Business formed before 1997.   A business formed before 1997 and taxed as a corporation under the old rules will generally continue to be taxed as a corporation.

Business formed after 1996.   The following businesses formed after 1996 are taxed as corporations.

S corporations.   Some corporations may meet the qualifications for electing to be S corporations. For information on S corporations, see the instructions for Form 1120S, U.S. Income Tax Return for an S Corporation.

Personal service corporations.   A corporation is a personal service corporation if it meets all of the following requirements.

Personal services.   Personal services include any activity 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.

Other rules.   For other rules that apply to personal service corporations see Accounting Periods, later.

Closely held corporations.   A corporation is closely held if all of the following apply.

Other rules.   For the at-risk rules that apply to closely held corporations, see At-Risk Limitations, later.

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.

Election to reduce basis.   In a section 351 transaction, if the adjusted basis of the property transferred exceeds the property's fair market value, the transferor and transferee may make an irrevocable election to treat the basis of the stock received by the transferor as having a basis equal to the fair market value of the property transferred. The transferor and transferee must make this election by attaching a statement to their tax returns filed by the due date (including extensions) for the tax year in which the transaction occurred. For more information on making this election see section 362(e)(2)(C) of the Internal Revenue Code, and Notice 2005-70, 2005-41 I.R.B. 694.

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 Basis of property transferred, earlier, and 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.

This section will help you determine when and how to report a corporation's income tax.

Other penalties can be imposed for negligence, substantial understatement of tax, reportable transaction understatements, and fraud. See sections 6662, 6662A, and 6663 of the Internal Revenue Code.

Generally, a corporation must make installment payments if it expects its estimated tax for the year to be $500 or more. If the corporation does not pay the installments when they are due, it could be subject to an underpayment penalty. This section will explain how to avoid this penalty.

File Form 4466 before the 16th day of the 3rd month after the end of the tax year, but before the corporation files its income tax return. Do not file Form 4466 before the end of the corporation's tax year. An extension of time to file the corporation's income tax return will not extend the time for filing Form 4466. The IRS will act on the form within 45 days from the date you file it.

If a domestic corporation acquires a U.S. real property interest from a foreign person or firm, the corporation may have to withhold tax on the amount it pays for the property. The amount paid includes cash, the fair market value of other property, and any assumed liability. If a domestic corporation distributes a U.S. real property interest to a foreign person or firm, it may have to withhold tax on the fair market value of the property. A corporation that fails to withhold may be liable for the tax, and any penalties and interest that apply. For more information, see section 1445 of the Internal Revenue Code; Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities; Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interest; and Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests.

Accrual method.   Generally, a corporation (other than a qualified personal service corporation) must use the accrual method of accounting if its average annual gross receipts exceed $5 million. A corporation engaged in farming operations also must use the accrual method.

  If inventories are required, the accrual method generally must be used for sales and purchases of merchandise. However, qualifying taxpayers and eligible businesses of qualifying small business taxpayers are excepted from using the accrual method for eligible trades or businesses and may account for inventoriable items as materials and supplies that are not incidental.

  Under the accrual method, an amount is includable in income when:

  Generally, an accrual basis taxpayer can deduct accrued expenses in the tax year when:

  There are exceptions to the economic performance rule for certain items, including recurring expenses. See section 461(h) of the Internal Revenue Code and the related regulations for the rules for determining when economic performance takes place.

Nonaccrual experience method.   Accrual method corporations are not required to maintain accruals for certain amounts from the performance of services that, on the basis of their experience, will not be collected, if:

  This provision does not apply if interest is required to be paid on the amount or if there is any penalty for failure to pay the amount timely.

Percentage of completion method.   Long-term contracts (except for certain real property construction contracts) must generally be accounted for using the percentage of completion method described in section 460 of the Internal Revenue Code.

Mark-to-market accounting method.   Generally, dealers in securities must use the mark-to-market accounting method described in section 475 of the Internal Revenue Code. Under this method any security held by a dealer as inventory must be included in inventory at its FMV. Any security not held as inventory at the close of the tax year is treated as sold at its FMV on the last business day of the tax year. Any gain or loss must be taken into account in determining gross income. The gain or loss taken into account is treated as ordinary gain or loss.

  Dealers in commodities and traders in securities and commodities can elect to use the mark-to-market accounting method.

Change in accounting method.   A corporation can change its method of accounting used to report taxable income (for income as a whole or for the treatment of any material item). The corporation must file Form 3115, Application for Change in Accounting Method. For more information, see Form 3115 and Publication 538.

