PwC Warns Against Sequestering Corporate AMT Credits

March 15, 2018

Thomas West, Esq.
Tax Legislative Counsel
U.S. Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, D.C. 20220

Re: Application of Federal Budget Sequestration to Alternative Minimum Tax Credit Refunds

Dear Mr. West:

Thank you for meeting with us last week to discuss the arguments against and potential implications of applying the sequestration provisions of the Budget Control Act of 2011 (“BCA”) to the taxpayer refunds of corporate alternative minimum tax (“AMT”) credits (“MTCs”) provided for under the recently enacted Tax Cuts and Jobs Act (“TCJA”). As discussed at our meeting, we are providing the following analysis on behalf of a working group of companies that would be severely harmed should Treasury apply the BCA sequestration to refunds of MTCs. The working group represents companies across multiple industries that are concerned about this issue as discussed more fully in this letter. A list of the companies comprising this working group is in Exhibit II attached to this letter.

Executive Summary

Taxpayers are seeking confirmation that the annual direct spending sequester created by the BCA does not apply to the TCJA provisions that refund corporate MTCs between 2018 and 2021. There are clear reasons why it should not apply.

The Tax Reform Act of 1986 established the corporate AMT in order to ensure that no taxpayer with substantial economic income could avoid a tax liability through the excessive use of exclusions, deductions, and credits. The corporate AMT provisions provided for the refund of AMT payments through a credit mechanism, whereby MTCs reduced future tax when such exclusions, deductions, and credits were less significant relative to the taxpayer's regular taxable income. The MTC carried forward indefinitely.

The TCJA repealed the corporate AMT and provided a new statutory mechanism mandating a full refund of MTCs to taxpayers. As MTCs represent prepayments of taxes intended to be refunded to taxpayers as offsets against future tax liability, the MTC refunds ordered by the TCJA are simply the return of tax payments already made by taxpayers, i.e., amounts held by the government that the taxpayer has the right to fully re-claim. Accordingly, refunds of MTCs are not government “outlays” subject to sequester under the BCA.

Background

The TCJA repealed the corporate AMT effective for tax years beginning after December 31, 2017, required taxpayers to use credits for AMT previously paid to reduce their regular tax liabilities, and provided for full refund of the balance not absorbed by regular tax liabilities. The TCJA requires the government to refund 50 percent of the remaining balance of MTCs carried forward to taxpayers in each of the tax years 2018-2020. In 2021, the TCJA states that any and all remaining MTCs are fully refundable, without qualification or condition.

For purposes of the Balanced Budget and Emergency Deficit Control Act of 1985 (BBEDCA), as amended by the BCA in 2011 and in subsequent budget agreements in 2013 and 2015, certain credits refundable to taxpayers count as “mandatory” outlays from the federal budget. As a result, the Office of Management and Budget (“OMB”) has, for several years, interpreted the BCA sequester to apply to “Payments Where Certain Tax Credits Exceed Liability for Corporate Tax.” For fiscal years 2018 and 2019, OMB determined the sequestration amount to be 6.6 percent and 6.2 percent respectively. Not all payments to taxpayers are subject to the BCA sequester. Credits refundable to individual taxpayers are excluded specifically by statute. Likewise, refunds of tax overpayments are reductions in governmental receipts (versus an outlay) and thus exempt from the BCA sequester.

Taxpayers are seeking confirmation that the annual direct spending sequester does not apply to the TCJA-authorized MTC refunds that will arise between now and 2021. What follows are the reasons the BCA sequester should not apply to those refunds of alternative minimum tax credits.

Congress clearly intended the TCJA to provide corporations a full benefit for MTCs

Congress repealed the AMT, but in doing so permitted taxpayers to continue to claim MTCs, evidencing its recognition that MTCs directly relate to prior years' payments of tax that Congress intended to refund to taxpayers. The MTCs are recovered first by credit against regular income tax liability with the excess paid out as a refund of tax previously paid. The TCJA committee report on page 323 clearly states that “the full amount of the minimum tax credit will be allowable in taxable years beginning before 2022.”

As evidenced by the renewed and recent debate over discretionary spending levels, Congress is clearly cognizant of the sequester required by the BCA, and yet made explicit that this subsequent statute would result in the full refund of MTCs, suggesting the TCJA supersedes application of the BCA sequester and allows taxpayers full refund of their credits.

