)
• Cannot be from a specified service trade or business (SSTB) — health, law, accounting, consulting, performing arts — above income thresholds
• QBI excludes W-2 wages and investment income (capital gains, dividends, interest)

Self-Employment Tax — By Entity

★ Deducting Entity Losses — Entity Selection ★

• C corp losses: No immediate benefit — trapped at entity level as NOL. Only helps if/when the corp earns future income.
• Flow-through losses: Pass to owners immediately and can offset other income (subject to basis, at-risk, passive-activity, and excess-business-loss limits).

Chapter 16 — Corporate Operations

Corporate vs. Individual Tax Formula — The Contrast

★ Book-Tax Differences (BTDs) ★

Every BTD has two dimensions. You need both to answer an exam question correctly:

• Permanent vs. Temporary — does it ever reverse?
• Favorable vs. Unfavorable — does it decrease (F) or increase (U) taxable income vs. book income?

★ §197 Asset Acquisition Goodwill ★

• Tax: Amortize over 15 years straight-line as §197 intangible
• Book (GAAP): No amortization; only impairment
• If tax amortization > book impairment → favorable temporary BTD
• If book impairment > tax amortization → unfavorable temporary BTD
• Stock acquisition goodwill: No tax amortization allowed → impairment creates unfavorable PERMANENT BTD

★ Dividends Received Deduction (DRD) ★

NOL Rules (Post-2020)

• No carryback for NOLs arising in tax years beginning after 12/31/2020
• Carry forward indefinitely
• Can only offset up to 80% of taxable income (computed before the NOL deduction)
• Use on FIFO basis (oldest first)
• Pre-2018 NOLs: 2-yr back, 20-yr forward, 100% of TI

Charitable Contributions — Corporate

• Limited to 10% of adjusted taxable income (TI before charitable, DRD, NOL CB, and capital loss CB)
• Excess carries forward 5 years (FIFO)
• Accrual corps can elect to deduct contributions authorized by board before year-end if paid by April 15 (or 15th day of 4th month)

Deduction Sequencing (Critical)

Chapter 18 — Nonliquidating Distributions

★ The Three-Tier Distribution Waterfall ★

Every corporate distribution is tested against this sequence. Memorize it.

Earnings & Profits (E&P)

• E&P measures a corporation's economic earnings available for distribution — NOT the same as retained earnings.
• Computed starting from taxable income with adjustments (add back DRD, municipal interest; subtract federal tax, nondeductible items).
• Current E&P = current-year economic earnings. Accumulated E&P = prior-year cumulative.

Four E&P Scenarios for Classifying a Distribution

Noncash Property Distributions

To the shareholder:

• Amount of distribution = FMV of property (reduced by liabilities assumed by SH, but not below zero)
• SH's basis in received property = FMV (no downward adjustment for liabilities)
• Classification (dividend / ROC / cap gain) follows the 3-tier waterfall

To the distributing corporation:

• Gain recognized as if property sold at FMV (even though no sale occurred)
• Loss NOT recognized on distribution
• E&P increases by gain recognized; E&P decreases by greater of FMV or basis (reduced by liabilities)

★ Constructive Dividends ★

The IRS may assert a distribution exists even without a formal declaration when a C corp transfers value to a shareholder disguised as something else. Common triggers:

• Excessive compensation to shareholder-employees
• Below-market loans from corp to SH
• Rent paid to SH in excess of FMV
• SH use of corporate property (cars, homes, jets) without reimbursement
• Unreasonably high interest paid on SH debt
• Bargain sales of corporate property to SH

Chapter 19 — Corporate Formation & Liquidation

Why Defer? (Policy)

Congress enacted §351 so that taxpayers can incorporate a going concern without triggering tax on what is essentially a mere change in form. The shareholder's investment continues — just in corporate-stock form instead of directly in the assets. The deferred gain is preserved via carryover basis.

