ALTERNATIVE MINIMUM TAX The Undeniable Fact... AMT Matters and Why

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1 ALTERNATIVE MINIMUM TAX The Undeniable Fact... AMT Matters and Why DAVID N. MCPHERSON, JD, LL.M, PRODUCT MANAGER >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>> White Paper

2 Introduction Each year, relatively few corporate taxpayers find themselves actually paying the Alternative Minimum Tax (AMT). This leads some tax professionals to dismiss AMT and its associated calculations as nothing more than tortured tax department busywork. That is a mistake. In fact, it is essential that every tax professional understand the far-reaching impact of AMT. Typically, corporate taxpayers discover they have an AMT liability at the point where they would believe they owe no tax at all. Obviously, this is an expensive surprise that tax professionals can easily avoid. Corporate tax professionals are the advocates for the positions their companies take on annual tax returns. One way they can help their companies avoid overpaying taxes and maximize the use of every tax credit is to understand the role AMT plays its risks and opportunities. In discussing AMT issues with tax professionals, their usual response is, Well, I m not in AMT so why should I care? I usually respond with, Ignoring the AMT and its associated calculations can have serious, unintended consequences. The fact is, they may owe AMT and not know it. Ignoring the AMT can produce consequences such as: Overpayment of taxes due to improper maintenance of AMT attributes, thus limiting the corporate taxpayer s ability to reduce its tax by reducing its Alternative Minimum Taxable Income (AMTI) via preferences and adjustments, cumulative Adjusted Current Earnings (ACE), etc. Underutilization of AMT Net Operating Loss (AMT NOL), leading to an unnecessary overpayment of taxes due to the need for its recalculation each time regular taxable income changes. Underutilization of General Business Credit (GBC) when the Tentative Minimum Tax (TMT) is not optimized; also leading to an unnecessary overpayment of taxes since additional GBC could have been used to offset the taxpayer s regular tax liability. An IRS examination for failing to take into account the effects of AMT (i.e., the 10 percent haircut ) when the company files a Form 1139 (Corporate Application for Tentative Refund), i.e., a carryback claim. Furthermore, if a company is generating NOLs in 2010 and 2011, some AMT may be due since unlike 2009, there is no suspension of the 90 percent limit on AMT NOLs via IRC Section 172(b)(1)(H). That, in and of itself, is a good reason to start paying closer attention to AMT. There are software tools, such as BNA Corporate Tax Analyzer, that are designed to assist tax professionals with minimizing the complexity of tracking AMT and help them to avoid costly mistakes associated with poor maintenance of AMT attributes. But before discussing BNA Corporate Tax Analyzer, let s review the history of AMT to understand its complexity, importance, and implications. The Alternative Minimum Tax The AMT is a federal tax imposed on top of the regular tax in the amount the tax so computed exceeds the taxpayer s regular federal income tax after credits. Effectively, taxpayers pay the higher of the two taxes, regular or AMT. It is an alternative tax because the rules for this minimum tax system constitute a complete, but not a separate and independent, set of rules to the regular tax system. 2

3 Corporations became subject to the AMT on January 1, 1987 via the 1986 Tax Reform Act. See Pub. L. No , 100 Stat (1986). The AMT a taxpayer pays becomes a credit [Minimum Tax Credit (MTC)] that may be allowed in future years against regular tax, but not to the extent regular tax would be reduced below the AMT. Basically, a corporation that pays AMT and eventually claims all of its AMT credits will have the same total tax liability over this period as it would have had in the absence of the AMT. Changing the Playing Field In 1993, the Internal Revenue Service began taking the position that certain limitations based on taxable income for regular tax purposes must be recalculated for AMT purposes, particularly the charitable contributions deduction. As purported justification for this position, the IRS declared that AMT was a separate and independent tax system. The only guidance provided was on Form 4626 Instructions for 1993 and subsequent years. In time, however, the courts, and even the Service itself, have thrown considerable doubt on the basis for such recalculations. For 1993, the Form 4626 (Alternative Minimum Tax Corporations) Instructions were changed from previous years, specifying that certain limitations be recalculated for AMT purposes. The IRS appears to have relied on the Blue Book for Tax Reform Act of 1986 (page 438 of the General Explanation prepared by the Staff of the Joint Committee on Taxation) as the primary reason for the changes. The Service then issued Prop. Reg. Section (Alternative Minimum Tax for Noncorporate Taxpayers), effective for taxable years beginning after In the supplementary information, the Service stated that subsection (a) requires that the AMT be treated as a tax system that is separate from and parallel to the regular tax system. Although the IRS presented numerous reasons for treating the AMT as a separate tax system, it provided virtually no guidance in the proposed regulation or the supplementary information on how to implement such a system. Ultimately, the authority for any such adjustments must be given in the Code, regulations, and legislative history. Further, in Technical Advice Memorandum (TAM) , the Service itself appears to have backed away from its rationale behind the 1993 Form 4626 instructions. The taxpayer in that TAM had increased regular taxable income by the amount of the targeted jobs credit generated during the year, via IRC Section 280C(a), but it did not increase the Alternative Minimum Taxable Income (AMTI) by that amount. As support for its position, the taxpayer relied upon page 438 of the Blue Book. However, the Service ruled against the taxpayer. It concluded that the taxpayer must increase both regular taxable income and AMTI by the amount of the jobs credit, despite the fact that credit can only be utilized against the regular tax and not against the AMT. In explaining its position, the IRS made it clear that the meaning of a separate and independent income tax system is subject to interpretation. The following are three pertinent excerpts from the Service s ruling: Although the phrase separate but parallel does not appear anywhere in the applicable statutes, we agree with Taxpayer that after the 1986 Act the AMT generally functions as a tax system separate from but parallel to the regular tax system. Our disagreement with Taxpayer goes to the issue of exactly what is meant when it is said that the AMT constitutes a tax system separate from but parallel to the regular tax system. In our view, 3

