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 effective for taxable years beginning after December 31, 2022 (the AMT). Originally a provision of the now-defunct Build Back Better Act, the AMT was revived by Senators Chuck Schumer and Joe Manchin earlier this month. The AMT managed to survive the budget reconciliation process, including a “vote-a-rama” in the Senate (i.e., a procedure in which Senators propose an unlimited amount of amendments to budget-related bills). The corporate AMT applies only if the 15% rate applied to a designated corporation’s financial statement income exceeding $1 billion with adjustments is greater than the corporation’s regular US Federal income tax liability plus any base erosion anti-abuse tax (BEAT). According to the Joint Committee on Taxation, approximately 150 of the world’s largest companies may potentially be subject to the AMT.1 Consequently, there are a range of issues to consider in applying this new tax.
This alert provides a high-level overview of the AMT with preliminary observations and potential implications. As practitioners and taxpayers have the opportunity to digest the new statute, it will be interesting to see what major issues arise, where clarification is needed, and what direction is provided by the IRS and Treasury in issuing implementation guidance.
Section 10101 of the IRA2 generally imposes a 15% corporate minimum tax on the adjusted financial statement income of an applicable corporation with global profits in excess of $1 billion over three consecutive tax years. An applicable corporation is liable for the AMT to the extent its tentative minimum tax exceeds its regular US Federal income tax liability plus its liability for the base erosion anti-abuse tax (BEAT). In other words, the IRS will now require applicable corporations to compute two separate calculations for Federal income tax (FIT) purposes, paying the greater of either the AMT or the regular tax liability plus any BEAT.
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. A corporation satisfies this test if its average annual adjusted financial statement income for the three-taxable year period ending with the relevant taxable year exceeds $1 billion.
The liability for the AMT results from the excess of 15% of the adjusted financial statement income for the taxable year over the corporate AMT foreign tax credit for the taxable year. It may seem confusing but an applicable corporation that is subject to the AMT receives a credit that can be used to offset its regular federal income liability in a future tax year when it is subject to the regular corporate tax provisions; however, this credit cannot be used to reduce its future AMT liability.
As with most recent tax legislation, the devil will be in the details regarding the true impact of the AMT. As a threshold matter, the AMT is imposed on an applicable corporation with “average annual adjusted financial statement income” exceeding $1 billion. Also, any foreign-parented multinational groups that include at least one US domestic corporation may be subject to the AMT 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.
The AFSI threshold is based on an applicable corporation’s “adjusted financial statement income” or “AFSI.” To determine AFSI, an applicable corporation must review the net income or losses reported on its “applicable financial statement” or “AFS.” The term, AFS is defined in Section 451(b)(3) and it is based on a concept first established by the IRS in administrative guidance addressing income recognition and subsequently codified with the Tax Cuts and Job Act, when Section 451(b)’s income recognition provisions were enacted.
The term, applicable financial statement, generally refers to an audited GAAP or IFRS financial statement used for SEC reporting purposes. An AFS also includes other financial reports, which may encompass for example, reports prepared to secure credit, statements used to provide financial information to shareholders, and reports maintained by private companies in anticipation of becoming public. Although these reports do not rise to the level of an audited financial statement, they are considered an AFS for AMT purposes.
AFS net income is merely the starting point in calculating AFSI for purposes of the AMT. After confirming the appropriate amount of net income reported on an applicable corporation’s AFS, the 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, as summarized in the table below:
In addition to determining the amount of AFSI taking into account various adjustments, particularly items that are included or excluded from an applicable company’s AFS net income, an additional statutory detail, which may have significant effect, is the aggregation rule provided in Section 59(k)(1)(D), which determines an applicable corporation’s status for this purpose. 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 adjusted financial statement income for purposes of determining whether the $1 billion threshold has been exceeded.
Importantly, once a corporation exceeds the $1 billion threshold and becomes subject to the AMT, it generally remains an applicable corporation even if its AFSI falls below the $1 billion level. The legislative language provides that an applicable corporation’s status may be revised if: (i) there is an ownership change; (ii) the corporation fails the adjusted financial statement income test for consecutive years as provided by the IRS; or (iii) the corporation satisfies a safe harbor established by Treasury. The AMT is effective for taxable years beginning after December 31, 2022.
Additionally, while headlines indicate the AMT applies to corporations with an average annual adjusted financial statement income exceeding $1 billion, that threshold may be different for certain foreign-parented corporations due a similar aggregation rule as discussed above. A domestic corporation that is a member of a foreign-parented multinational group may be liable for the AMT if two statutory tests are satisfied. First, the AFSI of the group must exceed $1 billion with, solely for purposes of determining whether a corporation meets the average annual adjusted financial statement income test, the income of all foreign group members included in the determination. Second, provided the foreign-parented group’s AFSI exceeds $1 billion, then the AFSI of the domestic member must by itself exceed $100 million. If both tests are satisfied, then the AMT applies. For this purpose, a foreign-parented multinational group for a taxable year includes two or more entities if at least one entity is a domestic corporation and at least one entity is a foreign corporation, such entities are included in the same AFS with respect to such year, and either the common parent of the entities is a foreign corporation, or, if there is not a common parent, the entities are treated as having a common parent which is a foreign corporation. It is important to note that 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. Additionally, regulatory authority is explicitly requested to address applicable corporations for in this context.
Additionally, to the extent a corporation has been in existence for less than three taxable years, the AMT applies the average annual adjusted financial statement income test on the basis of the period during which the corporation has been in existence. Further, for any taxable year of less than 12 months, AFSI is required to be annualized by multiplying the adjusted financial statement income for the short period by 12 and dividing the result by the number of months in the short period. An applicable corporation with less than three taxable years of history may find the financial statement income test produces unexpected results.
1 JCT memo to Senate Finance Committee (August 1, 2022).
2 H.R. 5376.