The tax reform bill passed by the Senate early Saturday morning (the “Senate bill”) retains the corporate alternative minimum tax (“AMT”) apparently without any changes to current law. Earlier versions of the Senate bill, consistent with the bill passed by the House, repealed the corporate AMT. This late change to the Senate bill has a number of apparently far-reaching (and hopefully unintended) consequences for corporate taxpayers, including potentially undoing many of the benefits of the international tax reform provisions that are part of the bill.
Background on AMT. Under section 55, a corporation’s federal income tax for the year is increased to the extent that its “tentative minimum tax” (“TMT”) for the year exceeds its “regular tax” for the year. A corporation’s TMT for the year is generally equal to 20% of the corporation’s “alternative minimum taxable income” (“AMTI”) for the year. The computation of AMT starts with the regular taxable income and then is determined with (generally, but not always, increased by) the adjustments described in sections 56 and 58, and is increased by various tax preference items described in section 57.
Use of the Same Rate. The basic framework of the AMT is predicated upon the tax rate applicable for purposes of the AMT being lower than the tax rate that would otherwise apply. However, under the Senate bill, beginning in 2019 the AMT corporate tax rate and the regular corporate tax rate would each be 20%. As a result, a taxpayer would generally lose, in whole or in part, the benefit of any deduction or income exclusion that is taken into account for regular income tax purposes but is not taken into account (or is adjusted) in determining AMTI.
Needed Changes. The effect would be only partially mitigated if the AMT corporate tax rate were reduced to a rate below 20%. We hope (and cautiously expect) that Congress will in fact rethink the Senate’s decision to retain the corporate AMT. However, if Congress retains the corporate AMT, we believe it is necessary that Congress both (i) meaningfully reduce the applicable AMT corporate tax rate and (ii) make further amendments to clarify that certain tax deductions (including those deductions integral to the new approach to international taxation) are not treated as adjustments or tax preference items that are added back in computing the AMT.
FDII, GILTI and Participation Exemption Impact if Changes are Not Made. In the absence of such changes, the retention of the corporate AMT threatens to eliminate as much as 75% of the intended benefit of the Senate bill’s lower tax rates for “foreign derived intangible income” (“FDII”) and “global intangible low-taxed income” (“GILTI”), as well as the 100% participation exemption deduction for dividends from specified 10%-owned foreign corporations, with the effect that the United States would continue to operate under a worldwide system of taxation.
As described above, section 55(b)(2) defines AMTI as taxable income determined with, among other things, the adjustments in section 56. Section 56(g)(1) in turn provides for an increase to AMTI, commonly referred to as the “ACE” adjustment, for 75% of the excess of “adjusted current earnings” over AMTI (without the ACE adjustment and the AMT NOL deduction). ACE is calculated by making certain adjustments to AMTI. Importantly, one such adjustment (section 56(g)(4)(C)(i)) provides that no deduction is allowed for any item “if such item would not be deductible for any taxable year for purposes of computing earnings and profits.”
There is not a complete set of statutory rules for determining earnings & profits (“E&P”), but, in general, noneconomic expenses, even if deductible for regular income tax purposes, do not reduce E&P because they are noneconomic deductions and thus don’t reduce the corporation’s ability to make distributions to shareholders. Therefore, for example (although we are not aware of any statute or authority directly on point), it is commonly accepted that neither the dividends-received deduction (“DRD”) nor the section 199 deduction for qualified production activities is deductible in computing E&P. This is consistent with the other provisions of section 56(g)(4)(C), starting with clause (ii), which provides an exception to clause (i) for the DRD, and clause (v), which contains a specific exception for the 199 deduction. Neither of these exceptions would be necessary if these deductions weren’t within the scope of clause (i) as items that are not deductible for purposes of computing E&P.
The FDII/GILTI deductions and the participation exemption deduction are each noneconomic deductions that (like the DRD and the section 199 deduction) are intended to reduce the effective rate of, or eliminate the residual, US tax on the income to which such deductions relate. Therefore, absent the inclusion of an express exception for these deductions in section 56(g)(4), it appears likely that these deductions would be added back to AMTI for purposes of determining ACE and therefore, all other things being equal, would increase AMTI by an amount equal to 75% of the amount of these deductions – effectively undoing 75% of the intended tax benefit of these deductions.
(It’s worth noting that section 56(g)(4)(C)(vi) contains an exception for the deduction allowable under section 965 – which under current law is a reference to the temporary dividends-received deduction that was allowed in connection with the repatriation of deferred foreign earnings in 2004 and 2005. Apart from providing additional support for the proposition that this deduction would otherwise be within the scope of clause (i) absent the exception, section 56(g)(4)(C)(vi) has the effect (perhaps serendipitous) of excluding from the ACE adjustment the participation exemption deduction that applies for purposes of the transition tax on accumulated deferred foreign earnings, since the transition tax and related participation exemption deduction would be adopted as section 965, replacing the existing section 965.)
Other items that are deductible or excluded from gross income from the computation of regular taxable income, but which are included in the computation of AMTI – such as interest income on tax-exempt state and local bonds – would appear to be similarly affected.
Coordination of BEAT and AMT. Moreover, it is also not entirely clear how the corporate AMT is intended to interact with the “base erosion and anti-abuse tax” (“BEAT”) contained in the Senate bill, which itself operates as a type of alternative minimum tax. For example, it appears that, under section 56(c)(1), the BEAT would be included in the amount of regular tax paid by the taxpayer for purposes of determining whether the taxpayer is liable for the AMT. However, it appears that under proposed section 59A(b)(1), the AMT is not included in the amount of regular tax paid by the taxpayer for purposes of determining whether the taxpayer is liable for the BEAT.