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Date: November 2003
Tax Administration
Federal, state and local governments levy taxes in the United States. The federal government imposes income taxes, excise taxes, and estate and gift taxes. Most states and other local jurisdictions levy franchise, income and/or capital-based taxes as well as sales, use, property, estate and gift taxes.
Filing Procedures and Tax Payments
Tax systems within the United States are based on the principle of self-assessment. That is, if minimal thresholds are met, federal and various state and local tax laws require taxpayers to file annual returns to report their taxable income, determine their tax liability, compare this tax liability to any taxes withheld or estimated taxes paid, and reconcile any balance due or overpayment. Corporate tax returns are generally due by the 15th day of the 3rd month following the close of a tax year (i.e., March 15th for a calendar year). A corpo-ration is not required to have the calendar year as its tax year.

Corporations are generally required to make quarterly estimated tax payments based on their current year's projected federal tax liability. Most states also require the payment of estimated tax. Failure to make these estimated payments can result in fines and penalties.
Statute of Limitations
Generally, the IRS must assess a deficiency in income tax within three years after the return is filed. The statutory period for assessment is extended to six years, however, for taxpayers that have omitted an amount of gross income representing more than 25% of the gross income stated in the return. If no return has been filed, the IRS may assess tax at any time -- in other words, the statute of limitations never begins.
Taxation of Resident Corporations
In the United States, taxable income of corporations is ultimately subject to two levels of taxation: first at the corporate level and again at the shareholder level when earnings are distributed. A resident corporation is a corporation incorporated under the laws of the United States.
Tax Rates
Regular Corporate Tax Rates
For the 2002 tax year, taxable income up to $75,000 is subject to graduated marginal rates of taxation: 15% on the first $50,000 and 25% on the next $25,000. Amounts in excess of $75,000 are taxed at a marginal effective rate of 34%; however, corporations with taxable income between $100,000 and $335,000 receive only partial benefit of the lower 15% and 25% rates, because an additional 5% is added (for a total applicable rate of 39%) to phase out the benefit of the lower rates. Amounts in excess of $10 million are taxed at a marginal effective rate of 35%; an additional 3% tax, not to exceed $100,000 is imposed on corporate taxable income over $15 million. This increase in tax phases out the benefits of the 34% rate. Therefore, corporations with taxable income over $18.33 million pay a flat rate of 35%.
Alternative Minimum Tax
The alternative minimum tax (AMT) is designed to prevent a corporation with substantial economic income from using preferential deductions, exclusions and credits to reduce significantly or eliminate its U.S. 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%. It is an "alternative tax" because, after computing both the regular tax and the AMT, a corporation pays the higher of the two.

