Alternative Minimum Tax (Pulliam)

Alternative Minimum Tax

Darlene Pulliam

Copyright © 2016 by Darlene Pulliam

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ISBN 978-0-9974924-4-6

Part I

Overview

101 The Alternative Minimum Tax

The basic structure of the current alternative minimum tax (AMT) is primarily the result of amendments by the 1986 Tax Reform Act (86 Act). The AMT system is a parallel tax system, requiring the application of the AMT rates to a broader tax base than the regular taxable income. The taxpayer pays the greater of the regular income tax or the tentative AMT. The tentative AMT is the alternative minimum tax base (see formula below) multiplied by the alternative minimum tax rates, less the AMT foreign tax credit.

The alternative minimum tax that existed prior to the 86 Act applied only to individuals. The pre-86 Act add-on minimum tax applied to corporations. Both of these minimum taxes that were part of the law prior to the 86 Act usually applied only to taxpayers with substantial tax preferences such as capital gains and tax shelter losses. Since very few taxpayers had such transactions, most taxpayers were not subject to the tax.

The structure of the current AMT causes many more taxpayers to be subject to the tax. Many of the adjustments contained in the current AMT law, such as the positive adjustment for personal and dependency exemptions, affect almost all individual taxpayers. Consequently, not only relatively wealthy taxpayers but also many middle-income taxpayers are finding themselves subject to the AMT.

105 Basic Structure and Underlying Concepts of the AMT

The AMT is based on different basic concepts than the minimum tax prior to the 86 Act. The adjustments discussed in Part II are, to a great extent, the method for applying these concepts that underlie the AMT.

The first concept is that the AMT system is a separate, freestanding system. Conceptually, the tentative minimum tax could be computed without computing the regular taxable income, using the methods required under the AMT system. However, the AMT is computed by starting with the regular taxable income and making adjustments or adding preferences.

Note: Unless the AMT specifically requires a different method for purposes of computing AMTI, the regular income tax method. In Charles C. Allen, III, Tax Court held that the rule barring deduction for the portion of wages equal to the target jobs credit applies equally for purpose of computing AMTI. There is no adjustment or preference requiring a different amount to be used for regular income tax purposes and AMT purposes. See Charles C. Allen, III, 118 TC 1, 1/4/02.

Another concept is that one purpose of the AMT is to accelerate the payment of income taxes. When an individual takes advantage of the tax law allowing a tax accounting method such as accelerated depreciation, the computation of the AMT may require that taxes be paid now by requiring a positive adjustment in computing AMT income. However, a negative adjustment may be made later, reducing the AMT in later years. For many of the adjustments, the effect is to not require that additional taxes are due because of the AMT, but to require that taxes are due earlier because of the AMT. In addition, the AMT credit may reduce the amount of regular taxes due in the future. This is not true of exclusion adjustments such as the individual adjustment for itemized deductions. For exclusion adjustments, AMT may be required in a given year and there will be no corresponding reduction in the tax in the future.

The current AMT is a very broad-based tax. The adjustments affect many tax-advantaged methods that were not addressed by the add-on minimum tax or former alternative minimum tax. Included in the current AMT are adjustments for such accounting methods as accelerated depreciation (addressed to a lesser extent by the former minimum taxes), tax-exempt interest, and passive losses. A very burdensome adjustment is the ACE adjustment, bringing most, if not all, profitable corporations not subject to the regular income tax into a tax-paying position and requiring excessive amounts of record keeping.

The alternative minimum tax formula can be outlined as follows:

Begin with: Regular taxable income before the net operating loss (NOL) deduction

Add/Subtract: Adjustments other than adjusted current earnings (ACE) adjustment

Add: Tax preferences

Equals: Alternative minimum taxable income (AMTI) before ACE adjustment and NOL deduction

Add/Subtract: Adjusted current earnings adjustment (corporations only)

Subtract: AMT net operating loss deduction

Equals: Alternative minimum taxable income

Subtract: Exemption

Equals: Tentative minimum tax base

Multiple by: AMT rates

Equals: Tentative minimum tax before foreign tax credit

Subtract: AMT foreign tax credit

Equals: Tentative minimum tax

Subtract: Regular tax before all credits except the foreign tax credit and possessions tax credit

Equals: Alternative minimum tax

The computation of the alternative minimum tax (AMT) is outlined is Sections 55, 56, 57 and 58. The alternative minimum taxable income (AMTI) is determined by using adjustments and preferences to increase or reduce regular taxable income. The alternative minimum tax rates are applied to determine the tentative minimum tax before reduction for the foreign tax credit. The tentative minimum tax is reduced by the foreign tax credit to arrive at the tentative minimum tax. The tentative minimum tax is compared to the regular income tax. If the tentative minimum tax is greater than the regular income tax, the difference is the AMT. AMT is added to the regular income tax to result in the amount of taxes due.

The payment of the AMT generally increases the amount of AMT credit to be carried forward to future years. If the regular income tax is greater than the tentative minimum tax, the regular income tax may be reduced by any AMT credit carried forward. The regular income tax may be reduced to an amount no less than the tentative minimum tax. This reduced regular income tax is the amount of taxes due.

