Control of a corporation.

To be in control of a corporation, you or your group of transferors must own, immediately after the exchange, at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the outstanding shares of each class of nonvoting stock.

Services rendered.

The term property does not include services rendered or to be rendered to the issuing corporation. The value of stock received for services is income to the recipient.

Property of relatively small value.

The term property does not include property of a relatively small value when it is compared to the value of stock and securities already owned or to be received for services by the transferor if the main purpose of the transfer is to qualify for the nonrecognition of gain or loss by other transferors.

Property transferred will not be considered to be of relatively small value if its fair market value is at least 10% of the fair market value of the stock and securities already owned or to be received for services by the transferor.

Stock received in disproportion to property transferred.

If a group of transferors exchange property for corporate stock, each transferor does not have to receive stock in proportion to his or her interest in the property transferred. If a disproportionate transfer takes place, it will be treated for tax purposes in accordance with its true nature. It may be treated as if the stock were first received in proportion and then some of it used to make gifts, pay compensation for services, or satisfy the transferor's obligations.

Money or other property received.

If, in an otherwise nontaxable exchange of property for corporate stock, you also receive money or property other than stock, you may have to recognize gain. You must recognize gain only up to the amount of money plus the fair market value of the other property you receive. The rules for figuring the recognized gain in this situation generally follow those for a partially nontaxable exchange discussed in Publication 544 under Like-Kind Exchanges. If the property you give up includes depreciable property, the recognized gain may have to be reported as ordinary income from depreciation. See chapter 3 of Publication 544. No loss is recognized.

Nonqualified preferred stock.

Nonqualified preferred stock is treated as property other than stock. Generally, it is preferred stock with any of the following features.

For a detailed definition of nonqualified preferred stock, see section 351(g)(2) of the Internal Revenue Code.

Liabilities.

If the corporation assumes your liabilities, the exchange generally is not treated as if you received money or other property. There are two exceptions to this treatment.

For more information on the assumption of liabilities, see section 357(d) of the Internal Revenue Code.

The liability assumed is not treated as money or other property. The recognized gain is limited to $10,000, the cash received.

Loss on exchange.

If you have a loss from an exchange and own, directly or indirectly, more than 50% of the corporation's stock, you cannot deduct the loss. For more information, see Nondeductible Loss under Sales and Exchanges Between Related Persons in chapter 2 of Publication 544.

Basis of stock or other property received.

The basis of the stock you receive is generally the adjusted basis of the property you transfer. Increase this amount by any amount treated as a dividend, plus any gain recognized on the exchange. Decrease this amount by any cash you received, the fair market value of any other property you received, and any loss recognized on the exchange. Also decrease this amount by the amount of any liability the corporation or another party to the exchange assumed from you, unless payment of the liability gives rise to a deduction when paid.

Further decreases may be required when the corporation or another party to the exchange assumes from you a liability that gives rise to a deduction when paid after October 18, 1999, if the basis of the stock would otherwise be higher than its fair market value on the date of the exchange. This rule does not apply if the entity assuming the liability acquired either substantially all of the assets or the trade or business with which the liability is associated.

Basis of property transferred.

A corporation that receives property from you in exchange for its stock generally has the same basis you had in the property, increased by any gain you recognized on the exchange. However, the increase for the gain recognized may be limited. For more information, see section 362 of the Internal Revenue Code.

Paid-in capital.

Contributions to the capital of a corporation, whether or not by shareholders, are paid-in capital. These contributions are not taxable to the corporation.

Basis.

The corporation's basis of property contributed to capital by a shareholder is the same as the basis the shareholder had in the property, increased by any gain the shareholder recognized on the exchange. However, the increase for the gain recognized may be limited. For more information, see section 362 of the Internal Revenue Code.

The basis of property contributed to capital by a person other than a shareholder is zero.

If a corporation receives a cash contribution from a person other than a shareholder, the corporation must reduce the basis of any property acquired with the contribution during the 12-month period beginning on the day it received the contribution by the amount of the contribution. If the amount contributed is more than the cost of the property acquired, then reduce, but not below zero, the basis of the other properties held by the corporation on the last day of the 12-month period in the following order.

Reduce the basis of property in each category to zero before going on to the next category.

There may be more than one piece of property in each category. Base the reduction of the basis of each property on the following ratio:

If the corporation wishes to make this adjustment in some other way, it must get IRS approval. The corporation files a request for approval with its income tax return for the tax year in which it receives the contribution.

When to pay estimated tax.

Installment payments are due by the 15th day of the 4th, 6th, 9th, and 12th months of the corporation's tax year. For 2004, 20% of any estimated tax otherwise due in September 2004 will not be due until October 1, 2004.

If any due date falls on a Saturday, Sunday, or legal holiday, the installment is due on the next business day.

How to figure each required installment.

Use Form 1120–W to figure each required installment of estimated tax. You will generally use one of the following two methods to figure each required installment. You should use the method that yields the smallest installment payments.

Method 1.

Each required installment is 25% of the income tax the corporation will show on its return for the current year.

Method 2.

Each required installment is 25% of the income tax shown on the corporation's return for the previous year.

To use Method 2:

Also, if the corporation is a large corporation, it can use Method 2 to figure the first installment only.

A large corporation is one with at least $1 million of modified taxable income in any of the last 3 years. Modified taxable income is taxable income figured without net operating loss or capital loss carrybacks or carryovers.

Other methods.

If a corporation's income is expected to vary during the year because, for example, its business is seasonal, it may be able to lower the amount of one or more required installments by using one or both of the following methods.

Use Schedule A of Form 1120–W to see if using one or both of these methods will lower the amount of any required installments.

Refiguring required installments.