4 the separate but parallel principle does not encompass the type of adjustment advocated by Taxpayer. The separate but parallel nature of the AMT arises from the statutory provisions imposing AMT, and these provisions do not produce the result Taxpayer desires... The mere statement that one tax system is separate from another tax system only makes it clear that at least two different taxes are involved. It conveys no information regarding the degree of difference, which may vary over a broad continuum. The IRS ruled against the taxpayer because there was nothing in the statutory language or legislative history of the 1986 Act allowing it to treat the Section 280C(a) add-back differently for AMT purposes. Quite reasonably, TAM required the taxpayer to look to the Code or legislative history for support of its position. The statutory language and legislative history of the 1986 Act contains nothing specifying that the charitable and depletion limitations be refigured for AMT purposes. Additionally, there is no such support in the Form 4626 instructions. Therefore, following the reasoning in the TAM, no such adjustments should be required. Internal Revenue Code Section 59(h) lists the regular taxable income limitations that are to be recomputed for Alternative Minimum Taxable Income purposes. It states: The limitations of Section 704(d) [partnership losses], Section 465 [at risk limitations], and Section 1366(d) [S corporation losses] (and such other provisions as may be specified in regulations) shall be applied for purposes of computing the Alternative Minimum Taxable Income of the taxpayer for the taxable year with the adjustments of IRC Section 56, 57, and 58. Note that Section 59(h) does not list the charitable deduction or depletion limitations among those that are to be recomputed. Although it authorizes regulations to add to the list, no such regulations have yet been issued. In fact, there appears to be no specific authority for recomputing these limitations either in the Code, the regulations, or in the legislative history. Absent any such authority, the regular tax limitations apply, and no recalculation is required for AMT purposes. Key Court Rulings In Allen v. Commissioner, 118 T.C. 1, 10 (2002), the Tax Court ruled on the same issue as TAM and reached the same result. The court specifically relied on the Code for its determination. IRC Section 280C(a) specifies that taxable income is to be increased by the amount of the jobs credit. IRC Section 55 specifies that AMTI equals taxable income with the modifications specified in Sections 56 though 58. Since IRC Section 280C(a) is not specifically referenced in Sections 55 through 58 (or Section 59 which includes definitions, etc.), the court ruled that AMTI must also include the increase due to the jobs credit. In Ventas Inc. v. United States, 57 Fed. Cl. 411 (7/30/03), the U.S. Court of Federal Claims also ruled on the same issue and also concluded AMTI must be increased by the amount of the jobs credit. In doing so, the court explicitly rejected the notion of the AMT as a separate tax system: Based on the language and legislative purpose of the alternative minimum tax, we conclude that (1) the basis of alternative minimum taxable income is regular taxable income, (2) adjustments to that income for purposes of computing alternative minimum taxable income are permitted only to the extent that they are congressionally prescribed, 4

