Tax planning after AMT reform.

• Author: Everett, John O.
• Position: Alternative minimum tax

EXECUTIVE SUMMARY

* Many small corporations that meet the Sec. 55(e) revenue test are exempt from the AMT.

* Legislative conformity of the AMT, ACE and RT cost recovery systems has significantly reduced the AMT for many corporations, including real estate and capital-intensive companies.

* For corporations still subject to the AMT, a number of planning strategies can potentially lower overall tax liability.

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As a result of recent legislative changes, many corporations have significantly reduced their alternative minimum tax (AMT) liability, and others have become exempt.

This article summarizes the relevant changes and provides AMT planning strategies.

In 1986, Congress was concerned that profitable corporate taxpayers were using legitimate tax incentives and deferral techniques to the point of paying little or no Federal income taxes. In effect, businesses were deferring income, accelerating expenses and using tax credits to minimize or eliminate their tax liability. To stop these perceived abuses, Congress enacted a parallel or "shadow" corporate tax, the alternative minimum tax (AMT), embodied within the regular corporate income tax system. This system has embedded in it a parallel system, adjusted current earnings (ACE), which further complicates the tax planning and compliance functions.

The AMT's purpose is to ensure that no taxpayer with substantial economic income avoids paying tax by using selected exclusions, deductions, net operating losses (NOLs) and tax credits. Compliance with AMT and ACE requires numerous computations. Although not every corporation will pay tax under this system, most must incur significant recordkeeping costs to comply.

One measure of how well a tax provision works is the lobbying pressure to repeal it; by that standard, the AMT is working very well. (1) Congress began the repeal of the corporate AMT in 1993, while ignoring the fact that the individual AMT is ensnaring more taxpayers than ever. (2) Although the threat of the corporate AMT has been lessened for many corporations (particularly smaller ones), this "shadow tax" can result in disastrous consequences for corporations that fail to plan properly for it. This article examines the revisions of the corporate AMT and offers planning strategies for corporations still subject to it.

This article illustrates the effects of some of the AMT and ACE rules discussed below by using Z Corp. as a case study. Readers less familiar with the complex computations needed to determine the AMT may find this article's exhibits useful in reviewing those rules, including Exhibit 1 on p. 216 (a summary of the ACE cost recovery rules), Exhibit 2 on p. 217 (Z Corp's schedule of assets), Exhibit 3 on p. 218 (Z's regular tax (RT) computation) and Exhibit 4 on p. 220 (Z's AMT computation). Z's alternative minimum taxable income (AMTI) is more than double (205%) its taxable income.

Exhibit 1: Summary of ACE cost recovery rules under Sec. 56(g)(4) Date placed in service Recovery method Property placed in service AMT cost recovery deductions (P/S) after 1993 Property P/S after Alternative depreciation 1989 and before 1994 system (ADS) Property P/S after ADS, using the AMT basis 1986 and before 1990 as of 1/1/90 Property P/S after ADS, using the RT basis of 1980 and before 1987 the property Property P/S before 1981 Same calculation as required for RT purposes Exhibit 2: Z's asset schedule Placed in Class MACRS Asset service Cost life life Cement mixers * 1/1/93 $400,000 20 15 Machinery/equipment 1/1/98 $350,000 10 7 Drill equipment 1/1/04 $400,000 10 7 Nonresidential realty 6/1/89 $300,000 N/A 31.5 Nonresidential realty 1/1/04 $200,000 N/A 39 Cost recovery deductions Asset MACRS AMT ACE Cement mixers * Machinery/equipment $11,800 $8,922 $10,000 Drill equipment 31,255 30,590 30,590 Nonresidential realty 271,435 271,435 271,435 Nonresidential realty 9,525 7,500 7,500 Total cost recovery deductions 4,922 4,922 4,922 AMT adjustment (MARS deduction--AMT deduction) $328,937 $323,369 $324,447 ACE adjustment (AMT deduction--ACE deduction) $5,568 $(1,078) * The cement mixers were sold in 2004, creating gain/loss adjustments for AMT and ACE purposes. Exhibit 3: Z Corp.'s RT computation Gross sales revenue $7,800,520 Cost of goods sold (a) (5,199,320) Gross profit $2,601,200 Gross dividends received (5% interest in domestic ACE corporation) 200,000 Gross dividends received (22% interest in domestic corporation) 100,000 Interest income--U.S. treasury notes 30,400 Interest income--state of Ohio bonds ($200,000) (b) 0 Interest income--1996 private activity bond issue ($400,000) (c) 0 Life insurance proceeds--death of company officer ($1,000,000) (d) 0 Gain (ordinary) on the sale of depreciable property (e) 115,520 Gain (capital) on installment sale of land (f) 250,000 Gross income $3,297,120 Organization costs 0 Depreciation cost recovery (g) (328,937) NOL carryforward to current year 0 Other ordinary operating expenses (908,041) Income before charitable deduction $2,060,142 Contributions (128,620) NOL carryback to current year 0 Income before DRD $1,931,522 DRD (h) (220,000) Taxable income $1,711,522 Gross tax liability 581,917 AMT (see Exhibit 4 on p. 220) 118,743 Credits against RT liability 0 Estimated Federal income tax payments for the year (640,000) Net RT liability $60,660 (a) Z uses LIFO. Current-year LIFO layer was $60,000. (b) Related expenses of $12,000 were incurred. (c) Related expenses of $18,000 were incurred. (d) Life insurance proceeds received from the death of a key employee. Premiums of $60,000 were paid on the policy during the current year; the cash surrender value of the date of death was $80,000. (There is no cash surrender value increase for the current year.) (e) A cement mixer (personalty) was sold on June 1 of the current year for $210,000; see Exhibit 2 on p. 217 for details. (f) Five hundred acres of business land were sold at the end of the current tax year for a total gain of...