★ §351 — The Three Requirements ★

1. PROPERTY is transferred — money, tangible assets, intangibles (patents, goodwill). Services are NOT property. If a SH contributes only services for stock, that SH gets ordinary compensation income (FMV of stock) and is excluded from the control group.
2. In exchange solely for STOCK of the transferee corporation (common or preferred; but not nonqualified preferred).
3. Transferors as a group must have CONTROL (§368(c)) immediately after: ≥80% of voting stock AND ≥80% of each non-voting class.

★ 5-Step Method (from the §351 Handout) ★

1. Realized gain/loss = (FMV of stock + boot + liability relief) − basis of property contributed
2. Recognized gain = LESSER of realized gain OR boot received. Losses never recognized in §351.
3. Unrecognized gain = realized − recognized (used for basis)
4. Character of recognized gain = character of property contributed (capital, §1231, ordinary)
5. Basis of stock received (two methods):

★ Boot Rules ★

• Boot = anything received other than stock of the transferee corp (cash, promissory notes, other property, excess liability relief)
• Boot does NOT disqualify §351 — it just triggers partial recognition
• Gain recognized = lesser of realized gain OR FMV of boot
• No losses are ever recognized, even with boot

★ §357 — Assumption of Liabilities ★

• General rule §357(a): Liability assumption is NOT boot
• Exception §357(b): If any liability was incurred for tax avoidance or non-business purpose → ALL liabilities assumed become boot
• Exception §357(c): If total liabilities assumed > total basis of property contributed → excess = recognized gain
• If both apply: §357(b) supersedes §357(c).

Worked Example — Al Pine Incorporation

Contributes inventory/building/land: FMV $375K, basis $175K, liability $75K. Receives only stock (FMV $300K).

Taxable Acquisitions — Asset vs. Stock

Corporate Liquidations (§331, §336, §337)

To the shareholder (§331):

• Treated as if stock were sold — amount realized (FMV of property − liabilities) vs. stock basis
• Gain or loss recognized; capital in character (stock is capital asset)
• Basis in property received = FMV on distribution date
• Exception §332: 80% corporate parent recognizes no gain/loss; takes carryover basis

To the liquidating corporation (§336):

• Treated as if it sold property at FMV
• Gains recognized; losses may be disallowed (related-party rules under §336(d))
• §337: No gain/loss on distributions to 80% corporate parent

Chapter 20 — Partnership Formation & Operations

Flow-Through Taxation: Entity vs. Aggregate

Partnerships mix two theories:

• Entity approach: Partnership files Form 1065, maintains books, owns assets — treated as separate entity for reporting.
• Aggregate approach: Income, character, and basis flow through to partners as if each directly owned a share of assets.

★ §721 — Partnership Formation ★

Analog to §351 but simpler — no control requirement, no 80% threshold.

• No gain or loss recognized on contribution of property
• Applies at formation AND thereafter (unlike §351's "immediately after" rule)
• Exception 1: Contribution of services in exchange for a capital interest → ordinary compensation income at FMV
• Exception 2: §752 deemed distribution — if debt relief exceeds contributing partner's basis, recognize gain
• §721(b) Exception: Contribution to investment partnership → taxable

★ Inside vs. Outside Basis ★

★ §752 — Debt Allocation ★

★ Outside Basis Formula ★

Holding Period — Tacking Rules

• Partner's interest: Tacks if capital or §1231 asset was contributed; otherwise begins on acquisition date
• Partnership's holding period in contributed property: Always tacks (character does NOT tack — character is determined at partnership level based on use)

Services for Partnership Interest

★ Form 1065 Reporting ★

• Form 1065: Partnership information return (not a tax liability return)
• Schedule K-1: Each partner's share of income, deductions, credits
• Ordinary business income: Line 1 — net of partnership operations
• Separately stated items: Items that could affect partners differently (capital gains, §1231 gains, charitable contributions, dividends, interest income, §179, foreign taxes, etc.)

