The President is expected to imminently sign the Inflation Reduction Act of 2022 (the “Act”), which was passed by both the Senate and House of Representatives. This Client Alert addresses two main tax provisions in the Act: (1) a new corporate alternative minimum tax imposed on certain corporations meeting a test based on their average annual adjusted financial statement income and (2) an excise tax imposed upon share repurchases by certain publicly traded corporations. While the Act contains various tax-related provisions aimed at addressing climate and health care policy, including certain tax credits for renewable energy, carbon capture and mitigation of greenhouse gas emissions, and an excise tax on pharmaceutical companies that do not comply with a new pricing agreement rule, those provisions are outside the scope of this Client Alert.
Notably, and of particular interest, the Act does not include provisions changing the treatment of carried interest or modifying or eliminating the cap on deductions for state and local taxes.
New Corporate Alternative Minimum Tax
Effective for taxable years beginning on or after January 1, 2023, a 15 percent new corporate alternative minimum tax (the “New AMT”) will be imposed on certain “applicable corporations” when such corporations’ tax liability under the New AMT exceeds their regular federal income tax liability (including liability for the base erosion and anti-abuse tax of Section 59A of the Internal Revenue Code of 1986, as amended (the “Code”)).
In order to be subject to the New AMT, a corporation (or a corporate group collectively) must be considered an “applicable corporation.” An applicable corporation is a corporation (other than an S corporation, regulated investment company, or real estate investment trust) that, for one or more prior taxable years ending after December 31, 2021, satisfies a test requiring that its average annual adjusted financial statement income (“AFSI”) exceed $1 billion over the previous three taxable years ending with the current taxable year (the “AFSI Test”) (e.g., if a corporation first met the AFSI Test for the 2023 tax year, it first would be an applicable corporation for the 2024 tax year). The tax base for the New AMT is the AFSI for the taxable year reduced by any New AMT foreign tax credit (which, when the corporation elects to take a credit for foreign income taxes, is generally based on the creditable foreign taxes taken into account on the applicable financial statements).
AFSI generally means the net income or loss as set forth on the corporation’s “applicable financial statement” (“AFS”) for the taxable year, subject to adjustments. An AFS generally includes a financial statement that is certified as prepared in accordance with generally accepted accounting principles (“GAAP”) and which is a 10-K, or an annual statement to shareholders, required to be filed with the Securities and Exchange Commission. Where an entity does not have such a financial statement, the AFS is an audited financial statement that is certified as prepared in accordance with GAAP and used for credit purposes, reporting to shareholders, or any other substantial nontax purpose. If there is no such audited financial statement, the AFS is any financial statement prepared in accordance with GAAP and filed with any other federal agency for a nontax purpose.
A number of adjustments are taken into account in determining AFSI, including but not limited to:
i. Appropriately adjusting the AFSI where the AFS covers a period that differs from the taxable year,
ii. Where the corporation is not included on a consolidated return, including only the dividends received from other affiliated corporations and other amounts (other than amounts required to be included under subpart F or global intangible low-taxed income) includible in gross income or deductible as a loss for federal income tax purposes with respect to such other corporations,
iii. Where the corporation is a partner in a partnership, only taking into account the corporation’s distributive share of the AFSI of the partnership,
iv. Where the corporation is a U.S. shareholder of a controlled foreign corporation, taking into account the corporation’s pro rata share of items taken into account in determining the AFSI of the controlled foreign corporation, subject to a restriction against having a net negative adjustment with respect to a controlled foreign corporation for any taxable year,
v. Where the corporation is a foreign corporation, applying the principles of Section 882 of the Code, which is intended to limit the application of the New AMT to income effectively connected with a U.S. trade or business,
vi. Disregarding U.S. federal income taxes,
vii. Where the corporation elects to take a credit for, rather than deduct, foreign income taxes, increasing the corporation’s AFSI for the foreign income taxes taken into account on the corporation’s AFS,
viii. Where the corporation is a charitable organization (or other organization subject to tax under Section 511 of the Code), only taking into account AFSI from unrelated trades or businesses (as defined in Section 513 of the Code) or derived from debt-financed property, and
ix. Taking into account depreciation as calculated for federal income tax purposes rather than any depreciation expense taken into account on the AFS.
In determining AFSI, a corporation can take into account certain net operating losses. Specifically, after AFSI is adjusted for the items noted above (and other items circumscribed in the new rules), it is reduced by either (i) the aggregate amount of financial statement net operating loss carryovers to the taxable year or (ii) 80 percent of AFSI as computed without regard to such net operating loss carryovers, whichever is less. In determining whether the AFSI Test is satisfied, net operating loss carryovers are disregarded.
