Avoiding the AMT depreciation adjustment.

• Author: Ellentuck, Albert B.
• Position: Alternative minimum tax

Editor's note: This case study has been adapted from PPC Tax Planning Guide--Closely Held Corporations, 15th Edition, by Albert L. Grasso, Joan Wilson Gray, R. Barry Johnson, Lewis A. Siegel, Richard L. Burris, James A. Keller, Gary W. Brown and Kim L. Saunders, published by Practitioners Publishing Company, Fort Worth, Tex., 2002 ((800) 323-8724; www.ppcnet.com).

Facts: Xenon Corp., a calendar-year C corporation, was formed on Nov. 1, 2002; it filed its first return for the two-month period ending Dec. 31, 2002. * On Jan. 10, 2003, Xenon purchased $100,000 of assets in each of the regular modified accelerated cost recovery system (MACRS) personal property asset classes (i.e., the three-, five-and seven-year classes). These are the first fixed assets Xenon purchased. * The corporation has a very limited administrative staff. Jacqueline Burns, its sole shareholder and president, wants to keep the financial and tax accounting requirements simple. * Xenon's tax adviser has made Jacqueline aware of the alternative minimum tax (AMT), both from a tax liability and an administrative standpoint. Xenon will likely have a relatively small regular tax liability for the next several years. However, AMT may be a problem, because Xenon intends to use the completed-contract accounting method on several long-term contracts. Issue: What elections can Xenon make to avoid or minimize the potential AMT depreciation adjustment resulting from the asset purchases?

Analysis

Corporations are exempt under Sec. 55(e)(1)(C) from the AMT for their initial year. They will be exempt from AMT in their second year if they pass a $5 million test under Sec. 55(e)(l)(B) based on their initial-year receipts. (For short tax years, receipts must be annualized.)

Xenon would be exempt from AMT for 2002, its first tax year. If it does not meet the $5 million test for 2003, in its second year, it will be subject to AMT in that year. According to Sec. 55 (e) (2) (A), the excess-depreciation adjustment applies only to property placed in service after the change date (defined as the first day of the tax year for which the taxpayer ceases to meet the small-corporation exemption). As a result, Xenon will have to include an excess-depreciation adjustment for property placed in service after 2002.

The following rules under Secs. 56(a)(1)(A) and 168(c) apply to property placed in service after 1998: 1. For property otherwise eligible for MACRS (200% declining-balance (DB) method), electing...