If after the corporation figures and deposits its estimated tax it finds that its tax liability for the year will be more or less than originally estimated, it may have to refigure its required installments to see if an underpayment penalty may apply. An immediate catchup payment should be made to reduce any penalty resulting from the underpayment of any earlier installments.

Underpayment penalty.

If the corporation does not pay a required installment of estimated tax by its due date, it may be subject to a penalty. The penalty is figured separately for each installment due date. The corporation may owe a penalty for an earlier due date, even if it paid enough tax later to make up the underpayment. This is true even if the corporation is due a refund when its return is filed.

Form 2220.

Use Form 2220 to determine if a corporation is subject to the penalty for underpayment of estimated tax and, if so, the amount of the penalty.

If the corporation is charged a penalty, the amount of the penalty depends on the following three factors.

A corporation generally does not have to file Form 2220 with its income tax return because the IRS will figure any penalty and bill the corporation. However, even if the corporation does not owe a penalty, complete and attach the form to the corporation's tax return if any of the following apply.

How to pay estimated tax.

Unless you volunteer or are required to make electronic deposits, you should mail or deliver your payment with a completed Form 8109 to an authorized financial institution. For more information, see the instructions for Form 1120–W.

Electronic Federal Tax Payment System (EFTPS).

You may have to deposit taxes using EFTPS. You must use EFTPS to make deposits of all depository tax liabilities (including social security, Medicare, withheld income, excise, and corporate income taxes) you incur in 2004 if you deposited more than $200,000 in federal depository taxes in 2002 or you had to make electronic deposits in 2003. If you first meet the $200,000 threshold in 2003, you must begin depositing using EFTPS in 2005. Once you meet the $200,000 threshold, you must continue to make deposits using EFTPS in later years even if subsequent deposits are less than the $200,000 threshold.

If you must use EFTPS but fail to do so, you may be subject to a 10% penalty.

If you are not required to use EFTPS because you did not meet the $200,000 threshold, then you may voluntarily make your deposits using EFTPS. However, if you are using EFTPS voluntarily, you will not be subject to the 10% penalty if you make a deposit using a paper coupon.

For information about EFTPS, access the IRS website on the Internet at www.eftps.gov, or see Publication 966, Electronic Choices for Paying ALL Your Federal Taxes.

To enroll in EFTPS, call one of the following phone numbers.

Or to enroll online visit www.eftps.gov.

Quick refund of overpayments.

A corporation that has overpaid its estimated tax for the tax year may be able to apply for a quick refund. Use Form 4466 to apply for a quick refund of an overpayment of estimated tax. A corporation can apply for a quick refund if the overpayment is:

Use Form 4466 to figure the corporation's expected tax liability and the overpayment of estimated tax.

Who must file.

Unless exempt under section 501 of the Internal Revenue Code, all domestic corporations in existence for any part of a taxable year (including corporations in bankruptcy) must file an income tax return whether or not they have taxable income.

Which form to file.

A corporation must generally file Form 1120 to report its income, gains, losses, deductions, credits, and to figure its income tax liability. However, a corporation may file Form 1120–A if its gross receipts, total income, and total assets are each under $500,000 and it meets certain other requirements. Also, certain organizations must file special returns. For more information, see the instructions for Forms 1120 and 1120–A.

When to file.

Generally, a corporation must file its income tax return by the 15th day of the 3rd month after the end of its tax year. A new corporation filing a short-period return must generally file by the 15th day of the 3rd month after the short period ends. A corporation that has dissolved must generally file by the 15th day of the 3rd month after the date it dissolved.

If the due date falls on a Saturday, Sunday, or legal holiday, the due date is extended to the next business day.

Extension of time to file.

File Form 7004 to request a 6-month extension of time to file a corporation income tax return. The IRS will grant the extension if you complete the form properly, file it, and pay any tax due by the original due date for the return.

Form 7004 does not extend the time for paying the tax due on the return. Interest, and possibly penalties, will be charged on any part of the final tax due not shown as a balance due on Form 7004. The interest is figured from the original due date of the return to the date of payment.

For more information, see the instructions for Form 7004.

Penalty for late filing of return.

A corporation that does not file its tax return by the due date, including extensions, may be penalized 5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% of the unpaid tax. If the corporation is charged a penalty for late payment of tax (discussed next) for the same period of time, the penalty for late filing is reduced by the amount of the penalty for late payment. The minimum penalty for a return that is over 60 days late is the smaller of the tax due or $100. The penalty will not be imposed if the corporation can show the failure to file on time was due to a reasonable cause. A corporation that has a reasonable cause to file late must attach a statement to its tax return explaining the reasonable cause.

Penalty for late payment of tax.

A corporation that does not pay the tax when due may be penalized ½ of 1% of the unpaid tax for each month or part of a month the tax is not paid, up to a maximum of 25% of the unpaid tax. The penalty will not be imposed if the corporation can show that the failure to pay on time was due to a reasonable cause.

Trust fund recovery penalty.

If income, social security, and Medicare taxes that a corporation must withhold from employee wages are not withheld or are not deposited or paid to the United States Treasury, the trust fund recovery penalty may apply. The penalty is the full amount of the unpaid trust fund tax. This penalty may apply to you if these unpaid taxes cannot be immediately collected from the business.

The trust fund recovery penalty may be imposed on all persons who are determined by the IRS to be responsible for collecting, accounting for, and paying these taxes, and who acted willfully in not doing so.

A responsible person can be an officer or employee of a corporation, an accountant, or a volunteer director/trustee. A responsible person also may include one who signs checks for the corporation or otherwise has authority to cause the spending of business funds.

Willfully means voluntarily, consciously, and intentionally. A responsible person acts willfully if the person knows the required actions are not taking place.

For more information on withholding and paying these taxes, see Publication 15, Circular E, Employer's Tax Guide.

Amended return.