115 Adjustments and Preferences

Adjustments are the means by which the tax-saving or tax-deferral effect of several tax methods or deductions is reduced. Some adjustments are made only by noncorporate taxpayers, some only by corporate taxpayers and many are made by all taxpayers subject to the AMT.

Some of the adjustments are exclusions. For example, the limitations of itemized deductions reduce the amount of the deductions that may be deducted for purposes of the AMT in any given year. The reduction is permanent and there will be no corresponding larger deduction in the future. Consequently, these adjustments result in a permanent increase in the amount of taxes paid.

However, many of the adjustments are deferrals. For example, in the early years of an asset’s life, the amount of the AMT depreciation deduction will generally be less than the regular income tax deduction. However, in future years, the AMT depreciation deduction amount will be greater, or the amount of gain on disposition will be less, than the regular tax amounts. For this type of adjustment, the AMT should result in an acceleration of the payment of taxes rather than a permanent increase in the amount of taxes paid.

The tax preferences remain from pre-86 Act law. The preferences that are found in Section 57 only increase alternative minimum taxable income and are permanent in nature. For example, tax-exempt interest on private activity bonds is not included in regular taxable income but must be added back to compute alternative minimum taxable income. There is no corresponding reduction in alternative minimum taxable income in future tax years.

NOTE: Adjustments are discussed at Part II and in the corporate AMT and individual AMT parts. Preferences are discussed at Part III and in the individual AMT part.

125 Taxpayers Subject to the AMT

C corporations, individuals, estates and trusts are subject to the tax. Even entities that do not pay the AMT directly are required to make the elections, such as depreciation methods, that flow through to the partners or other owners and may directly affect their AMT liability. Partnerships, S corporations, estates and trusts are the conduit entities that must provide AMT information to their owners, heirs, and beneficiaries. Since limited liability companies and limited liability partnerships are generally treated as partnerships, these entities are also conduit entities. The various entities that are affected by the AMT are discussed in the following paragraphs.

135 Corporations

Corporate taxpayers were first subjected to the alternative minimum tax (AMT) with the enactment of the Tax Reform Act of 1986 (86 ACT). Prior to this legislation, corporations had been subject to the add-on minimum tax. The AMT is a major departure from the former minimum tax.

The former add-on minimum tax only applied to a relatively small group of tax preferences. The tax rate was 15 percent. Good tax planning allowed most corporations to completely avoid the tax.

C Corporations were and continue to be a primary target of the AMT. An impetus to the passage of the provisions in the 86 Act was the public perception that many large corporations were generating large financial statement income, but taking excessive advantage of the tax law and paying little or no taxes, and even generating large refunds due to net operating loss carrybacks. The Book Untaxed Reported Profits (BURP) adjustment (repealed and replaced by the Adjusted Current Earnings adjustment) was specifically motivated by Congress’s desire to ensure that all profitable corporations pay some minimum amount of taxes. The BURP adjustment required that each corporation compare its pre-BURP alternative minimum taxable income with financial statement income. If the alternative minimum taxable income was less than financial statement income, the alternative minimum taxable income was increased by half of the difference. Consequently, every corporation would be taxed on at least half of its financial statement income. The BURP adjustment was replaced by the ACE adjustment discussed below.

The current AMT enjoys much broader application and affects a broad spectrum of corporations. The higher tax rate of 20 percent, the broadened tax base, and the general structure of the tax have resulted in a very significant burden on U.S. corporations. The Citizens for Tax Justice periodically issues statistics on the tax-paying records of large corporations. A statement by the director to the Senate Finance Committee in May of 1995¹ pointed out that in a survey in 1986, 130 of 250 companies surveyed had managed to pay no taxes in one of the five years surveyed. Mr. McIntyre reported that after the AMT was added to the tax law, the number of no-tax giant corporations in CTJ’s last comprehensive survey dropped sharply – to only seven in 1988. But the Institute on Taxation and Economic Policy (with the same Bob McIntyre as major contact) is now reporting that recent amendments to the AMT have allowed many companies to reduce the taxes paid under the AMT². In this study, the same Mr. McIntyre reported that the new survey found that the 250 companies paid only 20.1 percent of their profits in taxes, compared to 26.5 percent in the 1988 survey.

The AMT is structured as a second, parallel system – really a second and third parallel system when the adjusted current earnings (ACE) adjustment is considered. Substantial record keeping is required to compute the annual adjustments required. For example, the depreciation adjustments require that depreciation schedules be maintained for regular tax purposes, for AMT and for ACE. The ACE requirements are being reduced over time, but will continue to require substantial additional record keeping for the foreseeable future. See the discussion of ACE in Part V. The nature of the required adjustments presents very few planning opportunities to reduce the AMT burden. For example, if the corporation has tax-exempt interest income that has escaped taxation for purposes of the regular income taxable income and the alternative minimum taxable income, the interest is required to be included in ACE. The only means of avoiding this effect is to dispose of the municipal bonds.

