A Survey of Corporate Tax Changes Made by the Tax Reform Act of 1986
| Publication year | 1987 |
| Pages | 1 |
| Citation | Vol. 16 No. 1 Pg. 1 |
1987, January, Pg. 1. A Survey of Corporate Tax Changes Made by the Tax Reform Act of 1986
Cameron J. Syke, Denver, is an associate of the firm of Roath and Brega, P.C.
The Tax Reform Act of 1986 ("Act") makes the most extensive changes to the Internal Revenue Code of 1954 in the last thirty-two years. As evidence of this, the Act redesignates it as the Internal Revenue Code of 1986 (herein, "Code").(fn1) The purpose of this article is to summarize the most significant provisions of the Act as they affect corporations.
Perhaps the most fundamental change the Act makes is to establish for the first time corporate tax rates that are higher than individual tax rates. The result of this flip-flop is that traditional tax planning techniques designed to take advantage of the lower corporate tax rates are no longer sound. In planning for closely held corporations and their shareholders, practitioners need to understand the interrelationship between the individual tax rate structure and the corporate tax rate structure.
Beginning in 1988, there will be two individual income tax brackets and tax rates---15 and 28 percent.(fn2) However, the Act phases out the benefits of the 15 percent bracket and personal exemptions by an additional tax equal to 5 percent of the excess of the taxpayer's taxable income over certain levels. The effect of phasing out the 15 percent bracket and personal exemptions is to create a bracket in which the marginal tax rate is 33 percent. The top end of the 33 percent bracket will depend on the number of personal exemptions claimed by the taxpayer, and will change between 1988 and 1989 to reflect the increase in the personal exemption.
Also beginning in 1988, the Act eliminates the existing five corporate tax brackets and rates, and substitutes a three-bracket system as follows:(fn3)
The graduated 15 and 25 percent rates are phased out completely at more than $335,000 of taxable income. The phase-out mechanism operates through the imposition of an additional 5 percent tax on taxable income in excess of $100,000 up to taxable income of $335,000. This results in a maximum additional tax of $11,750 when corporate taxable income exceeds $335,000. This 5 percent additional tax imposes an actual marginal rate of 39 percent on taxable income between $100,000 and $335,000. Therefore, the effective corporate rate brackets under the Act are as follows:
Amount
+ 34|X% of the excess over $335,000
The new rate brackets are effective for taxable years beginning on or after July 1, 1987. For taxable years which include July 1, 1987, blended rates apply.(fn4) An average of the new and old tax rates will be imposed for such taxable years. Consequently, for a calendar year corporation, the maximum rate for 1987 is 40 percent (average of 46 and 34 percent), but the maximum marginal rate (from $100,000 to $335,000 taxable income) is 42.5 percent (average of 39 and 46 percent). In 1987, an additional 5 percent tax will be imposed on corporations with taxable income in excess of $1 million up to $1,405,000. This results in complete elimination of the benefit of the graduated
rate structure for corporations with taxable income of $1,405,000 or more. Accordingly, the maximum rate for corporations with taxable income in excess of $1 million is 42.5 percent (average of 34 percent and 51 percent).
Under prior law, an alternative corporate tax rate of 28 percent applied to a corporation's net capital gain if the tax computed using the alternative rate was lower than the corporation's regular tax. The Act eliminates the alternative tax rate for net capital gains beginning on or after July 1, 1987, when the new 34 percent corporate tax rate goes into effect.(fn5)
A transitional rule applies in the case of any taxable year which begins before January 1, 1987, and ends after that date. In such case, the rate of tax applied to net capital gains arising prior to January 1, 1987, is 28 percent, and the net capital gain tax rate with respect to capital gain arising after December 31, 1986, is 34 percent. As under present law, capital losses may only be carried forward and are allowed only to the extent of capital gains.
The Act significantly changes the minimum tax provisions for individuals and corporations. In general, the Act expands the alternative minimum tax for individuals, and replaces the prior law add-on minimum tax for corporations with a new alternative minimum tax similar to the individual alternative minimum tax.(fn6)
Individuals are subject to an alternative minimum tax ("AMT") which is payable, in addition to all other tax liabilities, to the extent it exceeds the individual's regular tax owed. The AMT was imposed at a flat rate of 20 percent (21 percent for post-1986 years as changed by the Act) on the alternative minimum taxable income ("AMTI") in excess of the exemption amount. The AMTI is generally equal to an individual's taxable income (as opposed to adjusted gross income under prior law), increased by certain tax preferences, and decreased by the alternative minimum tax itemized deductions.
Under prior law, corporations paid an add-on minimum tax on certain tax preference items. The tax was in addition to the corporation's regular tax and was generally equal to 15 percent of the corporation's tax preferences less the regular income tax or $10,000, whichever was greater.
The Act replaces the corporate add-on minimum tax with a corporate alternative minimum tax. The AMT for corporations, like individuals, is computed by multiplying the AMTI in excess of the exemption amount by the alternative minimum tax rate, which for corporations is 20 percent. The corporate exemption amount is $40,000.(fn7) There is a phase-out of the exemption amount equal to 25 percent of the amount by which the AMTI of the corporation exceeds $150,000.(fn8) This results in the exemption amount being fully phased out when AMTI exceeds $310,000.
AMTI is defined in Code § 55(b)(2) as the taxable income of the corporation adjusted for certain items described in Code §§ 56 and 58 and increased by tax preference items described in Code § 57. The most common adjustments and tax preference items as they relate to corporations are described below.
For property placed in service after 1986, the excess of depreciation for regular tax purposes (i.e., ACRS discussed below), over the alternative depreciation, is treated as a preference. Alternative depreciation is generally defined as straight-line depreciation over the ADR midpoint life of the property. In the case of real estate, the ADR midpoint life is forty years. In the case of personal property, the alternative depreciation is generally computed using the 150 percent declining balance method and switching to the straight-line method in the year necessary to maximize the deduction.
The alternative depreciation deduction is substituted for the ACRS deduction for all property placed in service after 1986. The result of this adjustment is a netting of depreciation each year. In years in which depreciation deductions for regular tax purposes exceed the alternative depreciation deductions, there will be positive items of tax preference, and in years in which the alternative depreciation deductions exceed the depreciation deductions for regular tax purposes, the taxpayer's tax preferences are reduced. With respect to property placed in service prior to 1987, regular tax depreciation is treated as a preference only to the extent it was a preference under prior law.
The excess of expensed intangible drilling costs over ten-year amortization is treated as a preference. However, only 65 percent, rather than 100 percent, of net oil and gas income may offset the preference.
The excess of expensed mining exploration and development costs over ten-year amortization is now a preference for all taxpayers, not just individuals and personal holding companies as under prior law.
The excess of percentage depletion over the adjusted basis of the depletable property is a preference for corporations as well as individuals.
Tax-exempt interest on "specified private activity bonds" is treated as an item of tax preference. "Specified private activity bonds" include any private activity bond (as defined in Code § 141) issued after August 7, 1986. For alternative minimum tax purposes, the phrase "specified private activity bonds" does not include any interest on a qualified Code § 501(c)(3) bond. Special rules apply in the case of refundings.
The use of the completed contract method or another method of accounting that permits deferral of income during the contract period is treated as a preference by requiring the use of the percentage of completion method for AMT purposes on post-February 28, 1986, long-term contracts.
For regular tax purposes, the Act limits the availability of the installment method of accounting for sales of trade or business or rental property where the selling price exceeds $150,000. The...
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