Section 481(a) adjustment.   The corporation may have to make an adjustment under section 481(a) of the Internal Revenue Code to prevent amounts of income or expense from being duplicated or omitted. The section 481(a) adjustment period is generally 1 year for a net negative adjustment and 4 years for a net positive adjustment. However, a corporation can elect to use a 1-year adjustment period if the net section 481(a) adjustment for the change is less than $25,000. The corporation must complete the appropriate lines of Form 3115 to make the election.

Personal service corporation.   A personal service corporation must use a calendar year as its tax year unless:

  If a personal service corporation makes a section 444 election, its deduction for certain amounts paid to employee-owners may be limited. See Schedule H (Form 1120), Section 280H Limitations for a Personal Service Corporation (PSC), to figure the maximum deduction.

Change of tax year.   Generally, a corporation must get the consent of the IRS before changing its tax year by filing Form 1128. However, under certain conditions, a corporation can change its tax year without getting the consent. For more information see Form 1128 and Publication 538.

When you go into business, treat all costs you incur to get your business started as capital expenses. See Capital Expenses in chapter 1 of Publication 535 for a discussion of how to treat these costs if you do not go into business.

However, a corporation can elect to deduct a limited amount of start-up or organizational costs. Any cost not deducted can be amortized.

Start-up costs are costs for creating an active trade or business or investigating the creation or acquisition of an active trade or business. Organizational costs are the direct costs of creating the corporation.

For more information on deducting or amortizing start-up and organizational costs, see the Instructions for Forms 1120 and 1120-A and chapters 8 and 9 of Publication 535.

A corporation that uses an accrual method of accounting cannot deduct business expenses and interest owed to a related person who uses the cash method of accounting until the corporation makes the payment and the corresponding amount is includible in the related person's gross income. Determine the relationship, for this rule, as of the end of the tax year for which the expense or interest would otherwise be deductible. If a deduction is denied, the rule will continue to apply even if the corporation's relationship with the person ends before the expense or interest is includible in the gross income of that person. These rules also deny the deduction of losses on the sale or exchange of property between related persons.

A corporation may make an election to be taxed on its notional shipping income at the highest corporate tax rate. If a corporation makes this election it may exclude income from qualifying shipping activities from gross income. Also if the election is made, the corporation generally may not claim any loss, deduction, or credit with respect to qualifying shipping activities. A corporation making this election may also elect to defer gain on the disposition of a qualifying vessel.

A corporation uses Form 8902, Alternative Tax on Qualifying Shipping Activities, to make the election and figure the alternative tax. For more information regarding the election, see Form 8902.

A corporation can make an irrevocable election on its tax return filed by the due date (including extensions) to deduct 50% of the cost of qualified refinery property (defined in section 179C(c) of the Internal Revenue Code), placed into service after August 8, 2005, and before January 1, 2012. The deduction is allowed the year the property is placed in service.

A subchapter T cooperative can make an irrevocable election on its return by the due date (including extensions) to allocate this deduction to its owners based on their ownership interest.

For more information see section 179C of the Internal Revenue Code.

A small business refiner can make an irrevocable election on its tax return filed by the due date (including extensions) to deduct up to 75% of qualified costs paid or incurred to comply with the Highway Diesel Fuel Sulfur Control Requirements of the Environmental Protection Agency (EPA).

A subchapter T cooperative can make an irrevocable election on its return filed by the due date (including extensions) to allocate the deduction to its owners based on their ownership interest.

For more information, see sections 45H and 179B of the Internal Revenue Code.

A corporation can claim a deduction for costs associated with energy-efficient commercial building property, placed in service after December 31, 2005, and before January 1, 2008. In order to qualify for the deduction:

The deduction is limited to $1.80 per square foot of the building less the total amount of deductions taken for this property in prior tax years. The corporation must reduce the basis of any property by any deduction taken. The deduction is subject to recapture if the corporation fails to fully implement an energy savings plan.

For more information see section 179D of the Internal Revenue Code.

A corporation must make special adjustments to certain items before it takes them into account in determining its taxable income. These items are known as corporate preference items and they include the following.

For more information on corporate preference items, see section 291 of the Internal Revenue Code.

A corporation can deduct a percentage of certain dividends received during its tax year. This section discusses the general rules that apply. For more information, see the instructions for Forms 1120 and 1120-A.

If a corporation receives an extraordinary dividend on stock held 2 years or less before the dividend announcement date, it generally must reduce its basis in the stock by the nontaxed part of the dividend. The nontaxed part is any dividends-received deduction allowable for the dividends.

