A C Corporation requires Form 1120 to be completed for tax purposes, while an S Corporation requires Form 1120S. Both forms contain Schedules M-1, M-2 and M-3. Schedule M-1 is used to reconcile book income to taxable income. Schedule M-2 is for analysis of accumulated adjustments. Schedule M-3 must be used, instead of Schedule M-1, if a corporation has total assets of $10 million or more. (Department of the Treasury, 2015)
In order to reconcile for the ABC Company as a C Corporation, using Schedule M-1, we start with net income per books, add the amount of income tax owed as well as expenses (ex. the casualty loss; the charitable contribution), then subtract tax exempt interest (dividend income) and other deductions in order to arrive at taxable income. (Department of the Treasury, 2015)
In order to reconcile for the ABC Company as an S Corporation, using Schedule M-1, ...view middle of the document...
Since net operating losses cannot be carried over year to year in an S Corporation, the company would only be able to carry forward this loss if it remains a C Corporation. Additionally, there are rules in place by the IRS to detect and prevent tax avoidance.
If ABC Company becomes an S Corporation, it may be required to pay certain taxes because it was previously a C Corporation. The new S Corporation, according to Hoffman, Maloney, Raabe, and Young (2013), “…may be required to pay a built-in gains tax, LIFO recapture tax, general business credit recapture, or passive investment income tax.” (Ch 22-3). Regarding inventory, if the LIFO value is higher than the FIFO value, an adjustment wouldn’t be permitted because it would be a negative adjustment. If the FIFO value is higher, the amount over the LIFO value is the taxable amount for purposes of the LIFO recapture tax. ABC company will be subject to a pre-election built in gains tax if, as an S Corporation, the company disposes of an asset within a certain number of years after switching from a C Corporation to an S Corporation. (Hoffman, et. al., 2013)
Department of the Treasury. Internal Revenue Service. (2015). 2014 Instructions for Form 1120. Retrieved from http://www.irs.gov/pub/irs-pdf/i1120.pdf
Department of the Treasury. Internal Revenue Service. (2015). Form 1120 U.S. Corporation Income Tax Return. Retrieved from http://www.irs.gov/pub/irs-pdf/f1120.pdf
Department of the Treasury. Internal Revenue Service. (2015). 2014 Instructions for Form 1120S. Retrieved from http://www.irs.gov/pub/irs-pdf/i1120s.pdf
Department of the Treasury. Internal Revenue Service. (2015). Form 1120S U.S. Income Tax Return for an S Corporation. Retrieved from www.irs.gov/pub/irs-pdf/f1120s.pdf
Hoffman, W., Maloney, D., Raabe, W., and Young, J. (2013) Gross Income: Concepts and Inclusions. South-Western Federal Taxation 2013: Comprehensive (Chapter 22-3). Available from: http://ng.cengage.com/static/nb/ui/index.html?nbId=6762&nbNodeId=939558#!&parentId=939595