United States Corporate income tax

A. Overview

(a)  In addition, many states levy income or capital-based taxes. An alternative minimum tax is imposed (see Section B).
(b)  Rates may be reduced by treaty.
(c)  Applicable to payments to nonresidents.
(d) Interest on certain “portfolio debt” obligations issued after 18 July 1984 and non-effectively connected bank deposit interest are exempt from withholding tax.
(e) This is the branch profits tax (see Section E).
(f) Special rules apply to certain types of losses and entities. For details, see Section D.

B. Taxes on corporate income and gains

Corporate income tax:

U.S. corporations are subject to federal taxes on their worldwide income, including income of foreign branches (whether or not the profits are repatriated). In general, a U.S. corporation is not taxed by the United States on the earnings of a foreign subsidiary until the subsidiary distributes dividends or is sold or liquidated. Numerous exceptions to this deferral concept may apply, however, resulting in current U.S. taxation of some or all of the foreign subsidiary’s earnings.
U.S. branches of foreign corporations generally are taxable on income that is effectively connected with a U.S. trade or business. However, if the foreign corporation is resident in a country having an income tax treaty with the United States, business profits are taxable by the United States only to the extent the income is attributable to a permanent establishment in the United States.
Rates of corporate tax:
Corporations with taxable income in excess of $18,333,333 are effectively subject to tax at a rate of 35% on all taxable income. A corporation’s taxable income exceeding $75,000 but not exceeding $10 million is taxed at 34%. Corporations with taxable income between $335,000 and $10 million are effectively taxed at 34% on all taxable income (including the first $75,000).  Corporations with taxable income of less than $335,000 receive partial benefit from graduated rates of 15% and 25% that apply to the first $75,000 of taxable income. A corporation’s taxable income exceeding $15 million but not exceeding $18,333,333 is subject to an additional tax of 3%. These rates apply both to U.S. corporations and to the income of foreign corporations that is effectively connected with a U.S. trade or business.

Alternative minimum tax:

The alternative minimum tax (AMT) is designed to prevent corporations with substantial income from using preferential deductions, exclusions and credits to significantly reduce or eliminate their tax liability. To achieve this goal, the AMT is structured as a separate tax system with its own allowable deductions and credit limitations. The tax is imposed at a flat rate of 20% on alternative minimum taxable income (AMTI). It is an “alternative” tax because corporations are required to pay the higher of the regular tax or AMT. To the extent the AMT exceeds regular tax, an AMT credit is generated and carried forward to offset the taxpayer’s regular tax to the extent it exceeds the AMT in future years.
In general, AMTI is computed by making adjustments to regular taxable income and then adding back certain nondeductible tax preference items. The required adjustments are intended to convert preferential deductions allowed for regular tax (for example, accelerated depreciation) into the less favorable alternative deductions that are allowable under the parallel AMT system. In addition, an adjustment based on “adjusted current earnings” can increase or decrease AMTI. Net operating losses may reduce AMT by up to 90%, compared to a potential reduction of 100% for regular tax purposes.
An AMT exemption applies to small business corporations that meet certain income requirements.

Capital gains and losses:

Capital gains are taxed at a maximum rate of 35%. In general, capital losses may offset only capital gains, not ordinary income. A corporation’s excess capital loss may be carried back three years and forward five years to offset capital gains in such other years.

Foreign tax relief:

A tax credit is allowed for foreign income taxes paid, or deemed paid, by U.S. corporations. The credit is generally limited to the amount of U.S. tax imposed on the foreign-source portion of a company’s worldwide taxable income. For tax years beginning on or after 1 January 2007, separate limitations must be calculated for passive income and for “general” category income (most types of active business income). For tax years beginning before 2007, separate limitations applied to various additional categories of income, including financial services income, shipping income and dividend income from each non-controlled (generally 10-50% owned) foreign corporation.

