On September 12, 2023, the Internal Revenue Service (IRS) and Department of the Treasury (Treasury) released a third substantive piece of guidance, Notice 2023-64 (Notice) clarifying the application of the new corporate alternative minimum tax (CAMT). Prior guidance clarifying application of the CAMT was released in Notice 2023-7 and Notice 2023-10, but questions lingered for many taxpayers and practitioners seeking to understand the myriad of issues that come with the calculation, evaluation and understanding of this new tax. The Notice addresses a range of topics from the nuances of Applicable Financial Statement (AFS) and Applicable Financial Statement Income (AFSI) determinations, to CAMT implications on consolidated groups and CFCs. This Alert summarizes the Federal tax accounting implications of new guidance contained in the Notice and highlights provisions that are of note to corporations expecting to be subject to the CAMT, including the prioritization of AFSs, new depreciation and amortization guidance in calculating AFSI, as well as allowable AFSI adjustments to prevent the duplication and/or omission of income.
Overview and Background
Enacted under the Inflation Reduction Act of 2022 (Act), the CAMT is imposed on an applicable corporation based on its AFSI for tax years beginning after December 31, 2022. A corporation is an applicable corporation for a tax year if it meets the average annual AFSI test for one or more years that (1) are prior to the current tax year and (2) end after December 31, 2021. An applicable corporation’s CAMT liability is equal to the excess, if any, of (1) its tentative minimum tax for the year over (2) the sum of its regular tax liability and its base erosion and anti-abuse tax (BEAT) liability for the year. The tentative minimum tax of an applicable corporation is generally equal to 15% of its AFSI (reduced by the amount of its CAMT foreign tax credit (FTC) for the current tax year).
Section 56A generally provides that AFSI is the net income or loss of the taxpayer set forth on the taxpayer’s AFS for the current taxable year. Section 56A provides certain adjustments a taxpayer may make to its financial statement income to arrive at AFSI, including, for example, adjustments to AFSI to prevent the omission of duplication of any item, as well as adjustments for depreciation, amortization for qualified wireless spectrum, and certain taxes. Section 56A also provides a number of baseline rules to address taxpayers with consolidated financial statements, taxpayers that are members of consolidated groups, as well as the implications of partnerships and CFCs in AFSI determinations.
While Section 55 established the CAMT and Section 56A clarifies AFSI for purposes of CAMT determinations, Section 59(k) defines an “applicable corporation” and the annual AFSI test a taxpayer must complete to determine whether the taxpayer has a CAMT liability. Generally, Section 59(k)(1)(B)(i) provides that a taxpayer meets the AFSI test if the average annual AFSI of the corporation for the three-taxable-year period ending with that taxable year exceeds $1 billion. To the extent a corporation is a member of a foreign-parented multinational group (FPMG), a corporation meets the average annual AFSI test if the AFSI of the FPMG exceeds $1 billion and the average annual AFSI of that corporation alone exceeds $100 million. The statute also layers in certain aggregation rules for determining applicable corporation status.
Determining a Taxpayer’s AFS
Sections 4 and 5 of the Notice clarify the manner in which a taxpayer may determine its AFS and the amount of its AFSI. Specifically, section 4 of the Notice provides a list, in order of descending priority, of various types of financial statements that may qualify as an AFS. A taxpayer’s highest priority financial statement is its AFS. In order of descending priority, Section 4.02(1) of the Notice provides that a taxpayer’s AFS is: (1) its GAAP statements (i.e., Form 10-K, annual statement to shareholders, audited financial statement of the taxpayer used for credit purposes, reporting to shareholder, or any other substantial non-tax purpose); (2) IFRS statements; (3) other government and regulatory statements, other than a tax return, filed with the US Federal government, or any Federal agency, state government, state agency, foreign government, foreign agency, or self-regulatory organization, e.g., FINRA; or, unaudited external financial statements.
Additionally, if a taxpayer restates its financial statement income for a taxable year prior to the date that the taxpayer files its original Federal income tax return for such year, the AFS that reflects the restated financial statement income must be prioritized over the first AFS that is issued for that specific accounting period. Adjustments to the financial results of a prior accounting period that are disclosed in the notes to an original AFS for comparison purposes (e.g., in the case of a change in accounting principle) do not constitute a restated AFS for that prior accounting period for purposes of this notice.
It is also notable that a taxpayer with both annual and periodic financial statements covering less than a 12-month period, the taxpayer must prioritize the annual financial statements over the periodic financial statements.