Use Form 1120X to correct any error in a Form 1120 or Form 1120–A.

S corporation status.

A corporation may not carry a capital loss from, or to, a year for which it is an S corporation.

Rules for carryover and carryback.

When carrying a capital loss from one year to another, the following rules apply.

Refunds.

When you carry back a capital loss to an earlier tax year, refigure your tax for that year. If your corrected tax is less than the tax you originally owed, use either Form 1139 or Form 1120X to apply for a refund.

Form 1139.

A corporation can get a refund faster by using Form 1139. It cannot file Form 1139 before filing the return for the corporation's capital loss year, but it must file Form 1139 no later than one year after the year it sustains the capital loss.

Form 1120X.

If the corporation does not file Form 1139, it must file Form 1120X to apply for a refund. The corporation must file the Form 1120X within 3 years of the due date, including extensions, for filing the return for the year in which it sustains the capital loss.

Publication 78.

You can ask any organization whether it is a qualified organization and most will be able to tell you. Or you can check IRS Publication 78, Cumulative List of Organizations, which lists most qualified organizations. The publication is available on the Internet at www.irs.gov or your local library may have a copy. You can also call Tax Exempt/Government Entities Customer Service at 1–877– 829–5500 to find out if an organization is qualified.

Cash method corporation.

A corporation using the cash method of accounting deducts contributions in the tax year paid.

Accrual method corporation.

A corporation using an accrual method of accounting can choose to deduct unpaid contributions for the tax year the board of directors authorizes them if it pays them within 2½ months after the close of that tax year. Make the choice by reporting the contribution on the corporation's return for the tax year. A declaration stating that the board of directors adopted the resolution during the tax year must accompany the return. The declaration must include the date the resolution was adopted.

Limit.

A corporation cannot deduct charitable contributions that exceed 10% of its taxable income for the tax year. Figure taxable income for this purpose without the following.

Carryover of excess contributions.

You can carry over, within certain limits, to each of the subsequent five years any charitable contributions made during the current year that exceed the 10% limit. You lose any excess not used within that period. For example, if a corporation has a carryover of excess contributions paid in 2002 and it does not use all the excess on its return for 2003, it can carry the rest over to 2004, 2005, 2006, and 2007. Do not deduct a carryover of excess contributions in the carryover year until after you deduct contributions made in that year (subject to the 10% limit). You cannot deduct a carryover of excess contributions to the extent it increases a net operating loss carryover.

More information.

For more information on the charitable contribution deduction, see the instructions for Forms 1120 and 1120–A.

Dividends from domestic corporations.

A corporation can deduct, within certain limits, 70% of the dividends received if the corporation receiving the dividend owns less than 20% of the corporation distributing the dividend. If the corporation owns 20% or more of the distributing corporation's stock, it can, subject to certain limits, deduct 80% of the dividends received.

Ownership.

Determine ownership, for these rules, by the amount of voting power and value of the paying corporation's stock (other than certain preferred stock) the receiving corporation owns.

Small business investment companies.

Small business investment companies can deduct 100% of the dividends received from taxable domestic corporations.

Dividends from regulated investment companies.

Regulated investment company dividends received are subject to certain limits. Capital gain dividends received from a regulated investment company do not qualify for the deduction. For more information, see section 854 of the Internal Revenue Code.

No deduction allowed for certain dividends.

Corporations cannot take a deduction for dividends received from the following entities.

Dividends on deposits.

Dividends on deposits or withdrawable accounts in domestic building and loan associations, mutual savings banks, cooperative banks, and similar organizations are interest, not dividends. They do not qualify for this deduction.

Limit on deduction for dividends.

The total deduction for dividends received or accrued is generally limited (in the following order) to:

For exceptions, see Schedule C on Form 1120 and the instructions for Forms 1120 and 1120–A.

Figuring the limit.

In figuring the limit, determine taxable income without the following items.

Effect of net operating loss.

If a corporation has a net operating loss (NOL) for a tax year, the limit of 80% (or 70%) of taxable income does not apply. To determine whether a corporation has an NOL, figure the dividends-received deduction without the 80% (or 70%) of taxable income limit.

Extraordinary dividend.

An extraordinary dividend is any dividend on stock that equals or exceeds a certain percentage of the corporation's adjusted basis in the stock. The percentages are:

Treat all dividends received that have ex-dividend dates within an 85-consecutive-day period as one dividend. Treat all dividends received that have ex-dividend dates within a 365-consecutive-day period as extraordinary dividends if the total of the dividends exceeds 20% of the corporation's adjusted basis in the stock.

Disqualified preferred stock.

Any dividend on disqualified preferred stock is treated as an extraordinary dividend regardless of the period of time the corporation held the stock.

Disqualified preferred stock is any stock preferred as to dividends if any of the following apply.

These rules apply to stock issued after July 10, 1989, unless it was issued under a written binding contract in effect on that date, and thereafter, before the issuance of the stock.

More information.

For more information on extraordinary dividends, see section 1059 of the Internal Revenue Code.

Business start-up costs.

Start-up costs are costs for creating an active trade or business or investigating the creation or acquisition of an active trade or business. Start-up costs include any amounts paid or incurred in connection with an activity engaged in for profit or for the production of income in anticipation of the activity becoming an active trade or business.

Qualifying costs.

A start-up cost is amortizable if it meets both of the following tests.

Start-up costs include costs for the following items.

Nonqualifying costs.

Start-up costs do not include deductible interest, taxes, or research and experimental costs.

Purchasing an active trade or business.

Amortizable start-up costs for purchasing an active trade or business include only investigative costs incurred in the course of a general search for, or preliminary investigation of, the business. These are the costs that help you decide whether to purchase a new business and which active business to purchase. Costs you incur in an attempt to purchase a specific business are capital expenses that you cannot amortize.

