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.