Section 4.02(5) confirms the statutory rule that if a taxpayer’s financial results are consolidated with the financial results of one or more other taxpayers on a consolidated AFS, the taxpayer’s AFS is the consolidated AFS. To the extent that a taxpayer’s financial results are also separately reported on an AFS that is of equal or higher priority to the consolidated AFS, then the taxpayer’s AFS is its separate AFS. However, Section 4.02(5)(b) denies that exception in two circumstances. A corporation that is a member of a consolidated group must use the consolidated AFS that contains the financial results of the consolidated group, regardless of whether the corporation’s financial results also are reported on a separate AFS that is of equal or higher priority to the consolidated AFS. Additionally, if a taxpayer is a member of a FPMG and if the common parent of the FPMG prepares a consolidated AFS that includes the taxpayer, the taxpayer must use the FPMG consolidated AFS, regardless of whether the taxpayer’s financial results also are reported on a separate AFS that is of equal or higher priority to the FPMG consolidated AFS.
Section 5 of the Notice confirms that a taxpayer determines its AFSI by adjusting its financial statement income (FSI) only as provided in Section 56A, regulations, or other guidance (with certain exceptions for scoping purposes of determining applicable corporation status under Section 59(k)). Section 5.02(2) provides that a taxpayer’s FSI is its net income or loss set forth on the income statement (also referred to as the statement of earnings, statement of operations, or statement of profit and loss) included in the taxpayer’s AFS for the tax year. FSI includes all items of income, expense, gain, and loss reflected in the net income or loss set forth on the income statement for the tax year, including nonrecurring items and net income or loss from discontinued operations, regardless of whether such amounts are realized, recognized, or otherwise taken into account for determining the taxpayer’s regular tax liability. Conversely, FSI does not include amounts reflected elsewhere in the taxpayer’s AFS, such as in retained earnings or other comprehensive income. The Notice also provides certain guidance with respect to the determination of FSI from a consolidated AFS, for consolidated groups, and with respect to certain foreign corporations, which will be addressed in separate subject-matter specific alerts by the Eversheds Sutherland Tax group.
AFSI Adjustment for Certain Taxes
Section 8.02 of the Notice provides helpful guidance with respect to the timing of adjustments to AFSI required by Section 56A(c)(5). Section 56A(c)(5) provides that AFSI shall be appropriately adjusted to disregard any federal income taxes, or income, war profits, or excess profits taxes with respect to a foreign country or possession of the United States, which are taken into account on the taxpayer’s AFS. The statute provides that the Secretary shall prescribe regulations or other guidance to provide for the proper treatment of current and deferred taxes under this provision, including the time at which such taxes should be taken into account.
Section 8.02 indicates that the AFSI adjustment for income taxes taken into account on a taxpayer’s AFS is made in the tax year(s) in which the income taxes increase or decrease the taxpayer’s FSI or are included as a component of an adjustment to AFSI under Section 11.02 of the Notice (to prevent duplication or omission of an item). Appropriate adjustments to AFSI with income taxes taken into account on the taxpayer’s AFS include income taxes accounted for as deferred tax expense (benefit), as current tax expense (benefit), or through increases or decreases to other AFS accounts (e.g., accounts that track FSI from investments in other entities under the equity method). Income taxes are considered “taken into account on an AFS” if any journal entry has been recorded in the journal used to prepare the taxpayer’s AFS (or another AFS that includes the taxpayer) for any year to reflect the income tax, even if it does not increase or decrease the taxpayer’s FSI at the time of the journal entry. Further, income taxes taken into account on a partnership’s AFS is also considered “taken into account” on any AFS of its partners.
AFSI Adjustments for Depreciation
Section 56A(c)(13) provides that AFSI is reduced by depreciation deductions allowed under Section 167 with respect to property to which Section 168 applies, to the extent of the amount allowed as deductions in computing taxable income for the year. The statute further provides that AFSI shall be appropriately adjusted to disregard any amount of depreciation expense that is taken into account on the taxpayer’s AFS with respect to such property. Additionally, AFSI shall be adjusted to take into account any other items determined by the Secretary necessary to ensure the property is accounted for consistent with the treatment provided for such property under Chapter 1 of the Code.
Section 4 of Notice 2023-7 provided guidance clarifying application of the AFSI depreciation adjustment, and the Notice clarifies and modifies that guidance. A taxpayer that chooses to rely on the interim guidance in section 4 of Notice 2023-7 on or after September 12, 2023, must apply the guidance as modified and clarified by the Notice.
The Notice modified and clarified Notice 2023-7 to provide the following:
- Property is “property to which Section 168 applies” (Section 168 Property) only to the extent such property is depreciated under Sections 167 and 168.