Disposition of business.

If you completely dispose of your business before the end of the amortization period, you can deduct any remaining deferred start-up costs. However, you can deduct these deferred start-up costs only to the extent they qualify as a loss from a business.

Organizational costs.

The costs of organizing a corporation are the direct costs of creating the corporation.

Qualifying costs.

You can amortize an organizational cost only if it meets all of the following tests.

The following are examples of organizational costs.

Nonqualifying costs.

The following costs are not organizational costs. They are capital expenses that you cannot amortize.

How to amortize.

Deduct start-up and organizational costs in equal amounts over a period of 60 months or more. You can choose a period for start-up costs that is different from the period you choose for organizational costs, as long as both are not less than 60 months. The amortization period starts with the month you begin business operations. Once you choose an amortization period, you cannot change it.

To figure your deduction, divide your total start-up or organizational costs by the months in the amortization period. The result is the amount you can deduct for each month.

How to make the choice.

To choose to amortize start-up or organizational costs, you must attach Form 4562 and an accompanying statement to your return for the first tax year you are in business. If you have both start-up and organizational costs, attach a separate statement to your return for each type of cost.

Generally, you must file your return by the due date (including any extensions). However, if you timely filed your return for the year without making the choice, you can still make the choice by filing an amended return within 6 months of the due date of the return (excluding extensions). For more information, see the instructions for Part VI of Form 4562.

Once you make the choice to amortize start-up or organizational costs, you cannot revoke it.

Start-up costs.

If you choose to amortize your start-up costs, complete Part VI of Form 4562 and prepare a separate statement that contains the following information.

You can choose to amortize your start-up costs by filing the statement with a return for any tax year before the year your active business begins. If you file the statement early, the choice becomes effective in the month your active business begins.

You can file a revised statement to include any start-up costs not included in your original statement. However, you cannot include on the revised statement any cost you previously treated on your return as a cost other than a start-up cost. You can file the revised statement with a return filed after the return on which you chose to amortize your start-up costs.

Organizational costs.

If you choose to amortize your organizational costs, complete Part VI of Form 4562 and prepare a separate statement that contains the following information.

Related persons.

For purposes of this rule, the following persons are related to a corporation.

Ownership of stock.

To determine whether an individual directly or indirectly owns any of the outstanding stock of a corporation, the following rules apply.

Personal service corporation.

For this purpose, a corporation is a personal service corporation if it meets all of the following requirements.

Reallocation of income and deductions.

Where it is necessary to clearly show income or prevent tax evasion, the IRS can reallocate gross income, deductions, credits, or allowances between two or more organizations, trades, or businesses owned or controlled directly, or indirectly, by the same interests.

Complete liquidations.

The disallowance of losses from the sale or exchange of property between related persons does not apply to liquidating distributions.

More information.

For more information about the related person rules, see Publication 544.

Dividends-received deduction.

The corporation's deduction for dividends received from domestic corporations is generally subject to an aggregate limit of 70% or 80% of taxable income. However, if a corporation sustains an NOL for a tax year, the limit based on taxable income does not apply. In determining if a corporation has an NOL, the corporation figures the dividends-received deduction without regard to the 70% or 80% of taxable income limit.

For more information on the dividends-received deduction, see Dividends-Received Deduction under Income and Deductions, earlier.

Because the corporation had an NOL, the limit based on taxable income does not apply.

For a carryback.

If a corporation carries back the NOL, it can use either Form 1120X or Form 1139. A corporation can get a refund faster by using Form 1139. It cannot file Form 1139 before filing the return for the corporation's NOL year, but it must file Form 1139 no later than one year after the year it sustains the NOL.

If the corporation does not file Form 1139, it must file Form 1120X within 3 years of the due date, plus extensions, for filing the return for the year in which it sustains the NOL.

For a carryforward.

If a corporation carries forward its NOL, it enters the carryover on Schedule K (Form 1120), line 12. It also enters the deduction for the carryover (but not more than the corporation's taxable income after special deductions) on line 29(a) of Form 1120 or line 25(a) of Form 1120–A.

Carryback expected.

If a corporation expects to have an NOL in its current year, it can automatically extend the time for paying all or part of its income tax for the immediately preceding year. It does this by filing Form 1138. It must explain on the form why it expects the loss.

The payment of tax that may be postponed cannot exceed the expected overpayment from the carryback of the NOL.

Period of extension.

The extension is in effect until the end of the month in which the return for the NOL year is due (including extensions).

If the corporation files Form 1139 before this date, the extension will continue until the date the IRS notifies the corporation that its Form 1139 is allowed or disallowed in whole or in part.

Modified taxable income.

A corporation figures its modified taxable income the same way it figures its taxable income, with the following exceptions.

The modified taxable income for any year cannot be less than zero.

Modified taxable income is used only to figure how much of an NOL the corporation uses up in the carryback or carryforward year and how much it carries to the next year. It is not used to fill out the corporation's tax return or figure its tax.

Ownership change.

A loss corporation (one with cumulative losses) that has an ownership change is limited on the taxable income it can offset by NOL carryforwards arising before the date of the ownership change. This limit applies to any year ending after the change of ownership.

See sections 381 through 384, and 269 of the Internal Revenue Code and the related regulations for more information about the limits on corporate NOL carryovers and corporate ownership changes.

Closely held corporation.

For the at-risk rules, a corporation is a closely held corporation if, at any time during the last half of the tax year, more than 50% in value of its outstanding stock is owned directly or indirectly by, or for, five or fewer individuals.

To figure if more than 50% in value of the stock is owned by five or fewer individuals, apply the following rules.

More information.

For more information on the at-risk limits, see Publication 925.

Personal service corporation.

For the passive activity rules, a corporation is a personal service corporation if it meets all of the following requirements.