The MTC refund is not “spending” that would be subject to sequestration; rather it is simply a refund of pre-paid tax to taxpayers

Though it may not be intuitive that a tax credit would count as spending, Congress routinely delivers government funds for various purposes by means of tax credits that subsidize or reward certain investments or activities or that provide income support. In some cases, Congress has made these tax credits refundable, meaning that the availability of the tax credit does not depend on whether the taxpayer has a tax liability against which the tax credit may be offset, which is particularly the case with individual credits that are part of the social safety net. In its January 2013 Report on Refundable Tax Credits, the Congressional Budget Office defined refundable tax credits as tax expenditures for budgeting purposes “because they resemble government spending programs by providing financial assistance to specific activities, entities, or groups of people.”

OMB has historically considered certain refundable tax credits as “outlays,” and, because they happen outside the annual appropriations process, deemed such outlays “mandatory” or “direct” spending subject to the BCA sequester absent a specific exclusion. Because of this, payments resulting from certain tax credits in excess of a corporation's tax liability have historically been subject to sequestration.

The TCJA-authorized refund of MTCs fundamentally differs from the refundable tax credits that have previously been subject to sequestration. There is one way, and only one way, for a taxpayer to have an MTC, and that is by having paid tax. Congress enacted the AMT to ensure taxpayers paid a minimum amount of tax in each year, primarily by eliminating timing benefits available under the regular tax system, thus accelerating the liability taxpayers would have incurred under the regular tax system. In designing the AMT, Congress chose not to repeal or directly limit any of the benefits in the Internal Revenue Code to which the AMT applied; it merely limited the amount of such benefits that taxpayers could use to reduce tax liability in any given year. A corporation's obligation with respect to paying AMT followed the general corporate rules, including the requirement to make estimated tax payments to cover any liability under the AMT.

The role of MTCs

The MTC was an essential part of the original design of the AMT, necessary to reconcile the timing differences between the two systems and ensure taxpayers' AMT payments would not, over time, result in payments in excess of their regular tax obligations. Unlike other tax credits, Congress did not design the MTC to subsidize or reward particular behaviors; rather, it was the measurement mechanism used to reconcile the payment of tax under the AMT system with the tax under the regular tax system. It ensured that the AMT did not overtax taxpayers by allowing them to carry forward their advance payments of tax, via the MTCs, to offset regular tax liability.

Unlike the individual AMT and other excise taxes, Congress never intended the corporate AMT as an additional permanent tax; rather, it intended the AMT as a prepayment of tax that would be returned eventually to taxpayers. The Joint Committee on Taxation (“JCT”) described the minimum tax "in large part as a timing device” designed to limit deferral of tax liabilities by requiring a “down payment” of taxes.¹ A refund of MTCs cannot exceed a taxpayer's income tax liability because the MTC refund represents the return of AMT paid in prior years. For federal budget purposes, MTC refunds should be treated in the same manner as other refunds of tax, which are exempt from the BCA sequester, and not as an outlay. Such a conclusion is the only way to reconcile the repeal of the corporate AMT with the purpose of the AMT as originally enacted by Congress.

Again, there is only one way for taxpayers to have MTCs, and that is because they have paid tax, not because they have undertaken an activity or made an investment for which Congress has provided an incentive or reward through a tax credit. The credit for AMT paid is akin to an NOL that, when carried back, creates an overpayment of tax. Sequestration does not apply to the refund of tax paid on account of the NOL carryback; likewise, it should not apply to a refund of AMT.

This view is evidenced by the fact that the MTC is not a general business credit listed under IRC § 38 but rather an indefinite carryforward of an advance payment of taxes intended by Congress to be fully refunded against regular tax liability. The distinction from the general business credit is important in that, while bearing the nominal title of “credit,” MTC carryforwards are substantively an overpayment Congress intended to be fully refunded at a future date through the measurement mechanics of the AMT system. The fact that Congress viewed an MTC as a mechanism for calculating tax liability and not as a tax benefit like a general business credit is demonstrated by the fact that it is not classified with general business credits and not subject to the same limitations, e.g., expiration after 20 years.

Prior to the enactment of the TCJA, the AMT provisions limited the use of MTC carryforwards to offset regular tax to the lesser of a) the MTC carryforward or b) the excess of regular tax over tentative minimum tax.² There was no provision for a cash refund of MTCs. The TCJA accelerated the return of MTCs by setting the tentative minimum tax as zero for years beginning after 2017, thus allowing for a full offset of regular tax.³ The mechanism under which the TCJA refunded unused MTCs in the years 2018-2021 further provides that the credit refundable be treated as a credit allowed under subpart C of the IRC governing “Refundable Credits.”⁴ Subpart C looks to IRC § 6401 with respect to the treatment of credits against income taxes for amounts treated as overpayments of tax.⁵ Pursuant to subpart C, where the amount of the credit allowable under subpart C exceeds the income tax imposed (as reduced by MTCs), that excess credit is considered an overpayment of tax.⁶

