Capital Gains and Losses for C Corporations
How are Capital Gains Taxed at the Corporate Level
Unlike S corporations, which are pass-through entities, and income, deductions, gains, losses, and credits are passed through the entity to the shareholders who report their share of these items on their personal income tax returns, all income earned by a regular C corporation is taxed at the corporate level. This is because a C corporation is not a pass-through entity. In addition, a different tax rate schedule applies to C corporations.
In other words, the lower capital gain rates for long-term capital gains enjoyed by individuals are not available to C corporations. Short-term and long-term capital gains are simply added to the corporation's ordinary income and taxed at the corporation's regular federal income tax rates.
There was a time when corporations enjoyed lower capital gain rates. Although corporations no longer receive preferential tax treatment for capital gains, they must still classify capital gains and losses as short-term and long-term. Use the corporation's Schedule D for reporting capital gains and losses.
Capital Losses Incurred By Corporations
Corporations may only offset capital losses against capital gains. They may not deduct them from the corporation's ordinary income. Net capital losses must first be carried back 3 years and offset against capital gains, if any.
If a loss is not fully applied against capital gains in the carryback period, the remaining loss is carried forward up to a maximum of 5 years.
If after carrying back a net capital loss 3 years and forward 5 years, part of the loss still remains as a result of not having sufficient capital gains to offset the loss against, it is lost forever.
Recomputing Tax Liability
When a net capital loss is carried back to a year that has a capital gain, the loss is subtracted from the gain reducing the corporation's taxable income. As a result, you must recompute the corporation's tax liability for that year.
A lower tax liability results in a refund of overpaid taxes. Apply for a refund on either Form 1139, Corporate Application for Tentative Refund or Form 1120X, Amended ended U.S. Corporation Income Tax Return.
If a capital loss exceeds a capital gain, the excess loss may not be used to reduce ordinary income or create an operating loss.
You'll get a faster refund if you file Form 1139. But it must be filed no later than one year after the year the net capital loss was incurred.
You must file this form if you don't file Form 1139. It must be filed within 3 years, including extensions, from the due date for filing the return for the year in which the net capital loss was incurred
How to Carry Back a Net Capital Loss
You may not pick and choose what year to carry a loss to . Here's the order you must follow to apply a loss:
- First, go back 3 years prior to the year of the loss.
- If part of the loss still remains, go back to the 2nd year prior to the year of the loss.
- If part of the loss still remains, go back to the 1st year prior to the year of the loss.
- If part of the loss still remains, carry it forward up to 5 years, maximum.
- Any net capital loss remaining after carrying it back 3 years and forward 5 years, is forfeited.
- In 2013, the corporation incurs a short-term capital gain of $2,000 and a long-term capital loss of $10,000.
- After netting the gain and loss, you end up with a net capital loss of $8,000. The net capital loss is treated as a short-term loss in the carryback and carryforward years.
- First, go back 3 years to 2010 to see if you had any capital gains to apply the loss against. You had no capital gains in 2010.
- Go back to 2011 to see if you had a capital gains in that year. You had no net capital gains this year either.
- Go back to 2012 to see if you had capital gains in that year. Turns out you did. You had a short-term capital gain of $5,000 and a long-term capital gain of $2,000.
- You first reduce the short-term gain by $5,000, zeroing it out.
- Then, you reduce the long-term gain by $2,000, zeroing it out.
- You refigure your tax for 2012 and apply for a refund.
- The remaining capital loss is $1,000 ($8,000 minus $7,000)
The remaining $1,000 loss must be carried forward 5 years. If you have no capital gains during the 5 year carryforward period, the unapplied $1,000 is lost forever.
Capital Losses from More than One Year
If you're carrying losses from more than one year, use the earlier year losses first.
Tax Planning Tip
Make sure you keep track of your capital gains and losses. As you can see from the example, if you end up having a capital gain of $1,000 in any year during the 5-year carry-forward period and you lose track of the unapplied net capital loss of $1,000, taxable income for the year the capital gain was included in income will be overstated by $1,000 and your corporation's tax liability will be higher.
Capital Losses for Corporations and Individuals Compared
Capital Gain Tax Treatment:
Corporations do not get preferential tax treatment for long-term capital gains. Net capital gains are included in a corporation's ordinary income and are taxed at the regular corporate federal income tax rates..
Individuals do get preferential tax treatment for long-term capital gains. Long-term capital gains for individuals are taxed at the lower capital gain rates.
Carryback and Carryforward Periods:
Corporations must carry net capital losses back 3 year then forward a maximum of 5 years. The carryback and carryforward procedure must be strictly followed, with the loss being carried back to the 3rd year prior to the loss year first. Then, if any remaining loss exists, it is carried to succeeding years.
Individuals may not carry a capital loss back. Individuals may only carry a capital loss forward. However, the loss may be carried forward indefinitely, not just for a limited period of time.
Capital Loss Deduction
Corporations may only deduct net capital losses from capital gains. They may not deduct net capital losses from the corporation's ordinary income. Capital losses that exceed capital gains are carried back 3 years first, then, if not used up, carried forward up to to 5 years.
Individuals may deduct capital losses from any income reported on Form 1040. However, for individuals, the annual deduction limit for capital losses is $3,000. If a capital loss exceeds $3,000, the excess must be carried forward.
- Return to the Tax Basics for Startups Table of Contents to find related links.