Navigating the Impact of CAMT

The IRS and Treasury recently issued a notice of proposed rulemaking, REG-112129-23 (the Proposed Regulations), outlining rules for applying the corporate alternative minimum tax (CAMT). This article focuses on the potential impact of this new guidance on partnerships, including private equity and venture capital funds. While partnerships are not directly subject to the CAMT, they may be required to maintain and report additional information to direct and indirect corporate partners, which may impact whether a related corporation is subject to the minimum tax.

The proposed regulations are extremely complex and contain more than 600 pages.

Overview of CAMT and Its Application

The CAMT was introduced as part of the Inflation Reduction Act and became effective for tax years beginning after Dec. 31, 2022. It imposes a 15% minimum tax on the adjusted financial statement income (AFSI) of an “applicable corporation.” A taxpayer’s AFSI is its financial statement income (FSI) or loss, with specific adjustments. The proposed regulations establish an ordering for the selection of the appropriate financial statement on which FSI is used. The CAMT is the excess of the corporation’s "tentative minimum tax," (which is 15% of the entity’s AFSI) over the sum of the corporation’s regular income tax and the BEAT (Base Erosion and Anti-Abuse Tax) liability. Certain foreign tax credits can offset this amount.

 To qualify as an “applicable corporation”, a corporation (other than an S corporation, a Real Estate Investment Trust, or a Regulated Investment Company) must have an average annual AFSI exceeding $1 billion for any three-year period ending in 2022 or later. The CAMT also applies to U.S. corporate subsidiaries of a foreign-parented multinational group (FPMG) if the group has over $1 billion and the domestic subsidiary has at least $100 million in average AFSI over a three-year period. Neither the $1 billion nor the $100 million threshold is inflation-indexed, potentially increasing the scope of applicable corporations over time.

Aggregation rules apply which treat related entities as a single entity to determine if the $1 billion and $100 million thresholds are satisfied (the single entity rule). Corporations can be aggregated with other entities (e.g., partnerships) in making this determination. Parties are considered related if they satisfy: i) a parent-subsidiary relationship (based on a more than 50% ownership of vote or value for corporations, or profits or capital interests for partnerships); ii) a brother-sister relationship (based on both control and effective control tests); or iii) a combined group of parent-subsidiary and brother-sister entities.

Where a corporation is aggregated with a partnership in which it is a partner, it must include the related partnership’s entire AFSI when determining whether it exceeds the thresholds to be an applicable corporation. For this test, a corporate partner is not limited to including its distributive share of AFSI of the partnership.

The proposed regulation provides that for purposes of determining if a corporation is an applicable corporation, the AFSI of affiliates is included only for the period during which the affiliates were related to the corporation. Prior guidance would have required an acquiring corporation to include a target’s three-year history with the acquirer to determine whether the acquirer exceeds the $1 billion threshold.

CAMT and Private Equity

For purposes of aggregation, the proposed regulations allow for the inclusion of entities not traditionally consolidated in financial statements, such as portfolio companies controlled by private equity funds engaged in a trade or business, to be grouped under CAMT. Consistent with the law, the proposed regulations do not contain express language that includes subsidiaries of private equity funds not engaged in a trade or business under the single entity rule. Commenters concluded that these subsidiaries of private equity funds not engaged in a trade or business should not be aggregated absent further guidance.  Hopefully, additional clarity will be provided when the regulations are finalized.

This single entity rule could lead to more blockers or public companies utilizing Up-C structures being considered "applicable corporations" if their group meets the $1 billion threshold for AFSI.

The proposed regulations apply the constructive ownership rules under IRC Sec. 1563(d)(1)(B) to attribute control through partnerships, meaning that private equity funds' ownership of portfolio companies, even indirectly, could count towards the CAMT threshold. This increases the likelihood of exceeding the $1 billion threshold. As an example, consider a private equity fund comprised of a foreign partnership that owns one foreign blocker corporation and one domestic blocker corporation, each of which owns a domestic portfolio company. Although the portfolio companies are not consolidated on the fund’s financial statements, the proposed rules would bring them into the FPMG because they are members of the same single employer group as the blockers that own them. Thus, the group would be broadened, potentially causing it to meet the threshold for applicable corporation status

Method of Computing CAMT

Under Proposed Regulation §1.56A-5(c), a CAMT entity partner must disregard any amount it reflects in its FSI for a partnership investment when calculating AFSI for that taxable year. Instead, it must include its distributive share of the partnership's AFSI, as detailed in §1.56A-5(e).