MTC refund analogous to IRC § 847 refund

There is a parallel to this treatment of the MTC refund in IRC § 847 and its repeal under the TCJA. Congress enacted § 847 to allow insurance companies to elect to pre-pay tax in an amount equal to a corresponding benefit for additional loss reserve deductions in excess of the general deduction afforded under IRC § 846 (essentially requiring insurers to limit loss reserve deductions to present value). These pre-payments of tax were tracked in a “special loss discount account” and as the additional loss reserves reversed and created taxable income, the prepayments held in the special loss discount account were applied to offset the tax on that income, effectively resulting in no additional tax liability. Similar to AMT, § 847 provided for a mechanism to pre-pay and refund tax liabilities and was intended to be revenue neutral to the taxpayer over time. The TCJA repealed § 847 and, in doing so, provided that any prepayments held in the special loss discount account remaining after the application to offset the effect of the related taxable income inclusion be treated as estimated tax payments under IRC § 6655 — not subject to sequestration.

The mechanism for crediting § 847 prepayments differs from the AMT only in the mechanics by which the amount of the pre-payment is derived. Section 847 determined the prepayment based on a single accelerated deduction, while the AMT rules determined the prepayment in reference to the difference in multiple deductions, exclusions and overall effect on tax. Although the measurement mechanics differ, the concept is identical. The pre-payments under both § 847 and the AMT rules represent taxpayer funds held by the government that the taxpayer has the right to reclaim in future years. Just as a refund of estimated tax payments is not a “mandatory outlay,” resulting in the application of the BCA sequester, neither should MTCs be treated as a mandatory outlay subject to sequester.

Distortive effects result depending on the timing of income

Tax policymakers have long criticized the AMT because of its pro-cyclical impact. The AMT was more likely to apply to companies when their revenues and income were down. Applying the sequester to refunds of MTCs would result in the continuation of the unfortunate pro-cyclical effect of the AMT. It would lead to disparate results depending on whether the taxpayer has sufficient income tax liability to absorb the full amount of the AMT credit in 2018 or must carry the MTC forward to succeeding years. Events occurring outside of taxpayers' control — such as natural disasters, market conditions, business cycles, etc. — influence taxpayers' regular tax liability in any given year, and could affect the ability to credit MTCs fully against tax, or to claim no credit resulting in an MTC refund. Taxpayers able to absorb the full MTC in 2018 would suffer no loss of credit. By contrast, the taxpayer carrying the MTC forward would suffer a loss of MTC in each year in which the MTC was subject to partial refund, unless the sequestered amounts were carried forward and fully refunded when the sequester lapses.

Exhibit I illustrates the disparate results from applying the sequester to two taxpayers with equal amounts of MTCs carrying forward into 2018 and generating the same amount of taxable income in the 2018-2021 refund period, but recognized differently within that period. The example illustrates how the application of sequestration to the refundable credit balance over the four year refund period irrationally penalizes the taxpayer with insufficient income tax liability in 2018 to absorb all of the MTC. This result clearly diverges from the intent of the TCJA.

Exhibit I further illustrates the contrary effect sequestration would have in respect of Congressional intent to refund MTCs fully. Prior to the TCJA, the AMT rules limited utilization of the MTC based on taxpayers' regular tax liabilities. In making the MTC refundable, Congress clearly intended to remove that limitation and refund the prepaid tax to the AMT taxpayer. The application of the BCA sequester to claw back the TCJA-authorized full refund of MTCs acts in effect like the old AMT rules, imposing a limitation on the ability to claim the full benefit of MTCs based on the amount able to fully offset regular tax liabilities. If Congress had not directed the refund of MTCs, taxpayers would have continued to secure the full return of these credits as an offset to their tax liabilities without any risk of diminution. Application of the BCA sequester in this context would put an AMT taxpayer in a worse position with respect to their MTCs than they were before the enactment of the TCJA — a result that is clearly incompatible with Congressional intent.

Sequester would promote behavior contrary to TCJA intent

The application of the BCA sequester to MTC refunds would drive taxpayer behavior contrary to both the provisions of and the intent of the TCJA. To avoid the effect of the sequester, taxpayers with MTC carryforwards may choose to engage in strategies to accelerate taxable income or not to avail themselves of TCJA incentives, either of which would be incongruent with the TCJA's purpose of returning MTCs to taxpayers to encourage more investment and increase economic growth. Applying the BCA sequester to MTC refunds would distort investment decisions reducing the TCJA's growth-enhancing effect. Below are examples of the distortions that sequester's application would produce among companies in the working group.