5 and (3) this result is consistent with the fact that the alternative minimum tax was enacted to serve as a safeguard within the regular income tax system, not as a wholly separate system. The U.S. Court of Appeals for the Federal Circuit affirmed the U.S. Court of Federal Claims in Ventas and cited Allen with approval (Ventas Inc. v. United States, Fed. Cir., No (8/24/04). See also, Sequa v. United States, 350 F.Supp.2d 447 (9/27/04), wherein a taxpayer s effort to seek a refund via an AMT NOL carryback to pre-1987 years was denied. The court agreed with the Allen and Ventas courts, noting that: courts have emphatically rejected this description (the AMT as a separate and independent income tax system ) as determinative of whether certain features of the Internal Revenue Code are applicable to AMT calculations. given the various conflicting provisions of the Internal Revenue Code and the legislative history of the AMT, the characterization of the AMT as wholly separate or parallel is unhelpful in resolving specific disputes the terms are mere semantics and have no value as interpretive tools. The AMT Calculation Today Thus, the starting point for determining income for AMT purposes is the corporation s regular taxable income, as modified by a series of additional computations, termed adjustments and preferences. Adjustments can either increase or decrease taxable income, whereas preferences are calculated on a property-by-property basis and only entered to the extent that they are positive. AMT income may effectively be reduced by up to 90 percent through net operating losses and foreign tax credits (prior to January 1, 2005), both of which are recalculated using AMT principles. The 20 percent tax rate is applied to this measure of income, yielding the tentative minimum tax. This amount is then compared to the corporation s regular tax liability before all credits except the foreign tax credit. If the tentative minimum tax is larger, the corporation pays the excess as AMT in addition to its regular tax liability. If the corporation s regular tax liability exceeds its tentative minimum tax, it may further reduce its regular tax by allowable business credits, but generally not below its tentative minimum tax. For corporations with large amounts of business credits, such as the credit for research and experimentation (R&D), the AMT may serve to increase the corporation s tax liability by delaying the use of these credits even if the corporation pays no AMT.* The corporate AMT is codified in Sections 55 through 59 of the Internal Revenue Code and is intended to ensure that corporate taxpayers will pay a minimum tax even when they owe no regular tax. Standard rules of business income taxation call for the recognition of income as it accrues, that is, at its receipt or when all events have occurred that fix the right to receive the income, whichever comes first. Deductions are permitted only when definite liabilities have been incurred. These standard rules are strongly influenced by, but differ somewhat from, both financial accounting practices and economic principles of income measurement.* Given the larger measure of taxable net income under the AMT, practically all corporations would pay AMT were it not for the fact that the tax rate under the AMT is lower than the maximum tax rate under the regular tax system. The corporate tax rate under the AMT is 20 percent, while the average corporate tax rate under the regular tax system is 35 percent. 5

6 Therefore, with regular tax rate about 57 percent higher than the AMT rate, a corporation s income must be at least 57 percent greater under the AMT before it must make payments using this system. It might at first appear that such a significant percentage change in net income would require that the AMT use different measures of includable income or allowable deductions relative to the regular tax system. But it would only take a small change in includable gross receipts or allowable deductions to create an AMT tax liability.* Because the AMT credits are taken after the corporation s AMT payments, however, the AMT has resulted in an acceleration of tax payments. The cost to the corporation of this acceleration is the forgone earnings on these funds. If a corporation must wait a long time before claiming its AMT credits, this cost may be a sizable fraction of the AMT payment.* The fact is, with the type of nuance and complexity involved in AMT, why take the risk of incurring additional tax due to tax planning and management only using spreadsheets? Today s tax professionals can rely on the same software tool that the IRS uses every day to deal with AMT issues when it determines the tax bill of corporate taxpayers. Eliminate Errors and Track AMT Complexities Easily BNA Corporate Tax Analyzer is a software application that calculates federal income taxes over multiple years. It dynamically analyzes regular tax and AMT separately. Therefore, tax professionals are assured that when Alternative Minimum Tax, or a combination of both regular and AMT, is due they can easily gauge the company s tax impact on a yearly basis Our four-year carryback calculation involved AMT and it was so complicated that there was no way we could do it manually. BNA Corporate Tax Analyzer came to the rescue, handling all of the calculations and automatically allocating the qualifying percentages over the applicable years. Gina Polweka, Senior Tax Manager, Western Refining, Inc BNA Corporate Tax Analyzer automatically does carryovers and carrybacks of regular and AMT tax attributes and displays the results in a system of input and output worksheets. It enables users to create up to 30 what-if scenarios so they may model several tax strategies at the same time. Bloomberg BNA has designed this software to address and effectively manage all the moving parts of the Alternative Minimum Tax: ACE Input Worksheets enable users to track E&P adjustments that in part determine cumulative ACE over as many as 30 years in order to maximize this tax attribute. Many corporations do a poor job of or do not maintain their AMT tax attributes if they are not in AMT from year-to-year. Consequently, they typically overpay any tax owed via AMT because they have no AMT tax attributes to offset against the AMTI. The AMT NOL is another attribute that typically is not tracked effectively. As a result, it is ineffectively utilized against the AMTI, which can sometimes result in paying up to ten times more tax than necessary. A primary reason is that each time AMTI is changed whether due to taxable income changes or changes to adjustments or preference items the AMT NOL must be recalculated up to its 90 percent maximum for each occurrence and then 6

