Module 16

1. Module 16 AMT and Other Special Corporate Taxes

2. Module Topics • Corporate alternative minimum tax • Personal holding company tax • Accumulated earnings tax

3. The Corporate Alternative Minimum Tax Key Learning Objectives • Understand the parallel income tax system of corporate taxation • Know how to minimize the alternative minimum tax liability

4. AMT Background • Policy reason • History of individual and corporate provisions • Compliance burden

5. AMT Concepts • Parallel tax system • AMT is a separate tax system • Differences will exist between regular taxable income and AMTI • Prepayment system • AMT accelerates income and defers deductions • Minimum tax credit available for future years

6. Corporate AMT Formula Taxable income Plus NOL deduction Plus tax preferences Plus/minus adjustments Tentative AMTI Plus/minus 75% ACE adjustment Minus ATMNOL (90% limit) AMTI Minus exemption AMT base (continued)

7. Corporate AMT Formula ATM Base x 20% Tentative minimum tax before FTC Minus AMT FTC (90% limit) Tentative minimum tax Minus regular tax (after FTC) AMT (if positive)

8. AMT Relief for Small Business C Corporations • The Taxpayer Relief Act of 1997 • Beginning in 1998 • Small business C corporations do NOT need to compute the AMT

9. AMT Relief for Small Business C Corporations • Requirements for exemption • Average gross receipts of • less than $5,000,000 • for the prior three years. • If a new entity • not a continuation of a prior business • automatically exempt for its initial year

10. Common Tax Preferences • Tax-exempt interest on private activity bonds • Excess accelerated depreciation on pre-87 realty • Excess percentage depletion • Excess intangible drilling costs

11. Common ± Adjustments • Post-86 realty • 40-year straight line • Post-86 personality • 150% on regular recovery period • Property transaction gains and losses • Long-term contracts

12. Compliance Query: AMT Depreciation Adjustments • ABC Corporation purchased $30,000 of office furniture in June. • It elected to expense $20,000 under §179. • The furniture is 7-year property • 200% declining balance for MACRS • 150% declining balance for ADS • prior to 1998, ADS was generally also a longer recovery period • What is the AMT depreciation adjustment?

13. Solution--Compliance Query: AMT Depreciation Adjustments Cost 30,000 Sec. 179 expense 20,000* Depreciable basis 10,000 *allowed for both regular tax and AMT MACRS: 10,000 x .1429 = 1,429 ADS: 10,000 x .1071 = 1,071 AMT adjustment (+) 358

14. 75% ACE Adjustment • ACE is another parallel tax system • Adjustment can be positive or negative • Limit on negative adjustment • ACE is a hybrid between AMTI and E&P • Complex calculation rules apply • Depreciation adjustments • E&P adjustments • Exclusion adjustments

15. Compliance Query: Calculating the ACE Adjustment • Tentative AMTI = 300,000 (1) ACE = 360,000 (2) ACE = 260,000 • Prior years’ net positive adjustment: 22,000 What is the ACE adjustment for (1) and (2)?

16. Solution--Compliance Query: Calculating the ACE Adjustment (1) ACE 360,000 AMTI 300,000 Difference 60,000 x 75% Positive ACE adjustment 45,000

17. Solution--Compliance Query: Calculating the ACE Adjustment (2) ACE 260,000 AMTI 300,000 Difference <40,000> x 75% Computed ACE adjustment <30,000> Limited to <22,000>

18. AMT Exemption • $40,000 • Reduced by .25 x (AMTI - $150,000)

19. Compliance Query: Calculating the AMT Exemption • XYZ Corporation has AMTI of $270,000 • What is the statutory exemption and AMT base?

20. Solution--Compliance Query: Calculating the AMT Exemption Exemption: 40,000 - .25(270,000-150,000) = 10,000 AMTI 270,000 Exemption 10,000 AMT Base 260,000

21. Personal Holding Company Tax Key Learning Objectives • Recognize the conditions in which the personal holding company tax applies • Know the components of the tax computation • Explore opportunities for avoiding the tax

22. PHC Tax--Overview • Penalty tax on “incorporated pocketbooks” • 39.6% rate applied to undistributed PHCI • Tax can be avoided by making sufficient dividend distributions

23. PHC Definition • C Corps are PHCs if they meet: • Stock ownership test, and • Passive income test

24. Stock Ownership Test • 5 or fewer individual shareholders... • Own > 50% in value of the stock… • Sec. 544 stock attribution rules apply • At any time during last half of year

25. Passive Income Test • PHCI ÷ AOGI 60 • Common PHCI items: • Dividends; interest; annuities; rents; royalties; certain personal service contracts • AOGI typically consists of: • Ordinary gross income • Less certain rent and royalty related expenses

26. Compliance Query: • Z Corporation has 5 shareholders and the following income for the year: • Gross merchandising income 80,000 • Capital gains 40,000 • Interest income 45,000 • Dividend income 35,000 • Adjusted income from rents 30,000 • Is Z corporation a PHC?

