The Corporate Alternative Minimum Tax – It May Apply More Often than You Think (article)
Congress enacted the alternative minimum tax (AMT) in the Tax Reform Act of 1986 as a replacement to the then existing add-on minimum tax. At the time of enactment, Congress believed that the use of certain tax incentives by profitable companies to eliminate or substantially reduce income taxes should be restricted. As discussed in this article, the rules pertaining to the calculation of the AMT differ markedly from the regular tax and can be highly complex.
The AMT is a separate, parallel calculation of taxable income and tax. Under the AMT system, a tentative minimum tax is assessed at the rate of 20% of alternative minimum taxable income (AMTI). The corporation pays the higher of the regular tax or the tentative minimum tax. The AMT is the excess of the tentative minimum tax over the regular tax. A $40,000 exemption is available to offset lower amounts of AMTI, but this exemption is fully phased out once AMTI exceeds than $310,000.
The possibility that AMT may increase a corporation's income tax liability is easily overlooked. Many of the items of income and deductions that are treated differently for AMT purposes are narrow, pertain only to specific industries or are applicable only in limited circumstances. Also, the most common AMT adjustment, the AMT calculation for depreciation, was more closely conformed to the depreciation methods used for regular tax, thus diminishing its impact.
Various circumstances also can lead you to think your tax bill is going to be low or nonexistent. For example, the economic downturn during the past several years resulted in some corporations accumulating large net operating loss (NOL) carryforwards. Corporations may also have available nonrefundable tax credit carryforwards, such as the research and development credit and various employment credits. Nevertheless, due to the substantial differences that continue to exist between the AMT and regular tax calculations, the AMT may still be payable even where there is no regular tax currently due. Quarterly estimated tax payments are required regardless of whether your total tax is a result of the AMT or regular tax, and penalties may be imposed if estimates are not timely paid.
The AMT does not apply to any corporation in its first year of existence. A corporation will continue to be exempt from the AMT in its second year of existence if its annualized gross receipts in year one were less than $5 million. Thereafter, these "small corporations" will continue to be exempt from the AMT if their average gross receipts in the prior three years (or portion thereof) are less than $7.5 million. Once a corporation fails to qualify as a small corporation for any year, it will be liable for the AMT in all future years, regardless of its average gross receipts.
The starting point for determining the AMT is federal taxable income before any net operating loss deduction. Certain enumerated tax preferences (permanent differences) are added to the starting point and various adjustments are added or subtracted (temporary differences) in order to arrive at AMTI. The most common tax preference item is tax-exempt interest income received on private activity bonds. The most common adjustment items are the difference in depreciation on personal property between the 200% declining balance method used for regular tax purposes and the 150% declining balance method used for AMT purposes, as well as the corresponding gain or loss adjustment on the disposition of that property. Another common AMT adjustment for manufacturers is from the domestic production activities deduction, because of the difference in the 9% deduction calculated on AMTI versus regular taxable income. Small contractors that are eligible for the completed contract method for long-term contracts for regular tax purposes are still subject to the percentage of completion method for AMT purposes.
Adjustments are also required for "adjusted current earnings" (ACE). The ACE adjustment is yet another alternative tax system that is built into the AMT calculation. Certain tax-exempt income items that increase a corporation’s earnings and profits and certain tax deductible items that do not decrease earnings and profits are ACE adjustments. Many ACE adjustments easily can be overlooked. Examples of tax-exempt income that are ACE adjustments include deferred installment sale income, tax-free bond interest (in excess of any private activity bond interest already included in AMTI) and the receipt of life insurance proceeds (including increases in cash surrender value) in excess of the basis in the policy. Examples of some of the tax deductible items that do not reduce ACE are the deductions relating to dividends received from corporations where the ownership interest is less than 20%, tax deductible dividends paid to an employee stock ownership plan and tax deductions relating to amortization of organizational costs. If the ACE calculated exceeds AMTI computed before the ACE adjustment, a corporation must increase its AMTI by 75% of the excess. If the ACE calculated is less than AMTI computed before the ACE adjustment, a corporation can decrease its AMTI to the extent of the cumulative net positive ACE adjustments made in previous years.
Once the ACE adjustment is determined, a corporation next must calculate its allowable alternative tax net operating loss deduction (ATNOLD). Since the AMT is a parallel tax, the ATNOLD is computed after taking into account all AMT adjustments and preferences and will differ from the regular tax net operating loss deduction. Of critical importance, the ATNOLD is limited to 90% of pre-ATNOLD AMTI. As such, a corporation with sufficient NOLs to offset its regular tax often will still have to pay AMT on 10% of its pre-NOL AMTI (unless offset by the AMT exemption).
With limited exceptions, nonrefundable tax credits available for regular tax purposes cannot reduce the AMT. The AMT can, however, be reduced by the foreign tax credit. A separate foreign tax calculation using AMT limitations is required to determine the amount of alternative minimum tax foreign tax credit (AMTFTC). A corporation should complete a separate Form 1118 to compute its AMTFTC.
Although of little help to corporations with large NOLs or tax credit carryovers where the corporation does not expect to pay regular tax in the near future, the only silver lining to these rules is that any AMT paid can be carried forward indefinitely to future years as a credit available to offset the regular tax. The AMT credit can be utilized to the extent that a corporation’s regular tax is greater than its tentative minimum tax in a subsequent year.
The alternative minimum tax is a stealth tax that often catches corporate taxpayers off guard. Consult your local CBIZ MHM tax professional to discuss whether and how the corporate AMT will affect your company.
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