Alternative minimum taxable income (AMTI) is computed by making adjustments to regular taxable income. To that result certain tax-preference items are added back. The required adjustments are intended to convert preferential deductions allowed for regular tax (for example, accelerated depreciation) into the less favorable deductions allowed under the AMT system. In addition, the "adjusted current earnings" adjustment requires AMTI to be increased by 75% of the excess of adjusted current earnings over AMTI before this adjustment. A corporation’s Adjusted current earnings is determined by increasing AMTI by certain items of income that are not otherwise recognized for AMT purposes but are included in determining earnings and profits. Interest income on tax-exempt obligations is an example of such an item. AMT net operating losses and, generally, AMT foreign tax credits may not be utilized to reduce the AMT by more than 90%.
Taxation of S Corporations
A domestic corporation that satisfies certain requirements may be exempt from federal income tax, including AMT and most other taxes, if its shareholders make an election for the corporation to be treated as an S corporation. S corporations are generally treated as nontaxable conduit entities. Regardless of whether any distributions are made, the shareholders of an S corporation are taxed currently on their share of the corporation's income. Similarly, current operating losses of an S corporation are generally passed through and deductible at the shareholder level, subject to certain limitations. Because the corporate-level tax is eliminated (and individual tax rates are generally lower than the corporate rates), S corporation status is often desirable.
To be eligible to make an S corporation election, the domestic corporation must have only one class of stock outstanding and its stockholders must:
  • Number no more than 35 (for purposes of this limitation, a husband and wife are counted as one shareholder, regardless of how they hold title to their shares);
  • Be individuals, estates or certain trusts; and
  • Not include any nonresident alien individuals.
    Determination of Taxable Income
    The computation of taxable income generally begins with income computed according to generally accepted accounting principles, but is adjusted for certain statutory tax provisions. As a result, the amount of taxable income frequently differs from the amount of income stated for financial reporting purposes.
    Domestic corporations are subject to U.S. income tax on their worldwide income from all sources, including the income of foreign branches, regardless of whether such income is repatriated. However, domestic corporations are generally not taxed on the earnings of a foreign subsidiary until the subsidiary remits its earnings, is sold or is liquidated. Exceptions may apply for certain income of controlled foreign corporations, foreign personal holding companies and passive foreign investment companies.
    Capital Gains and Losses
    Capital gains are taxable at the same rates as ordinary income. Generally, losses on the sale or exchange of capital assets may offset only capital gains, not ordinary income. A corporation's unused capital losses may be carried back for three years and forward for five years to offset capital gains realized in these other years.
    Deductible Expenses
    Generally, all ordinary and necessary expenses incurred in carrying on a trade or business, or with respect to property held for the production of income, are deductible against gross income. Deductible business expenses generally include, but are not limited to, salaries and wages, bad debts, rents, state and local income taxes, foreign income taxes (except where the taxpayer elects to treat foreign income taxes as a credit), property taxes, interest, business-related meals and entertainment, pension fund contributions, depreciation and amortization. These deductions are subject to many statutory limitations, such as the 50% limitation for deductible meals and entertainment. Also, many reserves and provisions are not deductible until paid (i.e., they are deductible on a cash basis). One common example is bad debt reserves.
    A depreciation deduction is available for most property, except land, used in a trade or business. Tangible depreciable property used in the United States is generally depreciated using accelerated depreciation systems normally under a 200% declining balance method. The most common depreciable lives of depreciable property includes:
  • Machinery and Equipment 7 or 12 years
  • Furniture and Fixtures 7 or 12 years
  • Commercial Buildings 39 years
  • Computer Equipment 5 years
    In addition, several types of intangible assets are amortizable over 15 years, on a straight-line basis, if they are acquired after August 10, 1993, such as goodwill, going-concern value, information base, know-how, trademarks, and covenants not to compete.
    Tax Credits and Incentives
    Foreign Tax Credit
    Domestic corporations may treat foreign income taxes as a deduction against U.S. taxable income or, alternatively, may elect to credit them against their U.S. tax liability, subject to limitations. Domestic corporations are also permitted to claim an indirect ("deemed-paid") foreign tax credit for foreign income taxes paid by foreign subsidiaries in which they hold a 10% or greater voting stock interest. The indirect foreign tax credit may be claimed on the receipt of actual dividends from the subsidiary, or the inclusion of subpart F income (i.e., deemed dividends).
    The foreign tax credit allowable for a taxable year is limited to the lesser of the following:
  • The foreign taxes paid or accrued; or
  • The taxpayer's U.S. tax on foreign-source taxable income. (This limitation is determined by the following formula: U.S. tax before credits multiplied by foreign-source taxable income over worldwide taxable income.)
    The foreign tax credit limitation is determined separately for various categories, or "baskets," of income including passive income, high-withholding-tax interest, shipping income, financial services income, dividends from 10%- to 50%-owned foreign corporation, and the general income basket for all other types of income.
    Net Operating Losses
    Net operating losses may generally be carried back for two years and forward for 20 years to offset taxable income in those other years. Significant limitations on the use of corporate net operating losses may apply, however, if a change in ownership of more than 50% in value of the stock of the loss corporation has occurred. Other restrictions may apply to the use of losses of acquired corporations.
    Treatment of Groups of Companies
    Consolidated Returns
    Domestic corporations that are members of an affiliated group may generally elect to file a federal consolidated income tax return and determine their U.S. tax liability on a consolidated (group) basis. If this election is made, losses sustained by group members may generally be offset against profits earned by other group members. An affiliated group consists of a parent-subsidiary chain of corporations connected by stock ownership representing at least 80% of the voting power and value of all classes of stock outstanding, excluding certain non-voting, preferred stock.
    Corporate Distributions
    In general, a corporation distributing property must recognize gain or loss as if it had sold the property at its fair market value in a taxable transaction. However, a corporation need not recognize gain or loss on a liquidating distribution to an 80% or more U.S. corporate shareholder if certain conditions are met. This exception is not generally available for liquidating distributions to foreign corporate shareholders unless the distributed property is a U.S. real property interest.
    Dividends Received Deduction
    Dividends received from other U.S. corporations generally qualify for a 70% dividends-received deduction, subject to certain limitations. The dividends-received deduction is increased to 80% if the recipient corporation owns at least 20% of the stock in the distributing corporation. Dividend payments from members of an affiliated group of U.S. corporations to other members qualify for a 100% dividends-received deduction.
    Thin-Capitalization Rules
    The U.S. tax law still favors characterization of shareholder contributions as debt rather than equity because interest expense is generally deductible against taxable income, and principal repayments can be used to distribute after-tax earnings with no further U.S. tax cost. No specific statutory limits are placed on the ratio of debt to equity, however a debt to equity ratio of 3:1 or less is generally acceptable assuming the taxpayer can service this debt on their own without assistance.
    Dividends, Interest and Royalties Paid to Foreign Affiliates
    Dividends, interest and royalties paid by domestic corporations to foreign affiliates are subject to a 30% U.S. withholding tax (or lower treaty rate) to the extent that the amounts constitute U.S.- source income not effectively connected with the conduct of a U.S. trade or business.