C. Tax administration

The annual tax return is due by the 15th day of the third month after the close of the company’s fiscal year. A corporation is entitled, upon request, to an automatic six-month extension to file its return. In general, 100% of a corporation’s tax liability must be paid through quarterly estimated tax installments during the year in which the income is earned. The estimated tax payments are due on the 15th day of the fourth, sixth, ninth and twelfth months of the company’s fiscal year. The Tax Increase Prevention and Reconciliation Act of 2005 increased the corporate estimated tax payments due for July, August and September 2012 and 2013 for certain large corporations. Under the Act, for corporations with assets of at least $1 billion, the payments due in July, August and September 2012 will be increased to 106.25% of the payment otherwise due and the next required payment will be reduced accordingly. In addition, for such corporations, the payments due in July, August and September 2013 will be increased to 100.75% of the payment otherwise due and the next required payment will be reduced accordingly.

D. Determination of trading income

Income for tax purposes is generally computed according to generally accepted accounting principles adjusted for certain statutory tax provisions. Consequently, taxable income typically does not equal income for financial reporting purposes.
In general, a deduction is permitted for ordinary and necessary trade or business expenses. However, expenditures that create an asset having a useful life longer than one year may need to be capitalized and recovered ratably.

Depreciation:

A depreciation deduction is available for most property (except land) used in a trade or business or held for the production of income, such as rental property. Tangible depreciable property that is used in the U.S. and placed in service after 1986 is generally depreciated under a modified accelerated cost recovery system (“ACRS”) basis.
In general, under the modified ACRS system, assets are grouped into seven classes of personal property and into two classes of real property. Each class is assigned a recovery period and a depreciation method. The following are the depreciation methods and recovery periods for certain assets:

Alternatively, a taxpayer may elect to use the straight-line method of depreciation over specified longer recovery periods or the methods prescribed for AMT purposes (which would avoid the need to make a depreciation adjustment for AMT purposes).
The cost of intangible assets developed by a taxpayer may be amortized over the determinable useful life of an asset. Certain intangible assets, including goodwill, going concern value, patents and copyrights, may generally be amortized over 15 years if they are acquired as part of a business after 10 August 1993.
Tax depreciation is generally subject to recapture on the sale of an asset to the extent the sales proceeds exceed the tax value after depreciation. The amounts recaptured are subject to tax as ordinary income.

Net operating losses:

If allowable deductions of a U.S. corporation or branch of a foreign corporation exceed its gross income, the excess is a net operating loss (NOL). In general, NOLs may be carried back 2 years and forward 20 years to offset taxable income in those years. A specified liability loss (product liability loss) may be carried back 10 years. Commercial banks may carry back bad debt losses 10 years and carry forward such losses 5 years. A real estate investment trust (REIT) may not carry back an NOL to a tax year in which the entity operated as a REIT. Farming business losses may be carried back five years. Limitations apply in utilizing NOLs of acquired operations.

Dividends:

In general, dividends received from other U.S. corporations qualify for a 70% dividends-received deduction, subject to certain limitations. The dividends-received deduction is generally increased to 80% of the dividend if the recipient corporation owns at least 20% of the distributing corporation. Dividend payments between members of an affiliated group of U.S. corporations qualify for a 100% dividends-received deduction. In general, an affiliated group consists of a U.S. parent corporation and all other U.S. corporations in which the parent owns, directly or indirectly, through one or more chains, at least 80% of the total voting power and value of all classes of shares (excluding nonvoting preferred shares).

Consolidated returns:

An affiliated group of U.S. corporations (as described in Dividends above) may elect to determine its taxable income and tax liability on a consolidated basis. The consolidated return provisions generally allow electing corporations to report aggregate group income and deductions in accordance with the requirements for financial consolidations. Consequently, the net operating losses of some members of the group can be used to offset the taxable income of other members of the group, and transactions between group members, such as intercompany sales and dividends, are generally deferred or eliminated until there is a transaction outside the group. Under certain circumstances, losses incurred on the sale of consolidated subsidiaries are disallowed.

Foreign subsidiaries:

Under certain circumstances, undistributed income of a foreign subsidiary controlled by U.S. shareholders is taxed to the U.S. shareholders on a current basis, as if the foreign subsidiary distributed a dividend on the last day of its taxable year. This may result if the foreign subsidiary invests its earnings in “U.S. property” (including loans to U.S. shareholders) or earns certain types of income (referred to as “Subpart F” income), including certain passive income and “tainted” business income.