Personal services.

Personal services are those performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts.

Employee-owners.

A person is an employee-owner of a personal service corporation if both of the following apply.

Closely held corporation.

For the passive activity rules, a corporation is closely held if all of the following apply.

More information.

For more information on the passive activity limits, see Publication 925.

Qualified personal service corporation.

A qualified personal service corporation is taxed at a flat rate of 35% on taxable income. A corporation is a qualified personal service corporation if it meets both of the following tests.

See section 1.448–1T(e) of the regulations for details.

General business credit.

Your general business credit for the year consists of your carryforward of business credits from prior years plus your total current year business credits. Current year business credits include the following.

Your general business credit for the current year may be increased by the carryback or carryforward of business credits from other years.

To claim a general business credit, you must first get the form or forms you need to claim your current year business credits. The above list identifies current year business credits. The form used to claim each credit is shown in parentheses. In addition to the credit form, you may also need to file Form 3800.

Who must file Form 3800.

You must file Form 3800 if any of the following apply.

The empowerment zone and renewal community employment credit is subject to special rules. This credit is figured separately on Form 8844 and is not carried to Form 3800. For more information, see the instructions for Form 8844.

The New York Liberty Zone business employee credit is an expansion of the work opportunity credit to include a new targeted group of employees in the New York Liberty Zone. This credit is figured separately on Form 8884 and is, generally, not carried to Form 3800. For more information, see the instructions for Form 8884.

See the Form 3800 instructions for more information about the general business credit.

Small corporation exemption.

A corporation is treated as a small corporation exempt from the AMT for its tax year beginning in 2003 if that year is the corporation's first tax year in existence (regardless of its gross receipts for the year) or:

For more information, see the instructions for Form 4626.

Form 4626.

Use Form 4626 to figure the tentative minimum tax of a corporation that is not a small corporation for AMT purposes.

Amount distributed.

The amount of a distribution is generally the amount of any money paid to the shareholder plus the fair market value (FMV) of any property transferred to the shareholder. However, this amount is reduced (but not below zero) by the following liabilities.

The FMV of any property distributed to a shareholder becomes the shareholder's basis in that property.

Gain from property distributions.

A corporation will recognize a gain on the distribution of property to a shareholder if the FMV of the property is more than its adjusted basis. This is generally the same treatment the corporation would receive if the property were sold. However, for this purpose, the FMV of the property is the greater of the following amounts.

If the property was depreciable or amortizable, the corporation may have to treat all or part of the gain as ordinary income from depreciation recapture. For more information on depreciation recapture and the sale of business property, see Publication 544.

Constructive stock distributions.

You must treat certain transactions that increase a shareholder's proportionate interest in the earnings and profits or assets of a corporation as if they were distributions of stock or stock rights. These constructive distributions are treated as property if they have the same result as a distribution described in (2), (3), (4), or (5) of the above discussion. Constructive distributions are described later.

This treatment applies to a change in your stock's conversion ratio or redemption price, a difference between your stock's redemption price and issue price, a redemption that is not treated as a sale or exchange of your stock, and any other transaction having a similar effect on a shareholder's interest in the corporation.

Expenses of issuing a stock dividend.

You cannot deduct the expenses of issuing a stock dividend. These expenses include printing, postage, cost of advice sheets, fees paid to transfer agents, and fees for listing on stock exchanges. The corporation must capitalize these costs.

Below-market loans.

If a corporation gives a shareholder a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate, the interest not charged may be treated as a distribution to the shareholder. For more information, see Below-Market Loans under Income and Deductions, earlier.

Corporation cancels shareholder's debt.

If a corporation cancels a shareholder's debt without repayment by the shareholder, the amount canceled is treated as a distribution to the shareholder.

Transfers of property to shareholders for less than FMV.

A sale or exchange of property by a corporation to a shareholder may be treated as a distribution to the shareholder. For a shareholder who is not a corporation, if the FMV of the property on the date of the sale or exchange exceeds the price paid by the shareholder, the excess may be treated as a distribution to the shareholder.

Unreasonable rents.

If a corporation rents property from a shareholder and the rent is unreasonably more than the shareholder would charge to a stranger for use of the same property, the excessive part of the rent may be treated as a distribution to the shareholder. For more information, see chapter 4 in Publication 535.

Unreasonable salaries.

If a corporation pays an employee who is also a shareholder a salary that is unreasonably high considering the services actually performed by the shareholder-employee, the excessive part of the salary may be treated as a distribution to the shareholder-employee. For more information, see chapter 2 in Publication 535.

Form 1099–DIV.

File Form 1099–DIV with the IRS for each shareholder to whom you have paid dividends and other distributions on stock of $10 or more during a calendar year. You must generally send Forms 1099–DIV to the IRS with Form 1096 by February 28 (March 31 if filing electronically) of the year following the year of the distribution. For more information, see the general instructions for Forms 1099, 1098, 5498, and W–2G.

Generally, you must furnish Forms 1099–DIV to shareholders by January 31 of the year following the close of the calendar year during which the corporation made the distributions. However, you may furnish the Form 1099–DIV to shareholders after November 30 of the year of the distributions if the corporation has made its final distributions for the year. You may furnish the Form 1099–DIV to shareholders anytime after April 30 of the year of the distributions if you give the Form 1099–DIV with the final distributions for the calendar year.

Backup withholding.

Dividends may be subject to backup withholding. For more information on backup withholding, see the general instructions for Forms 1099, 1098, 5498, and W–2G.

Form 5452.

File Form 5452 if nondividend distributions were made to shareholders.

A calendar tax year corporation must file Form 5452 with its income tax return for the tax year in which the nondividend distributions were made. A fiscal tax year corporation must file Form 5452 with its income tax return due for the first fiscal year ending after the calendar year in which the nondividend distributions were made.

