Nearly two months ago, on August 16, 2022, President Biden signed the Inflation Reduction Act of 2022 (the IRA) into law. Among the most notable IRA provisions is a 15% corporate alternative minimum tax on corporations with book profits exceeding $1 billion (the CMT). For previous reporting by Eversheds Sutherland regarding the CMT, see Signed, sealed, delivered: Biden signs Inflation Reduction Act enacting “new” corporate minimum tax and Back from the dead: Corporate minimum tax resurfaces at eleventh hour in Inflation Reduction Act of 2022. The CMT is effective for taxable years beginning after December 31, 2022. As a result, taxpayers are working to understand whether they are liable for the CMT, and, if so, to what extent. Inevitably, this analysis has resulted in the identification of a number of areas for which immediate guidance is necessary. As we await implementation and clarifying guidance from the IRS and Treasury, this alert highlights a number of preliminary issues relating to the CMT for which guidance is appropriate.
Overview
Section 10101 of the IRA generally imposes the 15% CMT on the adjusted financial statement income (AFSI) of an applicable corporation with global profits in excess of $1 billion over three consecutive tax years. The statute amends Section 59 of the Code to define an “applicable corporation” as any corporation, excluding S Corporations, Regulated Investment Companies, and Real Estate Investment Trusts (REITs) that meets the “average annual adjusted financial statement income test” for one or more tax years ending after December 31, 2021. Also, any foreign-parented multinational groups that include at least one US domestic corporation may be subject to the CMT if the US domestic corporation exceeds a modified AFSI threshold of $100 million, and the average annual adjusted financial statement income of the foreign-parented multinational group exceeds $1 billion.
To determine AFSI, an applicable corporation must review the net income or losses reported on its “applicable financial statement” or “AFS.” After confirming the appropriate amount of net income reported on an applicable corporation’s AFS, a taxpayer must then walk through the various provisions of the new statute and make appropriate adjustments to determine its AFSI. The statute provides a number of adjustments to AFS net income reflecting tax deductions and credits, ranging from adjustments to reflect applicable corporation’s that are members of a consolidated group to adjustments for depreciation, amortization and NOLs. In addition to determining the amount of AFSI taking into account various adjustments, Section 59(k)(1)(D) also provides that solely for purposes of determining whether an entity is an applicable corporation for purposes of the AMT, all AFSI of persons treated as a single employer under Sections 52(a) and (b) shall be treated as AFSI for purposes of determining whether the $1 billion threshold has been exceeded.
Notable issues requiring immediate guidance
As with the enactment of any new law, statutory rules and provisions may provide the general terms and conditions of the new provision, but the devil will be in the details regarding the nature and scope of the new provision. On its face, the CMT may appear simple, a 15% tax on corporations with book profits exceeding $1 billion, but the myriad defined terms and adjustments warrant clarifying and implementation guidance.
Impact of certain transactions on AFSI
While the statute provides a number of adjustments that may be taxpayer favorable, or unfavorable, to an applicable corporation’s AFSI amount, the adjustments beg for clarification and additional guidance. For example, in determining the amount of AFSI in a given tax year, there is uncertainty as to whether certain transactions, such as tax-free reorganizations, spin-offs and split-offs, produce AFSI that should be included in the CMT calculation. Alternatively, guidance will be needed to address whether, if a taxpayer completes a stock-for-stock disposition that does not yield cash but does result in net income for financial accounting purposes, whether that gain must be included in AFSI. Additionally, it will be important to address the treatment of book-tax differences generated by purchase accounting of taxable or tax-free transactions.
Adjustments to AFSI
Beyond the impact of certain transactions, guidance will be needed to clarify and provide detail regarding the numerous adjustments to AFSI, including, for example, the adjustment allowed for an applicable corporation to take into consideration its depreciation deductions for the relevant tax year. Many taxpayers have questioned the interplay with bonus depreciation rules as well as the treatment of items with book-tax differences, such as repair costs, which the IRS will need to address in order to allow taxpayers to make the necessary adjustments. Additionally, it would be helpful to clarify whether AFSI includes depreciation for gain or loss on assets sold when the depreciation is claimed prior to the AFSI testing period.