E. Significant other taxes

• Branch profits tax: Imposed on branch profits (reduced by reinvested profits and increased by withdrawals of previously reinvested earnings); the 30% rate may be reduced by treaty.
• Branch interest tax: Levied on interest paid by a branch (unless the interest would be exempt from withholding tax if paid by a U.S. corporation); the 30% rate may be reduced by treaty.
• Personal holding company (PHC) tax: Applies to a corporation not meeting the definition of a foreign personal holding company (FPHC) that satisfies a passive-income test; imposed in addition to regular tax or AMT on undistributed income at rate of 15%.
• Accumulated earnings tax: A penalty tax levied on a corporation (excluding a PHC) accumulating profits to avoid shareholder-level personal income tax.  Assessed on accumulated taxable income exceeding $250,000 ($150,000 for certain personal services corporations).  The rate has generally been the rate of the highest bracket, 39.6%, but was reduced to 15% for the years 2003 through 2008.  It is scheduled to return to 39.6% in 2009.
• State and local income taxes: Imposed by most states and some local governments with rates ranging from 0% to 13%.
• State and local sales taxes: Imposed by many states and some local governments. Rates vary.

F. Miscellaneous matters

Foreign investment:

The United States currently has no foreign-exchange control restrictions.

Debt-to-equity rules:

The United States has thin-capitalization principles under which the Internal Revenue Service (IRS) may attempt to limit the deduction for interest expense if a U.S. corporation is thinly capitalized. In such case, funds loaned to it by a related party may be recharacterized by the IRS as equity. As a result, the corporation’s deduction for interest expense may be disallowed, and principal and interest payments may be considered distributions to the related party subject to withholding tax.
The U.S. has no fixed rules for determining if a thin-capitalization situation exists. Although a debt-to-equity ratio of 3:1 or less is often acceptable to the tax authorities (provided the taxpayer can adequately service its debt without the help of related parties) the determination is made on a case-by-case basis based on the particular facts and circumstances.
However, a deduction is disallowed for certain “disqualified” interest paid on loans made or guaranteed by related foreign parties that are not subject to U.S. tax on the interest income received. This provision should not apply if the payer corporation’s debt-to-equity ratio does not exceed 1.5:1. If the debt-to-equity ratio exceeds this amount, the deduction of any “excess interest expense” of the payer is deferred. “Excess interest expense” is defined as the excess of interest expense over interest income, minus 50% of the adjusted taxable income of the corporation plus any “excess limitation carryforward.” Disallowed interest may be carried forward to future years and potentially allowed as a deduction. Special rules apply to corporate partners in partnerships for purposes of determining disallowances.
In addition, under U.S. Treasury regulations, interest expense accrued on a loan from a related foreign lender must actually be paid before the U.S. borrower can deduct the interest expense.

Transfer pricing:

In general, the IRS may redetermine the tax liability of related parties if, in its discretion, this is necessary to prevent the evasion of taxes or to clearly reflect income. Specific regulations require that related taxpayers (including U.S. persons and their foreign affiliates) deal among themselves on an arm’s length basis. Under the best-method rule included in the transfer-pricing regulations, the best transfer-pricing method is determined based on the facts and circumstances. Transfer-pricing methods that may be acceptable, depending on the circumstances, include uncontrolled price, resale price and profit-split. It is possible to reach transfer-pricing agreements in advance with the IRS.
If the IRS adjusts a taxpayer’s tax liability, tax treaties between the U.S. and other countries usually provide procedures for allocation of adjustments between related parties in the two countries to avoid double tax. In addition, transfer pricing is subject to detailed documentation rules and significant penalties may apply for using incorrect intercompany transfer prices.

Provided by Courtesy of 

Scott B. Hill
Director of International Tax Services - Americas
Ernst & Young LLP
New York, NY
+1 212 773 5550
Scott.Hill@ey.com

Marjorie Rollinson
Director of International Tax Services - National
Ernst & Young LLP
Washington, DC
+1 202 327 5757
Marjorie.Rollinson@ey.com