S Corporations and the AMT credit.

• Author: O'Connell, Frank J., Jr.
• Position: Alternative minimum tax

Beginning in 1997, the IRS permitted financial institutions to elect S corporation status. This change initially presented many challenges to financial institutions; many of their tax advisers had little exposure to the issues affecting S corporations and were immediately expected to be fluent in these matters.

One item that became an issue for many financial institutions was the applicability of the alternative minimum tax (AMT) credit. Although this is not an issue unique to them, financial institutions typically invest in municipal securities, whose interest income is exempt from Federal income tax. In computing alternative minimum taxable income (AMTI), this interest income is added back as an adjusted current earnings (ACE) adjustment item, thus increasing AMTI relative to regular taxable income. In certain instances, this results in the payment of AMT. The taxpayer carries forward the AMT paid as a credit against tax in subsequent years, to the extent the regular tax liability exceeds the tentative minimum tax (TMT).

When a C corporation elects S status, any unused AMT credit is treated as an S carryforward item. The taxpayer can use the AMT credit carryforward to offset any built-in gains (BIG) tax that the S corporation incurs during the 10-year recognition period. For financial institutions and their tax advisers (who were not accustomed to S taxation), the issue was how to determine the usable AMT credit amount. Sec. 53(c) provides for the use of the AMT credit, to the extent the regular tax liability exceeds the TMT (as determined in Sec. 55(b)). Sec. 55, however, generally applies only to C corporations (and individuals). Thus, how do S corporations bridge the gap between Sec. 55 and the S rules?

Step 1

First, the S corporation must compute its "regular tax liability." Regs. Sec. 1.1374-6(b) treats the tentative tax determined under Regs. Sec. 1.1374-1 (a)(3) as the regular tax liability. The S corporation's tentative tax is determined by multiplying 35% (the highest corporate tax rate) by the net recognized BIG for the tax year (Sec. 1374(d)(2)). Simply put, the BIG tax is the regular tax liability.

Example 1: Bank B elects S status, effective Jan. 1, 2000. On that date, B has a $75,000 AMT credit carryforward. In 2000, it sells various securities, resulting in a $125,000 ordinary gain, which is also a recognized BIG. B also sells a building at a $25,000 loss, which is a recognized built-in loss. In addition to these sales, B...