Beyond the adjustment provided for depreciation, taxpayers will also need clarification regarding the numerous book-tax differences that have been put into play by the statute. For example, the IRS will need to confirm whether book income related to cancellation of indebtedness income that is excluded under section 108(a)(1) also is excluded from AFSI.
In addition to depreciation and book-tax differences, there are a number of adjustments to AFSI related to foreign activities of a US taxpayer that merit further guidance. Taxpayers will want to understand how to prevent double counting of income in AFSI and dividend income with respect to CFCs, as well as how a Section 482 adjustment may or may not impact AFSI. It is also uncertain how foreign currency translation gains or losses factor into the determination of AFSI. With respect to foreign taxes paid, taxpayers will also need guidance regarding how foreign taxes paid at the partnership level are treated, what foreign taxes reflected on the financial statements are taken into account, as well as how and when to properly take into account the foreign tax determination for CMT foreign tax credit purposes.
Use of a taxpayer’s AFS to determine AFSI
Additionally, with respect to the requirement to use an AFS to determine AFSI, it will be critically important to confirm which AFS is used for determining an entity’s applicable corporation status when a taxpayer’s fiscal year differs from its taxable year, which is not uncommon among many taxpayers. Further, the statute’s cross-reference to Section 451(b)(3) demands a review of the recently-revised income recognition rules under Section 451(b) and the provisions under Treas. Reg. §1.451-3 to clarify the definition of AFS for CMT purposes and ensure the appropriate AFS and AFS amounts are considered in determining the starting point for an applicable corporation’s AFSI, for example, what amount is included and excluded in the computation of “net income or loss” in an AFS.
Duration of “applicable corporation” designation
Further, once a taxpayer has satisfied the AFSI test, guidance is required to understand how long such entity will be considered an applicable corporation. The statute provides that classification could change if there is an ownership change or the applicable corporation falls beneath the AFSI threshold for a number of years, but the statute empowers the IRS to make such determination. Further, guidance will be needed to identify when a corporation experiences a “change in ownership” and what occurs when such a corporation retains its status as an applicable corporation.
Scope of Section 52 aggregation rule on “applicable corporation” designation
In addition to guidance clarifying the length of time an entity’s “applicable corporation” designation lasts, there is great detail needed to understand the nature and scope of the Section 52 aggregation rule on the determination of whether an entity is an “applicable corporation.” For example, the IRS will need to clarify whether portfolio companies that are owned by a private entity fund are treated as related for purposes of section 52(a) or (b) and the Treasury Regulations thereunder. Further, guidance is required to understand how the three-year AFSI test applies when entities depart or join a section 52 group. Additionally, taxpayers that are a shareholder of a CFC will need to understand how the pro rata share rule applies with respect to CFCs that are part of the same section 52 group of a US shareholder for purposes of determining applicable corporation status.
Interplay of partnership tax rules
With respect specifically to issues plaguing entities classified as partnerships for US federal income tax purposes, a significant amount of guidance is required to address the treatment of partnerships for purposes of determining applicable corporation status, as well as the adjustments to AFSI needed to properly take into account the rules and principles of subchapter K. Further, it will be critically important to clarify the definition of “distributive share” of AFSI for purposes of the CMT and corporate partners, as well as providing clarification regarding information reporting by partnerships that have corporate partners, which are or may be subject to the CMT.
Conclusion
With the CMT effective for taxable years beginning after December 31, 2022, it is unquestionable that implementation and clarifying guidance is needed so that taxpayers may fully understand the scope of the new tax. While this alert highlights certain issues for which guidance would be helpful, it will be prudent for taxpayers to engage with the IRS and Treasury, provide comment letters and express areas of concern as now is the time that pencil is hitting the paper, fingers are hitting the keys, and the “devil” in those details is guidance that is being drafted.
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