- A taxpayer that changes its method of accounting for depreciation of any item of Section 168 Property for regular tax purposes must adjust its AFSI to reflect the Section 481(a) adjustment related to the change in order to prevent a duplication or omission of depreciation. An example demonstrates application of this rule.
- A taxpayer that capitalizes Tax Depreciation (as defined in Notice 2023-7) and recovers the capitalized amount through one or more deductions must reduce AFSI by those deductions regardless of whether the deductions are allowed under Section 167. An example provides that a taxpayer that capitalizes and amortizes Tax Depreciation under Section 174(a)(2) reduces its AFSI by the amortization deductions allowed under Section 174.
- A taxpayer that capitalizes Tax Depreciation to Section 1221(a)(1) property that is not inventory and recovers the capitalized amount through a computation of gain or loss from the sale or exchange of that property reduces AFSI by the amount of the capitalized Tax Depreciation.
- A taxpayer that takes a disposition loss (including an abandonment loss) into account in its FSI with respect to Section 168 Property for a tax year earlier than the year in which the disposition event occurs for regular tax purposes adjusts AFSI for the earlier tax year to disregard the disposition loss included in its FSI in that earlier year. The taxpayer must wait to take the disposition loss into account in its AFSI in the tax year in which the disposition event occurs for regular tax purposes.
In addition to modifying the depreciation guidance under Notice 2023-7, the Notice provides additional rules clarifying application of the depreciation adjustment. Specifically, the Notice clarifies that Section 56A(c)(13) does not apply to property that is not depreciated under Sections 167 and 168. Additionally, unless otherwise provided, a taxpayer that disposes of Section 168 Property for regular tax purposes and recognizes a gain or loss from the disposition in its FSI must recognize that gain or loss in its AFSI regardless of whether any gain loss is realized, recognized, or otherwise taken into account for regular tax purposes. For example, a taxpayer using the installment sale provisions under Section 453 to defer gain for regular tax purposes must recognize gain on disposition of installment sale property in its AFSI. Further, the nonrecognition rules of Section 1031 do not apply for purposes of determining AFSI gain or loss on disposition of property; rather, a taxpayer must recognize the entire redetermined gain or loss notwithstanding that only a portion is realized for regular tax purposes.
AFSI Adjustment for Qualified Wireless Spectrum
Section 56A(c)(14) provides that AFSI is reduced by amortization deductions allowed under Section 197 with respect to qualified wireless spectrum to the extent of the amount allowed as deductions in the tax year. AFSI is also appropriately adjusted to disregard any amount of amortization expense taken into account on the taxpayer’s AFS with respect to the qualified wireless spectrum and to take into account any other item the Secretary specifies as necessary to provide qualified wireless spectrum treatment consistent with that provided under Chapter 1 of the Code. Qualified wireless spectrum means wireless spectrum that was acquired after December 31, 2007, and before August 16, 2022, and which is used in the trade or business of a wireless telecommunications carrier.
Section 10 of the Notice provides guidance clarifying application of the qualified wireless spectrum adjustment. Specifically, the Notice clarifies that qualified wireless spectrum only includes amortizable Section 197 intangibles within the meaning of Section 197(c)(1) and (d)(1)(D). Further, the Notice clarifies that the qualified wireless spectrum adjustment to AFSI includes:
- A reduction by the amount of amortization deductions allowed under Section 197 with respect to qualified wireless spectrum allowed as a deduction in computing taxable income for the tax year (Deductible Tax Amortization);
- An adjustment to disregard:
- Amortization expense, disposition loss (including abandonment loss) that occurs prior to the tax year in which the disposition occurs for regular tax purposes, impairment loss, or impairment loss reversal that is taken into account in the taxpayer’s FSI with respect to qualified wireless spectrum (Covered Book Amortization Expense), and
- Any amount, other than Covered Book Amortization Expense, that is recognized as an expense or loss in the taxpayer’s FSI and reflected in the basis for depreciation (as defined in Treas. Reg. §§ 1.167(g)-1 and 1.197-2(f)(1)(ii) without regard to adjustments under Section 1016(a)(2) and (3)) of qualified wireless spectrum for regular tax purposes (Covered Book Wireless Spectrum Expense);
- With regard to an adjustment required under Section 481(a) for a change in method of accounting for amortization of any item of qualified wireless spectrum (Section 481(a) Adjustment for Amortization):
- A reduction by the amount of any negative Section 481(a) Adjustment for Amortization taken into account in computing taxable income for the tax year; and
- An increase by the amount of any positive Section 481(a) Adjustment for Amortization taken into account in computing taxable income for the tax year; and
- An adjustment for other items as provided in regulations or in other guidance.