7 re-saved on spreadsheets. BNA Corporate Tax Analyzer eliminates that busywork by automatically displaying, on a series of worksheets, AMT NOL movement and utilization separately, again for up to 30 years. TMT is important to calculate on a yearly basis even when a company does not owe AMT. That s because the organization needs to know how many credits, i.e. GBCs, can be taken against the tax due. Some GBCs are actually allowed up to 25 percent below the TMT floor. This matters because generally as the AMTI increases, TMT increases and the credit limitation can be smaller. Conversely, when AMTI decreases, TMT decreases and the credit limitation can be larger. BNA Corporate Tax Analyzer generates and displays all of this needed information in detailed, documented worksheets. Form 1139 carryback claims can also be affected by AMT. Ignoring the effects of AMT when filing a Form 1139 carryback claim when AMT is due (for refund via a NOL carryback) potentially exposes the corporate taxpayer to an unnecessary subsequent year examination. BNA Corporate Tax Analyzer not only prepares the Form 1139, while taking into account the effects of AMT, it will also allow the user to model data upon which the form is prepared for up to 30 scenarios. BNA Corporate Tax Analyzer, the software that s used by leading corporations and the IRS, frees corporate tax professionals from the constant monitoring of AMT attributes and its associated calculations in time-consuming, separate spreadsheets be it regular, alternative, or a combination of both. Conclusion The Alternative Minimum Tax will continue to present corporate tax professionals and their companies with complex, potentially costly challenges for the foreseeable future. Knowing how to effectively address AMT complexities and to produce error-free calculations in multiyear scenarios is in fact an important element of today s tax planning and management. As discussed in this paper, the consequences of ignoring AMT can be very significant. In today s economy, no company wants to find they have overpaid taxes, or that they need to write the IRS an unexpected check, complete with penalties and interest I know that I can rely on the product for accurate tax calculations in even very complex scenarios spanning many tax years... I have found BNA Corporate Tax Analyzer to be a worthwhile investment that has paid for itself many times over. Madeline Schneider, Director, Federal Tax Audits and Planning, Brunswick Corporation Spreadsheets and compliance software do not provide a multi-year approach to automatically track critical attributes accurately and use them properly against tax liabilities. That is why many of the nation s top corporations such as Brunswick, Honeywell, Northrop Grumman, and Seagate Technology, as well as the IRS, rely on BNA Corporate Tax Analyzer. * NTA Encyclopedia of Taxation and Tax Policy, Second Edition, edited by Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle, (1999). 7

8 BNA Corporate Tax Analyzer BNA Corporate Tax Analyzer is the only product that automates the calculation and tracking of carryforwards and carrybacks of NOLs, FTCs, AMT, GBCs, charitable contributions, and more over multiple years. With its comprehensive set of calculations, compliance, reporting and analysis, planning, and audit capabilities, BNA Corporate Tax Analyzer can enhance or replace risky, time-consuming spreadsheets, saving tax departments hundreds of hours of time and effort every year. About David McPherson David McPherson is a Product Manager and Senior Tax Specialist with Bloomberg BNA. An expert in corporate income taxation, David graduated from the University of Maryland with a B.S. in Management Studies. He earned his Juris Doctorate and LL.M from the University of Baltimore. About Bloomberg BNA s Software Products Bloomberg BNA offers expert software products for tax and accounting professionals. With category-leading software and top-rated technical support, we are the solution of choice for professional firms and corporations of every size. More than 70,000 customers, including the IRS, depend upon Bloomberg BNA s software products for the highest degree of tax, regulatory, and compliance expertise available in the market. About Bloomberg BNA Bloomberg BNA, a wholly owned subsidiary of Bloomberg, is a leading source of legal, regulatory, and business information for professionals. Its network of more than 2,500 reporters, correspondents, and leading practitioners delivers expert analysis, news, practice tools, and guidance the information that matters most to professionals. Bloomberg BNA s authoritative coverage spans the full range of legal practice areas, including tax & accounting, labor & employment, intellectual property, banking & securities, employee benefits, health care, privacy & data security, human resources, and environment, health & safety. Though intended to provide accurate and authoritative information, this publication is provided with the understanding that it does not constitute tax, legal, accounting, or other professional advice or service. This publication may not be reproduced, stored in a retrieval system, or transmitted in whole or in part, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of Bloomberg BNA. For more information call , contact your local Bloomberg BNA Representative, or visit South Bell Street, Arlington, VA, BNA Software, a division of Tax Management Inc. All rights reserved. CT002-WH rc 8

BNA Corporate Tax Analyzer. The essential software for corporate income tax management.

BNA Corporate Tax Analyzer. The essential software for corporate income tax management. BNA Corporate Tax Analyzer The essential software for corporate income tax management. BNA Corporate Tax Analyzer From compliance and analysis to IRS negotiations, you know that corporate tax management