Deterrent to TCJA tax incentives

The TCJA provided several mechanisms to spur investment in the U.S. economy, including the immediate expensing of fixed asset additions. These measures would facilitate the purchase and consumption of goods to promote greater production, employment, and reinvestment in the U.S. economy. The beneficial acceleration of expense deductibility by a taxpayer with an MTC carryforward would result in harm to that taxpayer, resulting from a greater refund of MTCs compared with using MTCs to offset tax. The application of the BCA sequester in this regard would result in a significant cost to the taxpayer, curtailing the benefit of full expensing intended by Congress. Taxpayers would achieve less than a 20% benefit of full expensing due to the effect of sequestration.

Each year, taxpayers invest billions of dollars in fixed assets necessary to deliver their services. For example, car rental companies invest billions of dollars each year in new cars and make investment decisions regarding vehicle purchases including both manufacturing source and length of time to hold those cars in their fleets. Car rental companies with MTC carryforwards, and other similarly situated taxpayers, must consider the benefits of TCJA incentives, including full expensing, as compared to the cost associated with sequestered MTC refunds. To prevent this sequestration of their MTC refunds, these taxpayers may opt not to avail themselves of incentives such as full expensing for the purpose of generating sufficient taxable income to allow for the full utilization of MTCs against tax in 2018. Were these taxpayers to opt into full expensing of fixed assets, the negative effect of the BCA sequester would reduce cash available to purchase new cars or other business assets causing taxpayers to consider lower cost purchases and to lengthen the time they hold their fleets and other tangible property.

Deterrent to municipal bond investments

The reduction in the corporate income rate effectively reduces municipal bonds' after-tax yield. The application of the BCA sequester to MTC refunds would exacerbate the market effect as the receipt of non-taxable income would result in less tax for MTCs to offset. Accordingly, municipal bond investors, which includes property and casualty (“P&C”) insurance companies, would be compelled to rethink and revise their investment strategies, which would have an adverse effect on state governments' ability to meet their infrastructure financing needs.

P&C insurance companies, a primary investor in the municipal bond market, purchase municipal bonds to match the timing of asset maturity with insurance liabilities (particularly workers' compensation) and to take advantage of the low capital charge associated with tax exempt bonds. Many believe that P&C companies invest in municipal bonds for their tax-favored status, but the reality is that companies invest in tax exempt bonds for different reasons. That is particularly the case for insurers with significant NOL carryforwards. The application of the BCA sequester to MTC refunds would discourage additional investments in municipal bonds and encourage sales from existing portfolios to increase taxable income for the purpose of preserving the value of their MTCs. That is the behavior Congress sought to mitigate by keeping the net tax for P&C companies' tax exempt bond interest at 5.25% and tying that rate to the corporate income tax rate.

Deterrent to U.S. taxpayer growth and competitiveness

Companies manage their capital to compete globally. For certain regulated industries, minimum levels of capital are required both to maintain existing business and to engage in new business. Upon enactment, the TCJA had the immediate effect of reducing capital for many taxpayers as a result of the write down of net deferred tax assets to reflect the lower corporate income tax rate. The application of the BCA sequester to MTC refunds would further reduce both the capital and expected cashflow of taxpayers with MTC carryforwards. Further, many companies suffering the burden of a BCA sequester would not be price competitive when compared to companies able fully to credit their MTCs. As a result, companies may engage in cost containment activities such as reducing employee headcount or decreasing spending on capital improvements and technology modernization.

The effect of a BCA sequester on MTC refunds would be keenly felt by taxpayers in the energy sector. For instance, domestic shale producers budget annual drilling programs based on anticipated operating cash flows and reinvest their operating cash flows in new domestic drilling. If the BCA sequestration were applied to MTC refunds, producers counting on the full refund of MTCs would realize an immediate reduction in drilling capital. Every $100 million sequestered from the domestic upstream industry precludes the drilling of dozens of horizontal shale wells, which indirectly support many jobs in the energy supply chain. In 2015, the oil and natural gas industry supported an estimated 10.3 million jobs and contributed more than $1.3 trillion (more than 7% of GDP) to the U.S. economy.⁷ U.S. producers continue to make remarkable advances in technology, developing domestic reserves more cost-effectively to lower break-even costs. These efforts increase U.S. competitiveness in the global oil and gas market. Congress enacted the TCJA to encourage such actions and to positively influence GDP growth, balance of payments, employment, tax receipts, and energy security. Sequestration of MTC refunds runs counter to these purposes, to the intent of Congress, and would adversely affect domestic energy production and U.S. consumers.