Current year earnings and profits.

If a corporation's earnings and profits for the year (figured as of the close of the year without reduction for any distributions made during the year) are more than the total amount of distributions made during the year, all distributions made during the year are treated as distributions of current year earnings and profits. If the total amount of distributions is more than the earnings and profits for the year, see Accumulated earnings and profits, later.

Accumulated earnings and profits.

If a corporation's current year earnings and profits (figured as of the close of the year without reduction for any distributions made during the year) are less than the total distributions made during the year, part or all of each distribution is treated as a distribution of accumulated earnings and profits. Accumulated earnings and profits are earnings and profits the corporation accumulated before the current year.

If the total amount of distributions is less than current year earnings and profits, see Current year earnings and profits, earlier.

Used with current year earnings and profits.

If the corporation has current year earnings and profits, figure the use of accumulated and current earnings and profits as follows.

Used without current year earnings and profits.

If the corporation has no current year earnings and profits, figure the use of accumulated earnings and profits as follows.

For more information about figuring earnings and profits, see the Worksheet for Figuring Current Year Earnings and Profits in the Form 5452 instructions.

Item D.

You are required to enter total assets here. Rose Flower Shop enters $67,967 from line 12(b) in Part III.

Line 1.

Gross sales, line 1a, for the year totaled $450,000 using an accrual method of accounting. Rose had no returned goods and allowances, so line 1c shows net sales of $450,000.

Line 2.

Cost of goods sold is $234,000. Figure this using the Cost of Goods Sold Worksheet, shown later.

Line 3.

Net sales less cost of goods sold results in a gross profit of $216,000.

Line 11.

Total income is $216,000.

Line 12.

The $60,000 is the salary of the company president.

Line 13.

Other salaries and wages of $72,000 are entered here. This includes only salaries and wages not included on line 12.

Line 16.

Rent for Rose Flower Shop's store was $48,000 for the year.

Line 17.

Deductible taxes totaled $12,500.

Line 19.

During the year, Rose Flower Shop contributed $1,500 to various charitable organizations. This amount exceeds the limit for deductible contributions, which is 10% of taxable income figured without the contribution deduction and special deductions which would be entered on line 25b. Taxable income without the contribution deduction is $7,500. Therefore, the contribution deduction is limited to $750 ($7,500 x 10%).

Line 22.

Other business deductions consist of $16,000 for advertising. If there were several expenses included in the total, Rose Flower Shop would have to prepare and attach a supporting schedule.

Line 23.

Total of lines 12 through 22 is $209,250.

Lines 24, 25c, and 26.

Taxable income on line 24 is $6,750. Since Rose Flower Shop did not have a net operating loss or special deduction, the same amount is shown on line 26.

Tax summary.

Rose Flower Shop enters on line 27 the total tax ($1,013) from Part I, line 6, page 2. It lists payments that can be applied against the tax on line 28. The only payments on the Rose Flower Shop return are four estimated tax deposits totaling $2,000. Enter this amount on lines 28b, 28d, and 28h. The resulting overpayment is $987, which Rose Flower Shop chooses to have credited to the next year's estimated tax. Rose Flower Shop could have chosen to have the overpayment refunded.

Signature.

An authorized corporate officer must sign the return.

Part I—Tax Computation.

Use the tax rate schedule in the form instructions to figure the tax on line 1. Lines 2 and 5, the credits and other taxes listed on Part I, do not apply to Rose Flower Shop. The tax of $1,013 is entered on lines 1, 4, and 6.

Part II—Other Information.

Answer all questions that apply to your business. Provide the business activity code number, business activity, and product or service information on lines (a), (b), and (c) of question 1. The business activity codes are provided in the instructions for Forms 1120 and 1120–A. Purchases of $186,490 appear on line (1) of question 5a. Other costs of $45,500 appear on line (3) of question 5a. The supporting itemization is not illustrated. These costs are directly related to the sale of flowers, wreaths, and plants, such as flower pots, vases, stands, boxes, and tissue paper.

Rose Flower Shop answers “No” to Question 7 and is required to complete Item D on page 1 and Parts III and IV on page 2.

Part III—Balance Sheets per Books.

You are not required to complete Part III if the answer to Question 7 in Part II is “Yes.” Rose Flower Shop must complete Part III and provide comparative balance sheets for the beginning and end of the tax year. Entries in Part III should agree with amounts shown elsewhere on the return or included on a worksheet. For example, the figures for beginning and ending inventories must be the same as those appearing on the worksheet in the form instructions for cost of goods sold.

Part IV—Reconciliation of Income (Loss) per Books With Income per Return.

You are not required to complete Part IV if the answer to Question 7 in Part II is “Yes.” Rose Flower Shop must complete Part IV.

To properly complete Part IV, you will need additional information from the corporation's books and records. The following profit and loss account appeared in the books of Rose Flower Shop for the calendar year.

Part IV starts with the net income (loss) per books, after reduction for federal income tax accrued, as shown in the corporation's profit and loss account. It provides for necessary adjustments to reconcile this amount with the taxable income shown on line 24, page 1.

Line 1.

$4,987 is the net income per books. It appears in the profit and loss account as net income per books after tax.

Line 2.

$1,013 is the federal income tax accrued for the tax year.

Line 5.

$750 is the nondeductible part of the charitable contribution.

Line 8.

$6,750 is the taxable income on line 24, page 1.

Item D.

You are required to enter total assets here. Tentex Toys enters $1,307,143 from line 15(d) on Schedule L.

Line 1.

Gross sales, line 1a, for the year totaled $3,250,000 using an accrual method of accounting. After subtracting returned goods and allowances of $50,000, line 1c shows net sales of $3,200,000.

Line 2.