    The earnings-stripping provisions may limit the interest expense deduction of a foreign-owned U.S. subsidiary or branch of a foreign corporation if it has a debt-to-equity ratio in excess of 1.5 to 1. This rule disallows otherwise deductible interest on loans to a related-party lender in a country where a U.S. treaty reduces the U.S. interest withholding tax to the extent this interest exceeds 50% of the corporation's adjusted taxable income for the year. Disallowed interest expense may be carried forward indefinitely and deducted in a tax year in which the corporation has an excess limitation (i.e., the amount of its net interest expense is less than 50% of its adjusted taxable income). The limit can also apply to interest on a loan from an unrelated party (such as a U.S. bank) if a related foreign person has guaranteed the loan. This guarantee rule applies whether or not a direct loan from such related foreign person would have been subject to earnings stripping. U.S. international tax reforms currently under consideration would materially change the earnings stripping calculations. Some of the changes under contemplation include the elimination of the 1.5:1 safe harbor, the elimination of the indefinite carry forward period for excess interest deductions and the reduction of the adjusted taxable income percentage.
    Intercompany Transactions
    U.S. tax law provides the IRS with very broad powers to adjust transfer prices between related parties to prevent evasion of taxes or to clearly reflect the income of related parties. The basic standard is that related-party prices must reflect the arm's length price that would apply between independent parties in comparable transactions. The arm's length standard applies to all types of transfers, including transfers of licenses and intangibles. Companies now must document their intercompany pricing policies or risk penalties upon IRS examination. In recent years the IRS has enforced these transfer pricing rules with increased tenacity.
    Taxation of Nonresident Companies
    Foreign corporations are generally subject to U.S. income tax on two categories of income:
  • Income that is effectively connected with the conduct of a U.S. trade or business, whether from U.S. or foreign sources; and
  • Fixed or determinable annual or periodical (FDAP) income from U.S. sources that is not effectively connected with a U.S. trade or business, such as interest, dividends, rents and royalties.
    Income effectively connected with a U.S. trade or business is subject to tax on a net basis, after deducting expenses incurred to produce such income. Normal corporate graduated income tax rates apply.
    FDAP income not effectively connected with a U.S. trade or business is generally subject to U.S. income tax on a gross basis -- without allowance for deductions -- at a 30% or lower treaty rate.
    Branch Profits and Interest Tax
    In addition to corporate income tax, foreign corporations engaged in a U.S. trade or business may be subject to branch profits or interest taxes. These taxes are intended to place U.S. branches of foreign corporations in a position similar to that of U.S. subsidiaries of foreign corporations vis-a-vis the U.S. withholding tax on dividends and payments of interest.

    The 30% branch profits tax is imposed on the non-reinvested after- tax earnings, known as the dividend-equivalent amount, of a U.S. branch of a foreign corporation. The branch profits tax may be reduced or eliminated by treaty if the foreign corporation is a "qualified treaty resident" of that country.

