The small business AMT exception.

• Author: Karlinsky, Stewart S.
• Position: Alternative minimum tax

The Taxpayer Relief Act of 1997 simplified corporate taxpaying and reporting for small businesses by exempting them from alternative minimum tax (AMT) if the new rules are met. These rules include an average annual gross receipts test that seems straightforward on its face. However, on closer inspection, the new rules are fraught with problems, such as when the "lookback period" begins for tallying average gross receipts. This article explains the new provisions and offers examples for corporations seeking to qualify for the AMT exemption.

The Taxpayer Relief Act of 1997 (TRA '97), Section 401(a), enacted a significant change to the corporate alternative minimum tax (AMT) system as it affects small businesses. Under new Sec. 55(e), effective for tax years beginning after 1997, the AMT is repealed for "small business corporations." According to Sec. 448(c) (1), a C corporation that had average gross receipts of less than $5 million for the prior three years is a small business corporation for this purpose. Further, a corporation that meets the $5 million gross receipts test will continue to be exempt from AMT as long as its average gross receipts do not exceed $7.5 million. A corporation that fails to meet the $7.5 million gross receipts test will be subject to AMT prospectively only.

This article discusses three major aspects of the new law: (1) the entities to be aggregated in determining gross receipts (including use of a short tax year and/or predecessor companies); (2) use of the minimum tax credit (MTC) in a year in which tentative minimum tax (TMT) is zero; and (3) the fresh-start provisions that apply when average gross receipts exceed $7.5 million.

Sec. 448(c) Issues

Gross Receipts Test

New Sec. 55(e)(1)(A) provides an AMT exemption for corporations that meet the Sec. 448(c) $5 million average gross receipts test. The first issue is when the three-year lookback period for the test begins.

Start of lookback period: According to the TRA '97 Conference Committee Report, 1 the three-year lookback period for the $5 million average gross receipts test is tax years after 1994 (i.e., tax years 1995, 1996 and 1997); however, the General Explanation of Legislation Enacted in 19972 (Blue Book), states that that is erroneous and that the three-year lookback period includes tax years beginning after 1993 (i.e., tax years 1994, 1995 and 1996). This in itself is an issue that, without resolution, could trigger much litigation.

New entity: A newly formed corporation in 1998 or thereafter not deemed to stem from a predecessor corporation is automatically exempt from AMT for its first tax year. If in the first tax year, the corporation's gross receipts exceed $7.5 million, the corporation will lose its AMT exemption starting in its second tax year. The exemption continues to apply only as long as average gross receipts remain at $7.5 million or less.

What happens if a new entity results from a tax-free spinoff of a division, branch or single-member limited liability company (LLC) in a D reorganization or Sec. 355 corporate division? If' it is not viewed as stemming from a predecessor company or being part of an affiliated group, it would be AMT-exempt in at least its first year of operation. Sec. 381 does not apply to the spinoff of a controlled corporation (because the distributing parent keeps all tax attributes, except earnings and profits and accumulated adjustments account); thus, the predecessor company rule should not apply. If the corporate division was non-pro rata, the controlled group rules of Secs. 52(a) and 1563(a) would likely not apply. If the new entity were to lose its AMT exemption in the future, the new Sec. 55(e)(3) anti-abuse rule (discussed below) would need to be considered. If' the distributing parent were exempt from AMT, the AMT and adjusted current earnings (ACE) rules (discussed below) would apply prospectively.

Short tax year: Sec. 448(c)(3)(B) and Temp. Regs. Sec. 1.448-1T(f)(2)(iii) require gross receipts for a short tax year to be annualized in computing gross receipts.

Example 1: X Corp., formed in 1998, had the following gross receipts:

Year Gross receipts 1998 (six-month tax year) $3,000,000 1999 $3,000,000 2000 $4,000,000 2001 $17,000,000 For 2001, X meets the $5,000,000 average gross receipts test, because the average gross receipts in 1998-2000 were only $4,333,333 (($6,000,000 + $3,000,000 + $4,000,000)/3). However, the average gross receipts test is not met for 2002, because average gross receipts for...