A last-minute decision to keep the corporate alternative minimum tax may undo several significant benefits written into the Senate’s tax reform bill, including those related to international reform.
“Everyone was taken by surprise by the retention of the corporate alternative minimum tax,” Eric Solomon of EY said. “Taxpayers have been scrambling to understand the implications for them,” he said, adding that “questions that have never been asked before are being asked.”
The crux of the issue is that the corporate AMT, with its broader tax base, now lies at the same rate as the newly reduced regular corporate tax rate under the bill. Under section 55, a 20 percent tentative minimum tax is imposed on corporate income in excess of an exemption amount. The alternative minimum taxable income is determined by making adjustments under sections 56 and 58 and increasing the amount by tax preference items under section 57.
“The whole concept of an AMT is predicated on there being a rate differential and when you have a 20 percent rate for both regular tax and AMT purposes, the AMT just doesn’t work like it’s supposed to,” Michael Mollerus of Davis Polk & Wardwell LLP said.
Mollerus said that even if the AMT rate were reduced, it would still be appropriate to carve out of the AMT’s adjusted current earnings (ACE) adjustment several of the newly enacted international deductions. “The whole purpose of those is to achieve rate reductions on that income, but they do it through a deduction, and it is a noneconomic deduction,” he said.
Under section 56(g), alternative minimum taxable income is increased by 75 percent of the excess of ACE over the alternative minimum taxable income before the adjustment. Generally, a deduction is not allowed under the AMT if an item would not be deductible for purposes of computing earnings and profits. As Mollerus argues in a blog post, while E&P is not defined under statute, noneconomic expenses do not reduce E&P because they don’t reduce a corporation’s ability to make shareholder distributions.
“What this requires is a basic understanding of earnings and profits and what goes into earnings and profits. And that’s one area of the law that’s been ambiguous for decades,” Solomon said, labeling the area “a hodgepodge.” Solomon cited section 312, which has some rules about E&P, but noted that was only a patchwork that didn’t provide answers to every question. Rather, E&P is understood as the dividend-paying capacity of a company, he added. “Companies are wondering whether deductions they take for tax purposes are the type that would get disallowed under this provision.”
Under current law, the corporate AMT touches far fewer taxpayers than it ignores. According to an IRS 2013 Statistics of Income report, out of nearly 5.9 million returns from active corporations, only a little over 10,000 were returns with AMT items.
Mirror Image Score
Initial reform efforts envisioned doing away with the AMT. But drafted as a revenue raiser to counter several other measures designed to win favor with Republican holdouts, the retention of the corporate AMT was scored by the Joint Committee on Taxation as raising $40.3 billion over 10 years. Notably, this is an exact reversal of the amount the provision’s repeal was estimated to lose in the earlier Senate and House proposals.
“When you are repealing it initially as part of current law, you don’t lose that much money because you have a high 35 percent tax rate. If you were to reinstate it after lowering the corporate rate to 20 percent and creating several new deductions, it raises a lot more when you put it back in at the end,” Drew Lyon of PwC said. Lyon expressed some skepticism about the “rather quick” mirror image score the JCT gave the provision’s retention, given the unavailability of many credits under the AMT, including the research credit.
The research credit is one of the largest business tax expenditures. Earlier this year, the JCT estimated that the research credit for corporations would cost the government $51.8 billion in lost revenue between 2016-2020, and the Treasury Office of Tax Analysis has pegged the cost at $135 billion over the next decade.
Solomon said that while it is likely the AMT was given an eleventh-hour reprieve for revenue purposes, congressional tax staff have been made aware of taxpayer concerns about its retention. He also wondered whether the JCT revenue estimate is accurate and whether the correct number is higher.
“That either suggests you find something else, or if you are going to keep the corporate AMT, you dial it way back,” Solomon said.
About Those International Deductions
Some of the most dramatic reform efforts come in the context of international taxation. Representing a move toward territoriality, both the House and Senate envision a 100 percent deduction for foreign-source dividends received from 10-percent-owned foreign entities with a disallowance of foreign tax credits. But this exemption may be rendered largely inert thanks to its confluence with the AMT.
Although the bill does not explicitly reference an exemption from the AMT for the new 100 percent dividends received deduction (DRD), current law does provide exclusions from the AMT of other DRDs. Lyon said the explicit exclusion of the new 100 percent DRD would be “a technical item” that needed correction. Mollerus added that since the AMT would undo 75 percent of the benefit of moving to a territorial system, he was “cautiously optimistic” that interaction between the two provisions would be rectified.
As part of a carrot-and-stick approach to the taxation of intangible income, the Senate calls for taxing global intangible low-taxed income (GILTI) of the aggregate profits of controlled foreign companies over a routine return, subject to a deduction. GILTI is the excess of CFC income over 10 percent of the shareholder’s pro rata share of the qualified business asset investment. Further, a domestic corporation’s foreign-derived intangible income (FDII) is taxed at a reduced rate with a 37.5 percent deduction allowed for the lesser of its FDII and its GILTI or its taxable income.
Because of the catchall ACE category of the AMT, deductions that would otherwise be allowed for GILTI income or FDII appear to be included under the AMT, Lyon argued, adding that the inclusion of these provisions in the AMT was “clearly inadvertent.”
“Essentially 75 percent of all these new deductions would get taxed under the AMT, and since there is a 20 percent tax rate under the AMT, a 15 percent tax rate would apply to this income,” Lyon said.
Deemed repatriation of previously accumulated foreign E&P would be excluded from the AMT, however.
“When section 965 was first enacted in 2004, [Congress] specifically included an adjustment to prevent the sort of interaction with adjusted current earnings,” Lyon said. “Presumably, with a little more time, they would have added these new [foreign] deductions to these lists of things that wouldn’t create AMT.”
Bonus depreciation rules previously enacted serve as the basis for applying 100 percent expensing in the bill, which would also be excluded from the AMT. “They’re getting that result again because they are using an existing section of the code,” Lyon said.
The BEAT Goes On
The Senate also seeks to institute a 10 percent minimum tax on multinationals, labeled the base erosion and antiabuse tax (BEAT). The tax is calculated on the difference between actual tax liability and what a company would have incurred if it hadn’t moved profits offshore.
Mollerus said it is uncertain how the BEAT is supposed to operate in conjunction with the AMT.
“Under the AMT rules, it appears that the BEAT is taken into account for purposes of determining your regular tax liability and thus whether you owe AMT. But then the AMT isn’t taken into account in calculating your regular tax liability for purposes of determining whether you owe the BEAT,” Mollerus said. “It’s a little bit circular and they need to be reconciled.”