When preparing consolidated tax returns and reporting within the privately-held business group, particular considerations need to be considered. The focus in this article will be on your midsized client’s business income and does not include international aspects, market share, or state-federal differences.
Whether to file consolidated is a question that many business owners ask themselves. Depending on the income level and type of business, the 20% deduction may not be available. A C-corporation will forfeit this portion of the business income deduction. However, it can be scheduled for eventual repeal.
The current corporate tax rates are noticeably less than those applied to higher business income levels taxed in Form 1040. The seven individual tax brackets include two lower than the corporate rate.
Tax planners usually know what kind of taxes would be incurred without their C corporations. There are a few different issues to consider, but the basics may focus on relatively lower rates for individuals compared with corporate tax. The current tax code favors companies with large profits, allowing them to pay lower rates than individuals. The current tax rate for corporations is set at 21%. However, this could change depending on inflation and whether or not it leads to a higher individual income bracket.
The decision to incorporate as a C corporation or not should be made carefully, considering both the potential tax benefits and drawbacks. The issue of double taxation arises when groups file consolidated returns. The source for taxable dividends is maintained on an aggregate basis. However, there may be relief within the group itself if it’s taxed at a lower rate than other members’ organizations that don’t share its parent company’s jurisdiction(s) or residence status (Regs 1 1552-1).
When incorporating, it’s important to consider the difference between deductible compensation and distributions; the former save taxes at your company tax rate while the latter is taxed as ordinary income.
The Decision to Consolidate
There are often good reasons to have multiple C corporations, and the incentive might have something to do with creditor protection. The consolidation process allows for the offsetting losses against income to minimize tax liability. Closely-held groups with pockets of unused C-corporation losses can be found in the business world. These companies may have profitable operations, but they go unnoticed because there is no public record for these profits to exist on tax returns or financial statements.
The idea of a consolidated return is to have one set of information for all the members, despite their different entities. If groups consolidate their returns, they can check the first box on Form 1120.
The consolidation election allows an affiliated group to file a return for the year with one copy instead of multiple individual documents. This can save time and money, but all members must consent before opting in.
The parent company decides to file for consolidation and attaches an Affiliation Schedule with information about members of their group. When a member corporation is included in the consolidated tax return, it must submit Form 1122. The form authorizes and consents to be reported as part of one filing with IRS regulations 1B150-75, which states that all members agree to report together.
To qualify, the parent company must own at least 80% of the voting power and equity of at least one other group member.
Consolidation and Reporting
Reporting available to individuals who own multiple corporations will not be consolidated if they have a brother or sister in S corporation status. The concept of consolidated reporting involves separate taxable income for members with adjustments that may arise from items such as intercompany transactions and depreciation. The IRS allows you to deduct your total net operating loss, which means that the less profitable portions are not eligible.
When consolidated reporting is required, several special rules need consideration. One such rule is the SRLY Rule, which stands for Separate Return Limitation Year. This rule helps prevent unfair treatment of members by the group and is a great way to prevent members from being disproportionately affected by pre-acquisition losses.
The concept of consolidated reporting allows for the offsetting and deferring of gains (and losses) on inter-company sales. The parent company would then have the option of requesting an exception for any individual subsidiary that desired it.
The offsetting of gains and losses is an integral part of operating income, but also when it comes to capital investments. You can avoid any tax on corporate dividends within your group by doing this.
The consolidation concept is vital for regular corporations rather than S Corporations when it comes to reporting. While the consolidated reporting concept is often applied to corporations, exempt organizations like REITs and mutual funds may file their returns if they wish. There’s also a problem with taxing dividends twice on them since they are treated as personal income by law and then distributed accordingly.
When a company has more than one subsidiary, it can be beneficial to adjust the stock basis so that each unit pays taxes only once. This protects against duplicate taxation and ensures an accurate measure of earnings for investors in parent companies. For example, when a parent company invests money into their subsidiary, they can report that as income. If the stock is sold twice its worth, it will break even.
The consolidated reporting rules are designed to avoid unfair duplication of income reporting. This is accomplished by making basic adjustments, which continue until the common parent makes a timely application showing good cause for discontinuing their filing status. The deadline for submitting the return is generally 90 days before the due date, including extensions.
When a company has multiple subsidiaries, it can be beneficial to subject them all as C corporations for tax purposes and then report the income from those companies together. This is true for both small businesses and large public companies alike; however, the advantage may depend on whether or not you’re in middle-market mode with multiple entities under one roof–or if all these separate groups will need their reporting template.