If a corporation receives a below-market loan and uses the proceeds for its trade or business, it may be able to deduct the forgone interest.

A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. A below-market loan generally is treated as an arm's-length transaction in which the borrower is considered as having received both the following:

Treat the additional payment as a gift, dividend, contribution to capital, payment of compensation, or other payment, depending on the substance of the transaction.

See Below-Market Loans in chapter 5 of Publication 535 for more information.

A corporation can claim a limited deduction for charitable contributions made in cash or other property. The contribution is deductible if made to, or for the use of, a qualified organization. For more information on qualified organizations, see Publication 526, Charitable Contributions, and Publication 78, Cumulative List of Organizations.

A corporation can deduct capital losses only up to the amount of its capital gains. In other words, if a corporation has an excess capital loss, it cannot deduct the loss in the current tax year. Instead, it carries the loss to other tax years and deducts it from any net capital gains that occur in those years.

A capital loss is carried to other years in the following order.

When you carry a net capital loss to another tax year, treat it as a short-term loss. It does not retain its original identity as long term or short term.

A corporation generally figures and deducts a net operating loss (NOL) the same way an individual, estate, or trust does. The same 2-year carryback and up to 20-year carryforward periods apply, and the same sequence applies when the corporation carries two or more NOLs to the same year. For more information on these general rules, see Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts.

A corporation's NOL generally differs from individual, estate, and trust NOLs in the following ways.

The following discussions explain these differences.

The at-risk rules limit your losses from most activities to your amount at risk in the activity. The at-risk limits apply to certain closely held corporations (other than S corporations).

The amount at risk generally equals:

The passive activity rules generally limit your losses from passive activities to your passive activity income. Generally, you are in a passive activity if you have a trade or business activity in which you do not materially participate during the tax year, or you have a rental activity.

The passive activity rules apply to personal service corporations and closely held corporations other than S corporations.

Corporations subject to the passive activity limitations must complete Form 8810, Corporate Passive Activity Loss and Credit Limitations. For more information on the passive activity limits, see the Instructions for Form 8810 and Publication 925.

Most corporations figure their tax by using the following tax rate schedule. An exception to that rule applies to qualified personal service corporations. Other exceptions are discussed in the instructions for Schedule J, Form 1120, or Part I, Form 1120-A.

The tax laws give special treatment to some types of income and allow special deductions and credits for some types of expenses. These laws enable some corporations with substantial economic income to significantly reduce their regular tax. The corporate alternative minimum tax (AMT) ensures that these corporations pay at least a minimum amount of tax on their economic income. A corporation (other than a small corporation exempt from the AMT) owes AMT if its tentative minimum tax is more than its regular tax.

The tentative minimum tax of a small corporation is zero. This means that a small corporation will not owe AMT.

A corporation's tax liability is reduced by allowable credits. The following list includes some credits available to corporations.

A corporation's tax liability is increased if it recaptures credits it has taken in prior years. The following list includes credits a corporation may need to recapture.

Most distributions are in money, but they may also be in stock or other property. For this purpose, “property” generally does not include stock in the corporation or rights to acquire this stock. However, see Distributions of Stock or Stock Rights, later.

A corporation generally does not recognize a gain or loss on the distributions covered by the rules in this section. However, see Gain from property distributions, later.

Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as “stock options”) are distributions by a corporation of rights to acquire its stock. Distributions of stock dividends and stock rights are generally tax-free to shareholders. However, stock and stock rights are treated as property under the rules discussed earlier under Money or Property Distributions if any of the following apply to their distribution.

For this purpose, the term “stock” includes rights to acquire stock and the term “shareholder” includes a holder of rights or convertible securities.

The following sections discuss transactions that may be treated as distributions.

A corporate distribution to a shareholder is generally treated as a distribution of earnings and profits. Any part of a distribution from either current or accumulated earnings and profits is reported to the shareholder as a dividend. Any part of a distribution that is not from earnings and profits is applied against and reduces the adjusted basis of the stock in the hands of the shareholder. To the extent the balance is more than the adjusted basis of the stock, the shareholder has a gain (usually a capital gain) from the sale or exchange of property.

For information on shareholder reporting of corporate distributions, see Publication 550, Investment Income and Expenses.

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, How To Get Help With Unresolved Tax Problems (now available in Chinese, Korean, Russian, and Vietnamese in addition to English and Spanish).

Free tax services.   To find out what services are available, get Publication 910, IRS 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.