Cost of goods sold is $1,920,000. This is the total from Schedule A (line 8) on page 2.

Line 3.

Net sales less cost of goods sold results in a gross profit of $1,280,000.

Lines 4 through 10.

Enter other items of income next. During the year, Tentex received $10,000 of dividends from domestic corporations, $5,000 of tax-exempt interest from state bonds, and $4,000 of taxable interest. It also received $1,500 interest on its business accounts receivable. Enter the gross amount of dividends on line 4 (you take the dividends-received deduction on line 29b). Line 5 shows total taxable interest of $5,500. Do not include tax-exempt interest in income.

Line 11.

Total income is $1,295,500.

Line 12.

Enter the salaries of $170,000 paid to company officers listed on Schedule E. Complete Schedule E because total receipts (line 1a plus lines 4 through 10 of page 1) are $500,000 or more.

Line 13.

Enter other salaries and wages of $438,000. This includes only salaries and wages not included on line 12 or deducted as part of cost of goods sold on line 2. For a manufacturing company such as Tentex, this amount represents nonmanufacturing salaries and wages, such as office salaries. See chapter 2 of Publication 535 for a discussion of salaries and wages.

Tentex is eligible for a $12,000 work opportunity credit figured on Form 5884 (not illustrated). You reduce the total amount of other salaries and wages, $450,000, by the $12,000 credit that is included on line 6d, Schedule J. Only the balance, $438,000, is shown on line 13.

Line 14.

Repairs include only payments for items that do not add to the value of the assets repaired or substantially increase their useful lives. Repairs total $14,000. See chapter 13 of Publication 535 for information on repairs.

Line 15.

Tentex uses the specific charge-off method of accounting for bad debts. Actual accounts written off during the year total $3,750. See chapter 11 of Publication 535 for information on bad debt deductions.

Line 16.

Rent for Tentex's office facilities was $110,000 for the year.

Line 17.

Deductible taxes totaled $43,750.

Line 18.

Interest expense accrued during the year was $27,200. This includes interest both on debts for business operations and debts to carry investments. It does not include interest to carry tax-exempt securities. See chapter 5 of Publication 535 for a discussion of deductible interest.

Line 19.

During the year, Tentex contributed $24,500 to the United Community Fund and $16,000 to the State University Scholarship Fund. The total, $40,500, is more than the limit for deductible contributions, which is 10% of taxable income figured without the contribution deduction and special deductions entered on line 29b. The amount allowable on line 19 is $32,673. The excess, $7,827, not deductible this year, can be carried over to a later year, as explained earlier under Charitable Contributions.

Lines 20 and 21.

Depreciation from Form 4562 (not illustrated) is $24,000. Enter it on line 20. Reduce this amount by the depreciation ($4,000) included in the amount claimed on line 5 of Schedule A. Enter it on line 21a. Deduct the balance of $20,000 on line 21b since it is the depreciation on the assets used in the indirect operations of the business.

Line 23.

Advertising expense was $51,420.

Lines 24.

Tentex maintains a profit-sharing plan for its employees. Tentex funded the plan with $32,650 in 2003. For information on retirement plans, see Publication 560, Retirement Plans for Small Business.

Line 26.

Other business deductions total $58,000. This includes miscellaneous office expenses, sales commissions, legal fees, etc. Attach a schedule that itemizes these expenses to the return. This example does not show the supporting itemization.

Line 27.

Total of lines 12 through 26 is $1,001,443.

Lines 28, 29, and 30.

Taxable income on line 28, before the net operating loss deduction and special deductions is $294,057. Since Tentex did not have a net operating loss, its only entry on line 29 is the dividends-received deduction of $8,000 from Schedule C, page 2. Enter this amount on lines 29b and 29c. Taxable income on line 30 is $286,057.

Tax summary.

Enter on line 31 the total tax ($82,812) from Schedule J, page 3. List payments you can apply against the tax on line 32. The only payments on the Tentex return are four estimated tax deposits totaling $90,000. Enter this amount on lines 32b, 32d, and 32h. The resulting overpayment is $7,188, which Tentex chooses to have credited to next year's estimated tax. Tentex could have chosen to have the overpayment refunded.

Signature.

An authorized corporate officer must sign the return.

Schedule A—Cost of Goods Sold.

Use Schedule A to report your cost of goods sold. This figure is beginning inventory, plus merchandise bought or produced during the year, less ending inventory. Because Tentex is a manufacturer, it must account for its costs of manufacturing as part of cost of goods sold. It valued goods on hand at the beginning of the year at $298,400 and at the end of the year at $755,700, using the lower of cost or market.

Add cost of goods manufactured during the year to beginning inventory. This cost consists of three items: direct materials, direct labor, and overhead. List material costs of $1,345,100 on line 2. This includes subcontracted parts as well as raw materials. Direct labor, on line 3, is $802,000. This amount includes wages paid to production-line workers and the part of supervisory salaries incurred for actual production of goods. It also includes 30% of the salaries paid to officers. Do not include payments already deducted on line 12 or 13 of page 1.

The $85,000 on line 4 is for indirect general administration costs. Other costs of $145,200 appear on line 5. These costs include factory overhead such as electricity, fuel, water, small tools, and depreciation on production-line machinery. This example does not show the supporting itemization. Note that $4,000 is depreciation on the assets used in the direct operations of the business.

Lines 9a through 9f.

Check all the boxes that apply to the business.

Schedule C—Dividends and Special Deductions.

Dividend income is $10,000, all of which qualifies for the 80% dividends-received deduction, line 2, because Tentex is a 20%-or-more owner. Enter the total dividends received on line 19, Schedule C, and on line 4 of page 1. Enter the total dividends-received deduction on line 20, Schedule C, and on line 29b of page 1.

Schedule E—Compensation of Officers.

