Ch6. Corporate & Individual Tax Deep Dive — Tax Adjustments and Income Computation

Corporate Tax Framework (Form 1120)

Taxable Income Computation:
Book net income (GAAP)
+ Additions to income (items taxable but not on books)
− Deductions (items deductible for tax but not on books)
− Disallowed deductions (book expenses not deductible for tax)
+ Income not on books (non-taxable book income reversed)
= Taxable income before NOL deduction

Net Operating Loss (NOL) deduction (80% limitation)
Corporate tax rate: 21% flat (post-TCJA)

Key Tax Adjustment Items

Nondeductible (Addback) Items:
Meals exceeding 50% deduction limit (§274)
Excess executive compensation above §162(m) limit ($1M)
Excessive deferred compensation
Fines, penalties, and taxes (income tax, not deductible)
Penalties and interest on late tax payments

Income Inclusions:
Dividend income (subject to dividends-received deduction)
Cancellation of debt income (§61)
Property received without adequate consideration

Book-Tax Difference Dispositions:
Temporary differences: adjust future taxable income
Permanent differences: never reverse (e.g., 50% meals, tax-exempt income)
Schedule M-1 / M-3 reconciliation required

Individual Tax Computation Structure (Form 1040)

Six Categories of Gross Income:
Interest, Dividends, Business, Wages, Pensions, Other

Income Calculation:
Gross Income − Exclusions = Included Gross Income

Above-the-Line Deductions (adjustments to income):
  IRA deduction, student loan interest, SE tax deduction,
  Health insurance premiums (self-employed),
  Alimony (pre-2019 divorce), educator expenses
= Adjusted Gross Income (AGI)

Below-the-Line Deductions (itemized or standard):
  Standard deduction: $15,000 (single) / $30,000 (MFJ) — 2025
  Itemized: mortgage interest (§163), state taxes (SALT cap $10,000),
             charitable contributions (§170), medical expenses (>7.5% AGI)
= Taxable Income

Tax Computation:
Taxable Income × Rate = Gross Tax
− Tax Credits (child tax credit, EITC, foreign tax credit, etc.)
= Net Tax Liability

Separate vs. Preferential Tax Rates

Preferentially Taxed Income:
Long-term capital gains: 0% / 15% / 20% (based on taxable income)
Qualified dividends: same rates as LTCG
Net investment income surtax: 3.8% (high-income taxpayers)

Retirement Income:
Traditional IRA / 401(k) distributions: ordinary income rates
Roth IRA qualified distributions: tax-free
Social Security benefits: 0%–85% includible depending on "combined income"

Capital Gains:
Short-term (≤1 year): ordinary income rates
Long-term (>1 year): preferential 0/15/20% rates
Collectibles: max 28%
Unrecaptured §1250 gain: max 25%

Key Concept Cards

Corporate Tax Rate = 21% Flat ★★★★★ : Post-TCJA single rate applies to all C-corporation taxable income. Memory hook: Corporate = 21% flat (no brackets)

Standard Deduction = $15,000 /$ 30,000 (2025) ★★★★★ : Single $15,000 / Married Filing Jointly$ 30,000. Adjusted annually for inflation. Memory hook: Standard deduction = roughly doubled by TCJA

LTCG / Qualified Dividends = 0/15/20% ★★★★☆ : Preferential rates, not taxed at ordinary income rates. Memory hook: Long-term = preferential rate, not ordinary

Practice Quiz

Q. If a corporation has nondeductible entertainment expenses, how are they treated in the tax return?

Post-TCJA, entertainment expenses are 100% nondeductible. These are added back on Schedule M-1 as a permanent difference. Unlike meals (50% deductible), entertainment has zero deductibility regardless of the business purpose. Tax professionals flag entertainment vs. meals classification as a key compliance point in expense reporting and audit defense.

Q. When does investment income get taxed at higher rates for individuals?

Qualified dividends and long-term capital gains are taxed at preferential 0/15/20% rates. However, for high-income taxpayers (MAGI above $200K single /$ 250K MFJ), an additional 3.8% Net Investment Income Tax (NIIT) under §1411 applies to the lesser of net investment income or excess MAGI. This can push the effective rate on investment income to 23.8% or higher. Tax-advantaged accounts (Roth IRA, 401(k)) and municipal bonds are key strategies to reduce this exposure.