For purposes of determining whether a corporation is an applicable corporation, all AFSI of persons treated as a single employer with such corporation (as determined under Section 52(a) or (b) of the Code) shall, subject to certain modifications, be treated as AFSI of such corporation.
Where a corporation is a member of a “foreign-parented multinational group” for any taxable year, then for purposes of determining whether the corporation meets the AFSI Test for such year, the AFSI of such corporation includes the AFSI of all members of the group (as determined without regard to certain adjustments, including those described in clauses (iii), (iv), and (v) above). “Foreign-parented multinational group” means, with respect to any taxable year, two or more entities if (1) at least one entity is domestic and at least one entity is foreign, (2) such entities are included in the same AFS for such taxable year, and (3) either (a) the common parent of such entities is a foreign corporation or (b) if there is no common parent, the entities are treated as having a common parent under rules provided by the Internal Revenue Service. For these purposes, if a foreign corporation is engaged in a trade or business within the United States, such trade or business shall be treated as a separate domestic corporation that is wholly owned by the foreign corporation.
A corporation that is a member of a foreign-parented multinational group for any taxable year will be treated as meeting the AFSI Test for a taxable year if (x) it satisfies the three-year $1 billion requirement described above for such taxable year, taking into account the rules in the preceding paragraph for calculating AFSI, and (y) the average annual AFSI of such corporation (determined without regard to the rules in the preceding paragraph for calculating AFSI and net operating loss carryovers) for the three-year period ending with such taxable year is $100 million or more.
Once a corporation meets the requirements to be subject to the New AMT, it will remain subject to the New AMT until (i) it has a change in ownership or fails to meet the AFSI Test for a specified number of consecutive years (yet to be defined) and (ii) the Internal Revenue Service determines that it would not be appropriate to continue to treat such corporation as an applicable corporation. A corporation that thereby ceases to be subject to the New AMT shall again be subject to the New AMT if it satisfies the AFSI Test for a taxable year beginning after the first year for which it ceased to be treated as an applicable corporation.
Stock Repurchase Excise Tax
Effective for repurchases occurring on or after January 1, 2023, the Act will impose a 1 percent excise tax on certain “repurchases” of a “covered corporation’s” stock during the taxable year (“Stock Repurchase Excise Tax”).
A covered corporation is generally defined as any domestic corporation with stock that is traded on an established securities market (within the meaning of Section 7704(b)(1) of the Code), and it generally includes any publicly traded corporation. The Stock Repurchase Excise Tax is imposed on (x) the fair market value of the repurchased stock, reduced by (y) the fair market value of such corporation’s stock issued in the same taxable year.
For purposes of this provision, a “repurchase” includes a transaction whereby the corporation acquires its stock from a shareholder in exchange for property, whether or not the stock acquired by the corporation is cancelled, retired, or held as treasury stock. The new law provides the Secretary with discretion to include as a repurchase any economically similar transaction. A repurchase will also include purchases of shares of a covered corporation by specified affiliates of the covered corporation from a third party. Specified affiliates are generally defined to include any corporation more than 50 percent of the stock of which (by vote or value) is owned, directly or indirectly, by the covered corporation and any partnership in which more than 50 percent of the capital or profits interests are held, directly or indirectly, by the covered corporation.
Where a foreign corporation is traded on an established securities market, acquisitions of the shares of such corporation by a specified affiliate shall be treated as repurchase of shares by a covered corporation, with the specified affiliate treated as the covered corporation. An exception is provided where the specified affiliate is a foreign corporation or a foreign partnership (unless the partnership has a domestic entity as a direct or indirect partner). In these circumstances, in calculating the Stock Repurchase Excise Tax, the fair market value of the repurchased stock is not reduced by stock issuances to employees of the covered corporation, but rather, only of the specified affiliate.
Special rules apply to repurchases or acquisitions by certain affiliates of shares of covered foreign corporations that are treated as surrogate foreign corporations for purposes of the corporate expatriation rules.
The Act provides a number of exceptions where the Stock Repurchase Excise Tax will not apply. The exceptions include (1) repurchases that are part of a reorganization under Section 368(a) of the Code, where no gain or loss is recognized by the shareholder on the repurchase as a result of such treatment; (2) repurchases where the repurchased stock (or stock with equivalent value) is contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan; (3) repurchases that do not in the aggregate exceed $1 million during the taxable year; (4) to the extent provided in Treasury Regulations, repurchases by a dealer of securities in the ordinary course of business; (5) repurchases by a regulated investment company or real estate investment trust; or (6) repurchases treated as a dividend for federal income tax purposes.