Guaranteed Payments

• Fixed amounts paid to a partner regardless of partnership income/loss
• Deducted in computing partnership ordinary income
• Separately stated on K-1 to recipient
• Ordinary income to receiving partner AND always SE income

Start-Up & Organization Costs

• Expense up to $5,000 immediately (each category separately)
• $5,000 phased out dollar-for-dollar as costs exceed $50,000
• Amortize remainder over 180 months
• Syndication costs: Never deductible (capitalized permanently)

Chapter 22 — S Corporations

Why S Corps Are Hybrid Creatures

S corps borrow heavily from both C corp and partnership rules:

• From C corp law: state-law formation, liability protection, §351 formation rules, stock basis concepts
• From partnership law: flow-through taxation, separately stated items, basis adjustments for income/loss

★ S Corp Shareholder & Corporate Requirements ★

★ Election Timing (Form 2553) ★

Termination of S Election

Voluntary revocation: Requires consent of shareholders holding >50% of stock.

Involuntary termination: Triggered automatically by:

• Failing any S corp requirement (e.g., issuing 101st stock certificate, transfer to nonresident alien)
• Excessive passive investment income — >25% for 3 consecutive years when corp has C corp E&P

Required Tax Year

• Default: calendar year
• May elect a natural business year end (§444) or demonstrate business purpose

★ S Corp Basis — Critical Differences from Partnerships ★

Loss Limitations — 4 Gatekeepers

1. Tax basis (stock basis, then debt basis if applicable)
2. At-risk amount (§465)
3. Passive activity rules (§469)
4. Excess business loss limitation (§461(l)) — $305K single / $610K MFJ (2025)

Operating Distributions — S Corp with No C Corp E&P

• Tax-free to extent of stock basis (like partnership)
• Excess over basis = capital gain
• No E&P concept when S corp was never a C corp

SE Tax — S Corp Advantage

• S corp ordinary income passing through to SH is NOT SE income (huge advantage vs. partnership GP)
• SH-employees pay FICA on reasonable W-2 wages only
• No guaranteed payments in S corps (partnership concept only)

Chapter 24 — US Taxation of Multinational Transactions

★ Key Terms ★

• Nexus: Minimum connection required for a jurisdiction to impose tax. The core question in all cross-border tax.
• Outbound transactions: US person earning income abroad (US-based Nike selling in Germany)
• Inbound transactions: Foreign person earning income in the US (Toyota Japan selling cars in US)
• Source: Jurisdiction based on where income is earned (territorial concept)
• Residence: Jurisdiction based on who earned it (citizenship-based concept)

★ Worldwide vs. Territorial Systems ★

Who Is a US Resident for Tax Purposes?

★ Source of Income Rules ★

★ Mitigating Double Taxation — Three Tools ★

1. Foreign Tax Credit (FTC):
   • Dollar-for-dollar credit against US tax for foreign income taxes paid
   • Limitation formula: (Foreign source TI ÷ Total TI) × Precredit US tax
   • Computed separately for 4 baskets: GILTI, foreign branch, passive, general
   • Excess FTC carries back 1 year, forward 10 years (except GILTI — no carryover)
2. Tax Treaties:
   • Bilateral agreements (US has ~66 in force) that define nexus and reduce withholding on cross-border payments
   • Common reductions: withholding on dividends, interest, royalties (default 30% → often reduced to 15% or lower)
3. Foreign Earned Income Exclusion (§911): Up to ~$130K (2025) for US citizens living abroad meeting bona fide residence or physical presence tests

Anti-Deferral Regimes (Why the US Doesn't Just Lose Revenue)

• Subpart F: Certain "tainted" passive-type income of Controlled Foreign Corporations (CFCs) is taxed to US shareholders immediately, even if not repatriated. Includes interest, dividends, rents, royalties, certain sales income, FX gains.
• GILTI (§951A): Global Intangible Low-Taxed Income — current taxation of CFC earnings above a 10% return on tangible assets. Added by TCJA 2017.
• BEAT (§59A): Base Erosion and Anti-Abuse Tax — min tax on large corporations that make deductible payments to foreign affiliates.
• FDII (§250): Reduced rate (13.125%) on Foreign-Derived Intangible Income — incentive to keep IP in the US.