Treatment of elected refundable MTCs

The IRS subjected MTCs refunded in lieu of bonus depreciation under § 168(k)(4) (enacted in 2008) to sequestration, making no distinction for the difference between MTCs and credits that were refundable without regard to current or past tax payments. Arguably, those MTCs should not have been subject to sequestration. That said, those MTCs were refunded under different circumstances: the result of an affirmative taxpayer election to claim refunds of MTCs in lieu of claiming bonus depreciation.

Refunds of MTCs under the TCJA are different for two reasons:

1. The elective nature of § 168(k)(4) is entirely distinguishable from the TCJA MTC refund provisions.

2. The TCJA requirement that all MTCs be refunded by 2021 supersedes any possible application of the BCA.

Conclusion

Treasury should confirm that MTC refunds pursuant to the TCJA are not subject to the BCA sequester. The return of MTCs to taxpayers represents a refund of tax paid, constituting a reduction in governmental receipts, not an outlay subject to BCA sequester. It was the clear intent of Congress to return taxpayers' MTCs over a statutorily defined period, and taxpayers cannot avoid taking these prepayments of a tax as refundable credits. The failure of such confirmation would require taxpayer business decisions and actions contrary to those the TCJA intended to facilitate. Furthermore, the application of the BCA sequester to MTC refunds would harm taxpayers most in need of capital — those with loss carryforwards and AMT deposits held by the government.

As such, MTC refunds directed by the TCJA should be exempt from sequestration just as refunds of other tax payments are exempt. If Treasury were to deem MTC refunds subject to sequestration, then Treasury should provide that sequestered amounts are carried forward and fully refunded at a later date when sequestration no longer applies. Under no circumstances should the sequestered amounts be permanently lost as that would be contrary to the clearly stated Congressional intent.

We would be happy to discuss any questions you may have in respect of this letter or otherwise to assist you in your efforts with respect to this important issue. Please feel free to call me at 202 414 1401 if you have any questions. We will follow up with you shortly.

Very truly yours,

Pamela F. Olson
Partner, PricewaterhouseCoopers LLP

cc:
Bradley Bailey, Deputy Assistant Secretary for Legislative Affairs
Krishna Vallabhaneni, Deputy Tax Legislative Counsel
Edith Brashares, Director of Business and International Taxation, Office of Tax Analysis
Christopher Call, Attorney-Advisor, Tax Legislative Counsel

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Exhibit I

Illustration of how MTC sequestration would impose disparate costs on similarly situated taxpayers based solely on the timing of taxable income recognition

For purposes of the example, the separate taxpayers both have $25M of MTCs carrying forward into 2018 and both generate $150M of taxable income in the years 2018-2021.

	2018	2019	2020	2021	Total
Taxpayer A
Taxable Income	15,000,000	30,000,000	45,000,000	60,000,000	150,000,000
Tax @21%	3,150,000	6,300,000	9,450,000	12,600,000	31,500,000
MTC utilized	(3,150,000)	(6,300,000)	(2,312,500)	—	(11,762,500)
MTC available for refund	21,850,000	4,625,000	—	—	26,475,000
MTC refunded	(10,925,000)	(2,312,500)	—	—	(13,237,500)
Sequestration (6.2%)	677,350	143,375	—	—	820,725
Net amount MTCs realized	13,397,650	8,469,125	2,312,500	—	24,179,275
Taxpayer B
Taxable Income	125,000,000	25,000,000	(20,000,000)	20,000,000	150,000,000
Tax @21%	26,250,000	5,250,000	(4,200,000)	4,200,000	31,500,000
MTC utilized	(25,000,000)				(25,000,000)
MTC available for refund	—				—
MTC refunded	—				—
Sequestration (6.2%)	—				—
Net amount MTCs realized	25,000,000	—	—	—	25,000,000

The example illustrates the $820,725 disadvantage Taxpayer A suffers as compared to Taxpayer B, simply by operation of the timing of recognizing an equal amount of taxable income over the four year MTC refund period.

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Exhibit II — Working Group Members

American Insurance Association
Washington, D.C.

American Council of Life Insurers
Washington, D.C.

Cabot Oil & Gas Corporation
Houston, TX

Delta Air Lines, Inc.
Atlanta, GA

Devon Energy
Oklahoma City, OK

Dynegy Inc.
Houston, TX

EOG Resources, Inc.
Houston, TX

The Hartford Financial Services Group, Inc.
Hartford, CT

The Hertz Corporation
Estero, FL

Nationwide Mutual Insurance Company
Columbus, OH

Newfield Exploration Company
Houston, TX

The Transamerica Corporation
Cedar Rapids, LA

Williams Companies, Inc.
Tulsa, OK