    In addition to the branch profits tax, the United States generally imposes a branch interest tax. Under the first part of this tax, interest actually paid by a U.S. branch is treated as if paid by a U.S. corporation. Accordingly, these interest payments are subject to a 30% withholding tax unless a lower income tax treaty rate applies or the payments would be exempt from U.S. withholding tax under regular domestic rules -- for example, as portfolio interest. Under the second part of the branch interest tax, a foreign corporation is subject to a 30% (or lower income tax treaty rate) "excess branch interest tax" on the excess of the U.S. branch's interest expense deduction (which is determined pursuant to an IRS regulatory formula) over the interest actually paid by the branch.
    Real Property Income and Gains
    Foreign corporations not engaged in a U.S. trade or business that derive rental income from U.S. real estate are generally subject to U.S. tax on gross rental income (no deductions are permitted) at a 30% rate. However, a "net election" may be made to treat such rental income as if it were effectively connected with the conduct of a U.S. trade or business. If this election is made, the rental income is taxable on a net basis, at graduated U.S. income tax rates, with allowance for deductions such as depreciation, interest and maintenance. Under the Foreign Investment in U.S. Real Property Tax Act (FIRPTA), when a foreign person sells a U.S. real property interest, any gain or loss recognized is treated as effectively connected income regardless of whether this election is made. Unless certain conditions are met, the FIRPTA provisions generally tax all dispositions of U.S. real property by foreign persons even if a U.S. transferor would qualify for non-taxable treatment on the transaction.
    State and Local Income Taxation
    Most states and many municipalities impose an income tax on corporations that are incorporated within the state or doing business within the state.
    State Corporate Income Tax
    A corporation may be subject to the taxing jurisdiction of more than one state. Although incorporated in only one state, the corporation may be "doing business" in several other states through branch operations or some other means. Each of these states may tax the part of the corporation's income that is apportionable to the particular state.

    Most states determine the portion of a corporation's income subject to tax by multiplying the corporation's federal taxable income, as adjusted for state modifications, by a three-factor formula based on that portion of the corporation's property, payroll and sales within the state.
    State Consolidated Returns
    Some states do not permit the filing of state consolidated returns, even for affiliated groups that have elected to file a federal consolidated return. In many states, regardless of intercompany ownership and transactions, each corporation having a nexus -- taxable contacts -- with the state may be required to file a separate state tax return. Other states either require or allow multistate controlled groups to report income on a combined basis if business operations are "unitary" in nature.
    Partnerships - Generally
    For U.S. tax purposes, partnerships are transparent conduit entities not subject to taxation at the entity level. The partners are taxed currently on their distributive share of partnership taxable income regardless of whether any distributions are made, and current losses sustained by the partnership are passed through and deductible at the partner level. The amount of a partner's distributive share of partnership loss or deduction that may be deducted by the partners is limited to the partner's adjusted basis in the partnership interest. A partner's adjusted basis is generally increased by the partners share of undistributed partnership income and liabilities of the partnership.
    Trusts - Generally
    Trusts are separate taxable entities in the United States. Business, commercial and investment trusts are generally considered associations formed to carry on profit-making businesses and are taxed as corporations. Other types of trusts, which are usually formed to protect, preserve and manage assets, are generally taxed as trusts.

    Almost all trusts are required to adopt a calendar tax year. A trust must generally report its entire income on Form 1041, which must generally be filed on or before April 15 following the close of the calendar tax year. In general, trusts must also make advance estimated tax payments quarterly.

    Trusts are treated as conduit entities on income that must be distributed currently or is distributed properly to beneficiaries. This distributed income retains its character in the hands of the beneficiaries, who must include it in determining their incomes.

    A trust is considered a simple trust if it is required to distribute all of its income currently, and a complex trust if not.

    Trusts are taxed as separate entities on undistributed income. Trusts determine taxable income by subtracting allowable deductions (including deductions for distributed income) and personal exemptions from gross income. In general, trusts are entitled to the same deductions and credits as individuals, although some exceptions apply.

    Tax rates for trusts are based on individual tax rates and range from 15% to 39.6%.
    U.S.-Switzerland Key Treaty Rates
    As part of consideration with any multinational companies with business between the United States and Switzerland, the United States-Swiss Income Tax Treaty ("Treaty") supplies such companies with reduced withholding rates on interest, royalties and dividends. Under the Treaty, withholding on dividends vary from 5 to 15 percent depending upon stock ownership. Furthermore, withholding on interest and royalties are subject to a 0 percent rate and, thus, exempt from withholding taxation. Please note that whenever relying on the Treaty for benefits, the Limitation on Benefits Clause must be analyzed in extreme detail. Generally, a claim for reduced U.S. withholding under an income tax treaty with the Unites States requires that a payor receive a specific form prior to the payment to grant the reduced withholding.
  • Tax Information for Businesses