The Notice clarifies that Section 56A(c)(14) does not apply to property not depreciated under Section 197. Further, a taxpayer that disposes of qualified wireless spectrum for regular tax purposes must adjust its AFSI for the tax year in which the disposition occurs to redetermine any gain or loss taken into account in its FSI with respect to the disposition for the year by making certain adjustments to the remaining AFS basis in that property. These adjustments include:
- A reduction by the cumulative Deductible Tax Amortization adjustments made with respect to the property;
- An increase by the Covered Book Amortization Expense and Covered Book Wireless Spectrum Expense adjustments made with respect to the property;
- An increase by the full amount of any positive Section 481(a) Adjustment for Amortization with respect to the property;
- A reduction by the full amount of any negative Section 481(a) Adjustment for Amortization with respect to the property; and
- An increase or reduction, as appropriate, by any other adjustments to AFS basis required under Section 56A, regulations, or other guidance with respect to the property.
AFSI Adjustments to Prevent Certain Duplications or Omissions
Section 56A(c)(15) grants the Secretary authority to issue regulations or other guidance to provide for adjustments to AFSI necessary to carry out the purposes of Section 56A, including adjustments to prevent the omission or duplication of any item. Under this grant of authority, Section 11 of the Notice provides that AFSI must be adjusted to take into account any cumulative adjustment resulting from a change in financial accounting principle to the taxpayer’s AFS retained earnings. Unless otherwise provided, this adjustment is made in the taxpayer’s AFSI ratably over the Adjustment Spread Period, beginning with the tax year in which the change in financial accounting principle is first implemented in the taxpayer’s AFS. With regard to duplications, the Adjustment Spread Period may be either four tax years or, a different period that does not exceed fifteen years if the taxpayer can demonstrate the duplication is reasonably anticipated to occur over that period. With regard to omissions, if the adjustment results in an increase to AFSI, the Adjustment Spread Period is four years. If the adjustment results in a decrease to AFSI, the adjustment must be taken into account in full in the tax year in which the change is implemented in the taxpayer’s AFS. The Adjustment Spread Period is accelerated to take into account any amounts not yet taken into account upon the cessation of a trade or business that is the subject of an accounting principle change adjustment.
Under the Notice, a change in priority of a taxpayer’s AFS is treated as implementing a change in financial accounting principle, and a taxpayer must make adjustments in accordance with the procedures described above.
Additionally, a taxpayer that restates an AFS and its FSI for a tax year after it has filed its federal income tax return for that year must account for the restatement by adjusting its AFSI for the first tax year following the restatement year for which it has not yet filed its original return. The restatement adjustment must account for the cumulative effect of the restatement on FSI, including any restatement of the beginning balance of retained earnings. However, in lieu of making a restatement adjustment, a taxpayer that files an amended return or administrative adjustment request (AAR) to adjust its regular taxable income as a result of the restatement must use the restated AFS for purposes of determining AFSI on the amended return or AAR.
Notably, no adjustment is provided for differences between when an item is taken into account in FSI and when it is taken into account for regular tax purposes. This is the case even where the timing difference originated before the effective date of the CAMT and reverses after that date. Despite commentators suggesting otherwise, the Notice provides that such differences do not give rise to duplications or omissions within the meaning of Section 56A(c)(15)(A).
Request for Comments
Section 16 of the Notice requests comments on issues addressed in the Notice as well as on issues not yet addressed in guidance. With regard to the AFSI depreciation adjustment, the Notice requests comments on simplified methods or safe harbors that should be provided; whether AFSI-only changes constitute changes in method of accounting requiring a Form 3115, Application for Change in Accounting Method; and, in the case of a taxpayer filing a method change to depreciate property under Sections 167 and 168, how to treat amounts that would have been included in an AFSI adjustment for depreciation in prior years. The Notice also requests comments on the guidance provided for qualified wireless spectrum and on AFSI adjustments to prevent omissions or duplications, including whether such adjustments can be traced to a specific trade or business and what events should be considered a “cessation” of a trade or business. Additionally, the Notice requested comments on issues not addressed therein, including whether any adjustments to AFSI are required in order to clearly reflect income. Taxpayers should carefully consider whether these provisions will impact their future tax liabilities, and any lingering questions or clarifications that would be useful in planning for compliance with the CAMT. To the extent they will be impacted, taxpayers may want to submit comments to the government.