Complete this schedule only if your total receipts (line 1a plus lines 4 through 10 of page 1) are $500,000 or more. (Tentex meets this requirement.) Since Tentex has only three officers, these are the only entries on the schedule. Include here only compensation for services rendered. Do not include dividends on stock held by the corporate officers.

Schedule J—Tax Computation.

Use the tax rate schedules in the form instructions to figure the tax on line 3. Applying the rates to Tentex's taxable income of $286,057 results in income tax of $94,812. Decrease this amount by the work opportunity credit of $12,000, resulting in a total tax of $82,812.

Figure the work opportunity credit on Form 5884. Tentex files Form 5884 (not illustrated) with its return to support this credit.

Other taxes and credits listed on Schedule J do not apply to Tentex this year.

Schedule K—Other Information.

Answer all questions that apply to the business.

Tentex answers “No” to Question 13 and is required to complete Schedules L, M–1, and M–2 on page 4.

Schedule L—Balance Sheets per Books.

You are not required to complete Schedule L if the answer to Question 13 on Schedule K is “Yes.” Tentex must complete Schedule L and provide comparative balance sheets for the beginning and end of the tax year. Entries on this page should agree with amounts shown elsewhere on the return. For example, the figures for beginning and ending inventories must be the same as those appearing on Schedule A, page 2. Note that the appropriated retained earnings of Tentex increased from $30,000 to $40,000 during the year, due to the setting aside of $10,000 as a reserve for contingencies. Tentex took this amount out of unappropriated retained earnings, as shown on Schedule M–2.

Schedules M–1 and M–2.

You are not required to complete Schedules M–1 and M–2 if the answer to Question 13 on Schedule K is “Yes.” Tentex must complete Schedules M–1 and M–2.

To properly complete these schedules, you need additional information from the books and records. The following profit and loss account appeared in the books of Tentex for the calendar year.

Tentex analyzed its retained earnings, and the following appeared in this account on its books.

Schedule M–1—Reconciliation of Income (Loss) per Books With Income per Return.

Schedule M–1 starts with the net income (loss) per books, after reduction for federal income tax accrued, as shown in the corporation's profit and loss account. It provides for necessary adjustments to reconcile this amount with the taxable income shown on line 28, page 1.

Line 1.

$193,588 is the net income per books. It appears in the profit and loss account as net income per books after tax.

Line 2.

$82,812 is the federal income tax accrued for the tax year.

Line 3.

$3,600 is the excess of capital losses over capital gains. The net loss is from the sale of securities.

Line 4.

This would show all income subject to tax but not recorded on the books for this year. This can happen if the corporation valued assets on its books at an amount greater than that used for tax purposes. When it has a sale of these assets, the gain included in taxable income is greater than that recorded on the books. It shows the difference here.

Line 5.

Tentex shows expenses recorded on its books that it does not deduct. The $7,827 listed on line 5b is for contributions over the 10% limit. Tentex itemizes the remaining nondeductible expenses on a statement (not illustrated) attached to the return. These include the following expenses.

Line 6.

Enter the total of lines 1 through 5.

Line 7.

This is income recorded on the corporation's books during the year that is not taxable and is not included on the return. This total, $14,500, includes insurance proceeds of $9,500 and tax-exempt interest on state bonds of $5,000.

Line 8.

This includes all deductions claimed for tax purposes but not recorded in the corporation's books. Tentex enters $1,620 on line 8a. This is the difference between the depreciation claimed on the tax return and the depreciation shown on the corporation's books. If the corporation had other deductions to itemize on this line but not enough space, it would attach an itemized statement to the return.

Line 9.

Enter $16,120, the total of lines 7 and 8.

Line 10.

The difference between lines 6 and 9 must agree with line 28, page 1.

Schedule M–2—Analysis of Unappropriated Retained Earnings per Books.

Schedule M–2 analyzes the unappropriated retained earnings as shown in the corporation's balance sheets on Schedule L.

Line 1.

This is from line 25 of Schedule L for the beginning of the tax year. Tentex enters $238,000.

Line 2.

This is the net income per books (after federal income tax), $193,588.

Line 3.

This shows all other increases to retained earnings. Enter the $18,000 refund of 2000 income tax.

Line 4.

This is the total of lines 1, 2, and 3.

Line 5.

This includes all distributions to shareholders charged to retained earnings during the tax year. Enter the $65,000 dividends paid.

Line 6.

This shows any decreases (other than those on line 5) in unappropriated retained earnings. These decreases are not deductible on the tax return at the time of the appropriation, but a deduction may be allowable on a later return. A common example is amounts set aside for contingencies. A customer was injured on company property during 2003 and the company retained an attorney. Tentex set up a contingent liability of $10,000 for the customer's claim. If they settle the claim during 2004 for $5,000, and the attorney's fee is $2,500, Tentex will charge $7,500 to retained earnings (appropriated). It will also deduct $7,500 in arriving at taxable income for 2004. Another common example of items entered on this line is the payment of the prior year's federal tax. Attach a schedule to the return listing all items taken into account for the amount shown on this line.

Line 7.

This is the total of lines 5 and 6.

Line 8.

$374,588 is Tentex's retained earnings at the end of its tax year. It determined this figure by subtracting the total on line 7 from the total on line 4. This figure must agree with the amount on Schedule L for the end of the tax year.

Contacting your Taxpayer Advocate.

If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.

The Taxpayer Advocate independently represents your interests and concerns within the IRS by protecting your rights and resolving problems that have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.

To contact your Taxpayer Advocate:

For more information, see Publication 1546, The Taxpayer Advocate Service of the IRS.

Free tax services.

To find out what services are available, get Publication 910, Guide to Free Tax Services. It contains a list of free tax publications and an index of tax topics. It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax topics.