The proposed approach for calculating this distributive share is the applicable method or “bottom-up” method, which requires a partnership to calculate its AFSI first, making adjustments required under CAMT, and then allocate the adjusted AFSI among its partners using their distributive share percentages. The distributive share percentage generally is the partner’s pro rata share of FSI attributable to the partnership divided by the partnership’s total FSI. An alternate method is used if the partner accounts for the partnership interest based on fair market value accounting.

Under certain situations, these computations can produce negative distributive share percentages for some partners. The Treasury is aware of this problem and is seeking comments from stakeholders.

The calculation of AFSI under the proposed regulations includes a new “deferred sale” rule with respect to property with a built-in gain or loss contributed to a partnership by a CAMT entity. The CAMT entity would be required to take into account any financial statement gain or loss ratably over the property's recovery period, with a 15-year recovery period for property that is not depreciated for AFS purposes. If the partnership sells the contributed property, any remaining deferred gain or loss for the CAMT entity is accelerated. Similarly, the proposed regulations also include deferred sale rules for property distributions. These rules seek to align CAMT with income tax rules by recognizing income over the recovery period instead of at the time of contribution or distribution.

In contrast, the calculation of AFSI does not include an adjustment for gain or loss on the sale or other disposition of a partnership interest reflected on the FSI of a partner. Further, multi-tiered partnership structures require the application of the proposed rules at each tier, beginning with the lowest-tier partnership. This may be a helpful nuance for investment managers because investment funds often account for their investments using a fair value method. Under this approach, mark-to-market adjustments would be removed from the calculation and replaced with the partner’s distributive share percentage of the partnership’s AFSI, starting with the lowest-tier partnership, which may not be required to utilize the fair value method. The bottom-up approach may, therefore, limit the risk that CAMT will be imposed on unrealized gains.

Treasury argues that the bottom-up method is more consistent with CAMT's framework than the top-down approach it considered, ensuring that necessary adjustments under Section 56A are considered. This approach also standardizes how CAMT entities calculate their distributive share of partnership AFSI, regardless of the accounting method used for the investment.

Increased Complexity and Compliance Workload for Private Equity Funds

The CAMT introduces additional complexity for private equity funds by requiring them to calculate and report AFSI for their entire group, including foreign and domestic entities. PE funds might need to consolidate financial data across a wide range of investments, even if they are not typically consolidated for financial reporting purposes.

The bottom-up approach proposed by the Treasury will likely result in significantly more work for partnerships and corporations holding partnership stakes. A partnership may need to calculate its AFSI and ensure accurate reporting to its CAMT entity partners if it receives a request for CAMT information from a partner within 30 days of the end of the partnership tax year to the extent the CAMT entity partner cannot determine its distributive share of the partnership’s AFSI without receiving such information.

A partnership is required to file information requested by a CAMT entity partner with the IRS and to furnish information to the CAMT entity partner in such a manner as required by the IRS. A partnership is not required to furnish the information to a CAMT entity partner until it has received a request. However, once a partnership has received a request, it is required to continue to provide the information to the CAMT entity partner for each subsequent taxable year unless notified otherwise by the CAMT entity partner. An upper-tier partnership subject to the reporting and filing requirements must request information from a lower-tier partnership, which must file the information with the IRS and provide it to the upper-tier partnership.

This complex process may lead to an increased compliance burden and may lead to investment funds weighing carefully whether to accept subscriptions from entities potentially subject to CAMT. These rules could require partnerships to maintain four sets of books: 1) financial accounting, 2) tax basis, 3) IRC Sec. 704(b) economic capital accounts and 4) CAMT.

For more information, please connect with your CBIZ tax advisor.