The AMT is computed on Form 4626 for corporations. The AMT credit is computed on Form 8827.

NOTE: The AMT’s application to C corporations is discussed at Part V – Computation of AMT – Corporations, Part VI – Adjusted current earnings and Part VII – Affiliated Group Filing a Consolidated Return.

ACE

Tax reformers have long been concerned about corporations that report a large financial statement income without the concurrent payment of income taxes. Corporations reporting large financial statement income while reporting large net operating losses have brought attention to the phenomena. These corporations have only engaged in legal tax avoidance and taken advantage of the tax methods enacted by Congress. In some cases these large corporations have been so adept at legally manipulating the tax law that they attracted public attention³, followed by Congressional attention and the alternative minimum tax. In crafting the Tax Reform Act of 1986 (86 Act), lawmakers expressed a desire to ensure that all corporations paid a minimum amount of tax on their financial statement income. The book income adjustment required by the 86 Act required that every corporation pay at least 10 percent of their financial statement income as an income tax. The book income adjustment was later replaced with the adjusted current earnings (ACE) adjustment.

The ACE adjustment is not in any way connected to financial statement income. However, the legislative goal of ACE is the same. Congress was trying to ensure that every corporation pays some income tax if that corporation is producing positive financial income. The ACE is based on concepts similar to the concepts found in the computation of earnings and profits (E&P) found in Section 312. However, the resulting amount of adjusted current earnings is a very different amount than current E&P. Generally, positive adjustments (income items) required in arriving at E&P are also required in arriving at ACE. However, negative adjustments (expense items) required in arriving at E&P are generally not allowed in arriving at ACE. Consequently, ACE is a very broad measure of income - often broader than financial statement income.

NOTE: The ACE adjustment is discussed at Part VI.

Affiliated Groups Filing Consolidated Returns

Taxpayers and tax practitioners have found the AMT to be quite complex. Applying the concepts of a parallel tax system and acceleration of tax payment based on slower deduction of tax benefits requires substantial computations. Complexity is also added by the substantial record-keeping requirements to provide information to compute the AMT. Another very complex area of taxation is the filing of a consolidated return by an affiliated group (consolidated group). The combination of these two complex areas of taxation has resulted in an extremely complex area of tax law.

The consolidated return regulations require that each member of the consolidated group compute separate taxable income. The amounts are summed and then various items such as the charitable contribution deduction are computed on a consolidated basis. The corporate tax rates are applied to the resulting consolidated taxable income to determine consolidated regular income tax.

AMTI is also computed on a consolidated basis. First, the separate AMTIs are determined, prior to the ACE adjustment, but including the effects of the other adjustments and preferences. These separate AMTIs are added together and the consolidated items are determined, but the consolidated net operating loss is excluded at this point. The consolidated ACE adjustment is computed, followed by the consolidated net operating loss. The consolidated tentative minimum tax is then computed and compared to the consolidated regular income tax.

Other consolidated issues include the computation of net operating losses and credits when corporations enter or leave the consolidated group.

NOTE: Affiliated groups filing consolidated returns are discussed at Part VII.

145 Individuals

The alternative minimum tax that was part of the law prior to the 86 Act applied only to individuals with substantial tax preferences such as capital gains and tax shelter losses. Since very few individuals had such transactions, most individuals were not subject to the tax. The current structure of the AMT causes many more individuals to be subject to the tax. Many of the adjustments now contained in the law, such as the positive adjustment for personal and dependency exemptions, affect almost all individual taxpayers. Consequently, not only relatively wealthy taxpayers but also many middle-income taxpayers are finding themselves subject to the AMT.

A tax-planning technique known as income sprinkling is to transfer income-producing property from a high-income taxpayer in a high marginal tax bracket to a related lower income taxpayer in a lower marginal tax bracket. This practice has been limited by treating a portion of the unearned income of children under the age of 14 as if it were earned by the parents and subjecting this income to the parents’ higher marginal tax rate. This tax is referred to as the kiddie tax. These children, just like all individuals, are also subject to the AMT, but have a their own AMT exemption amount.

The AMT for individuals is reported on Form 6251 attached to the Form 1040 filed annually. The AMT paid by children under the age of 14 is also computed on Form 6251. The AMT credit is computed on Form 8801 by all individuals.

NOTE: The application of the AMT to individuals is discussed at Part VIII – Computation of Alternative Minimum Tax for Individuals, and a discussion of the application of the AMT to children under the age of 14 is found at Part IX – Kiddie Tax. An analysis of the required levels of income and adjustments and preferences to cause the individual to be subject to the AMT can be found in 805.

155 Trusts and Estates

Estates and trusts play two roles in the computation of the AMT. First, the trust or estate may be subject to the AMT. A trust or estate computes AMT in the same manner as an individual, except that the Subchapter J rules apply. Although trusts and estates are potentially subject to all of the adjustments and preferences to which an individual is subject, by their nature there are some adjustments and preferences more commonly encountered with these entities. These adjustments and preferences include the preference for tax-exempt private activity bonds, the installment sale preference, and the passive activity loss adjustment. These taxes are reported with a Form