27. Solution--Compliance Query: PHCI = 110,000 (45,000 + 35,000 + 30,000) AOGI = 190,000 (80,000 + 110,000) PHCI AOGI = .579 Z Corporation is not a PHC

28. Exclusions From PHCI for Adjusted Income From Rents • Rent is excluded from PHCI if: • AIR 50% of AOGI and • Dividends paid (non-rental PHCI - 10% of OGI)

29. Computing the Personal Holding Company Tax Taxable income Plus positive adjustments Minus negative adjustments Adjusted taxable income Minus dividends paid deduction Undistributed PHCI x .396 PHC tax

30. Common Adjustments • Positive • Dividend received deduction • NOL deduction from other than preceding year • Charitable deduction carryover • Negative • Federal income taxes • Charitable contributions > 10% limit • Net capital gain (net of tax)

31. The Dividends Paid Deduction • Current-year dividends • Grace period dividends • 2.5 month and 20% rules • Consent dividends • Liquidating dividends • Dividend carryovers • Deficiency dividends

32. Avoiding the PHC Tax • Pay dividends! • Monitor rent so that it does not fall below 50% of AOGI • Do not lag when liquidating a corporation • Monitor passive income sources • Disperse stock ownership

33. Accumulated Earnings Tax Key Learning Objectives • Recognize the conditions in which the accumulated earnings tax applies • Know the components of the tax computation • Explore opportunities for avoiding the tax

34. Accumulated Earnings Tax Overview • Penalty tax on unreasonably accumulated income • 39.6% rate applied to accumulated taxable income • Tax can be avoided by making sufficient dividend distributions

35. Motivations to Accumulate Earnings • Low marginal tax rates (15%; 25%) on first $75,000 of income • Retained funds invested in corporate stock eligible for 70% or 80% dividend received deduction • Shareholders can hold, then sale their shares and get capital gain treatment

36. Establishing a Tax Avoidance Purpose • Tax applies if tax avoidance is one of the purposes of accumulating income • It need not be the dominant or controlling purpose

37. “Preponderance of Evidence” and Reasonable Business Needs • If a corporation has accumulated its earnings beyond the reasonable needs of the business... • It must prove by the preponderance of the evidence that the accumulation was not to avoid tax

38. Reasonable Business Needs “Good” Reasons • To provide for bona fide expansion of business or replacement of plant • To acquire a business enterprise through purchasing stock or assets • To provide for the retirement of bona fide indebtedness created in connection with the trade or business

39. Reasonable Business NeedsMore “Good” Reasons • To provide necessary working capital for the business • Bardahl formula • To provide for investments or loans to suppliers or customers if necessary • To provide for the payment of reasonably anticipated product liability losses

40. Key Factors • Plans to use accumulated earnings must be • Specific • Definite • Feasible

41. Research Query • Does the tax law specify any “bad” reasons for accumulating earnings?

42. “Bad” Reasons to AccumulateReg. § 1.537-2(c) • Loans to shareholders, relatives, or friends • Corporate funds used for personal benefit • Investments in properties or securities unrelated to corporation’s business activities • Protection against unrealistic hazards

43. Determining the Accumulated Earnings Tax Taxable income Plus positive adjustments Minus negative adjustments Adjusted taxable income Minus dividends paid deduction Minus accumulated earnings credit Accumulated taxable income x .396 Accumulated earnings tax

44. Common Adjustments • Positive adjustments • Capital loss carryovers and carrybacks • Dividends received deduction • Net operating loss deduction • Charitable deduction carryovers • Negative adjustments • Federal income taxes • Charitable contributions > 10% limit • Net capital gains (net of tax)

45. The Dividends Paid Deduction • Current-year dividends • Grace period dividends • No 20% rule • Consent dividends • Liquidating dividends

46. The Accumulated EarningsTax Credit • Safe harbor minimum • $250,000 (less accumulated earnings at end of last year) • Use $150,000 for certain service companies • Maximum credit • Earnings needed to meet reasonable business needs (less accumulated earnings at end of last year)