Question

Your client is contemplating changing from a sole proprietorship to a C corporation. He has heard the terms "book to tax differences," "dividends received deduction," and "differences in the charitable deduction," but would like a detailed discussion from you. What would you tell your client with respect to financial and corporate taxation? Discuss the differences, in detail, between a sole proprietorship and a corporation in how they treat "book to tax differences", "dividends received deduction", and "differences in the charitable deduction", by not only defining the terms, but how they are treated for both entities including any differences in the calculation of charitable deductions between the two entities.

Answer 1

While numerous transactions are dealt with equivalence for both financial and tax purposes, there are different transactions that, because of the nature or timing, are dealt with in a different way. These are termed as book-to-tax differences. These book-to-tax differences occur mostly under the heads of depreciation and amortization, inventory reserves, accrued accounts and the like. Accounting for a sole proprietorship doesn't require a different arrangement of bookkeeping records, since the proprietor is viewed as indistinguishable from the business. However, in the case of a corporation, business is considered to be separate from its owner, hence, the treatment of book-to-tax differences differs in sole proprietorship and corporation.

For a sole proprietorship, the taxes are charged on the income of the proprietor. In a corporation, the profits of the whole company are taxed separate from its proprietor. A corporation is subject to corporate income tax. Income of a C corporation is regularly taxed at the corporate level utilizing the corporate income tax rates. With the help of a dividends received deduction, any company that receives deductions from some other company can deduct that dividend from its final income which enables a reduction in its income tax correspondingly.

The general principle is that on the off chance that a company receives dividends from another corporation, at that point it is permitted to deduct 70% of those dividends under the DRD. That effectively cuts the tax rate on dividends from a top corporate tax of 35% to 10.5%. Notwithstanding, there are different guidelines that apply under certain specific circumstances. On the off chance that the corporation receives the dividends from a private company venture company as characterized under independent company law, at that point it can deduct 100% of the dividends, effectively making good on no regulatory expense by any stretch of the imagination. Correspondingly, for qualifying dividends paid by a corporation that is in the same associated group, the 100% deduction applies under the DRD. At long last, a different guideline offers an alternate DRD sum. On the off chance that the corporation receiving the dividend possesses in any event a 20% stake in the company paying the dividends, at that point the DRD sum ascends to 80%. That cuts the tax rate right to 7% on dividend income that the company is getting. This deduction is applicable only to a corporation and not a sole proprietorship firm.

When an organization or a sole proprietor pays towards charity, they can avail a deduction of that amount from their income which reflects as a deduction in their income tax accordingly. Such deduction is termed as a charitable deduction. In case of the C corporations, payments towards charity may be deducted upto 50% of adjusted gross income which will be calculated without considering net operating losses brought down. In case of sole proprietors, such deductions, whether business or entirely personal, must be reported on the Schedule A. For the proprietors who have been really generous with their donations, a maximum of 50 percent of deduction can be availed based on their adjusted gross personal income. However, certain donations will only qualify for a maximum of 30 percent of their adjusted gross incomes.