Almost two months ago, on August 16, 2022, President Biden signed the Inflation Reduction Act of 2022 (the IRA) in the law. Among the most notable provisions of the IRA is an alternative minimum tax of 15% on corporations with book profits over $1 billion (the CMT). For previous Eversheds Sutherland reports regarding CMT, see Signed, sealed, delivered: Biden signs Cut Inflation Act enacting ‘new’ minimum corporate tax and Back from the Dead: The Eleventh Hour Corporate Minimum Tax Resurfaces in the Cut Inflation Act of 2022. The CMT is effective for tax years beginning after December 31, 2022. Accordingly, taxpayers strive to understand whether they are liable for the CMT and, if so, to what extent. Inevitably, this analysis has resulted in the identification of a number of areas where immediate guidance is needed. As we await implementation and clarification of guidance from the IRS and Treasury, this alert highlights a number of preliminary CMT-related issues for which guidance is appropriate.
Section 10101 of the IRA generally imposes the IMC of 15% on the adjusted financial statement income (AFSI) of a relevant company whose aggregate profits exceed $1 billion over three consecutive tax years. The law amends Section 59 of the Code to define an “applicable corporation” as any corporation, excluding S corporations, regulated investment companies, and real estate investment trusts (REITs) that meet the “income test Adjusted Average Annual Financial Statements” for one or more tax years ending after December 31, 2021. In addition, any foreign-parent multinational group that includes at least one U.S. domestic corporation may be subject to CMT if the U.S. national corporation exceeds a modified AFSI threshold of $100 million, and the average annual adjusted financial statement revenue of the multinational group whose parent company is foreign exceeds $1 billion.
To determine the AFSI, a relevant company should look at the net income or losses reported in its “applicable financial statement” or “AFS”. After confirming the appropriate amount of net income reported on an applicable corporation’s AFS, a taxpayer must then review the various provisions of the new law and make the appropriate adjustments to determine their AFSI. The law provides for a number of adjustments to AFS net income reflecting tax deductions and credits, ranging from adjustments to reflect applicable companies that are members of a consolidated group to adjustments for depreciation, amortization and NOL. In addition to determining the amount of the AFSI taking into account various adjustments, Section 59(k)(1)(D) also provides that for the sole purpose of determining whether an entity is an applicable corporation for the purposes of the ‘AMT, all AFSI’s of persons treated as a single employer under Sections 52(a) and (b) will be treated as AFSI’s for purposes of determining whether the $1 billion threshold has been exceeded.
Notable issues requiring immediate advice
As with the enactment of any new law, the rules and statutory provisions may provide the general terms of the new provision, but the devil will be in the details regarding the nature and scope of the new provision. At first glance, CMT may seem straightforward, a 15% tax on corporations with book profits over $1 billion, but the myriad of terms and adjustments defined warrant clarification and implementation guidance.
Impact of certain operations on AFSI
While the law provides for a number of adjustments that may benefit or disadvantage taxpayers of a company’s applicable AFSI amount, the adjustments require further clarification and guidance. For example, when determining the amount of AFSI in a given tax year, there is uncertainty as to whether certain transactions, such as tax-free reorganizations, spin-offs and spin-offs , produce AFSI that should be included in the calculation of BMI. Alternatively, guidance will be needed to determine whether, if a taxpayer makes a stock-for-stock disposition that does not yield cash but generates net income for financial accounting purposes, whether that gain should be included in the AFSI. In addition, it will be important to address the treatment of accounting-tax differences generated by accounting for purchases of taxable or tax-exempt transactions.
Adjustments to AFSI
Beyond the impact of certain transactions, guidance will be needed to clarify and provide details regarding the many adjustments to the AFSI, including, for example, the adjustment permitted to a relevant company to account for its deductions for depreciation for the tax year concerned. Many taxpayers have questioned the interaction with the bonus amortization rules as well as the treatment of items with differences between books and taxes, such as repair costs, which the IRS will need to address in order to allow taxpayers to make the necessary adjustments. Also, it would be useful to clarify whether the AFSI includes amortization for gain or loss on assets sold where amortization is claimed prior to the AFSI trial period.
Beyond the intended adjustment for depreciation, taxpayers will also need clarification of the many book and tax differences brought into play by law. For example, the IRS will need to confirm whether book income related to the cancellation of debt income that is excluded under section 108(a)(1) is also excluded from AFSI.
In addition to depreciation and accounting tax differences, there are a number of AFSI adjustments related to a US taxpayer’s foreign operations that merit further guidance. Taxpayers will want to understand how to avoid double counting of income in AFSI and dividend income with respect to CFCs, as well as how a Section 482 adjustment may or may not impact the AFSI. It is also unclear how foreign currency translation gains or losses factor into the AFSI determination. With respect to foreign taxes paid, taxpayers will also need guidance on how foreign taxes paid at the partnership level are treated, what foreign taxes reflected in the financial statements are accounted for, and how and when to properly consider foreign taxes tax determination for BMI foreign tax credit purposes.
Using a Taxpayer’s AFS to Determine AFSI
Additionally, with respect to the requirement to use an AFS to determine the AFSI, it will be extremely important to confirm which AFS is used to determine the applicable corporate status of an entity when a taxpayer’s fiscal year differs from its tax year, which is not uncommon for many taxpayers. In addition, the statute’s cross-reference to Section 451(b)(3) requires a review of the recently revised revenue recognition rules under Section 451(b) and provisions under Treas. Reg. §1.451-3 to clarify the definition of AFS for IMC purposes and to ensure that appropriate AFS and AFS amounts are considered when determining an applicable company’s AFSI starting point, e.g. , what amount is included and excluded in the calculation of “net income”. or loss” in an AFS.
Duration of the “relevant company” designation
Additionally, once a taxpayer has met the AFSI test, guidance is needed to understand how long that entity will be considered an applicable corporation. The law provides that the classification could change if there is a change in ownership or if the company concerned falls under the AFSI threshold for a certain number of years, but the law empowers the IRS to make such a decision. . Additionally, guidance will be needed to determine when a corporation experiences a “change of ownership” and what happens when such a corporation retains its applicable corporate status.
Scope of the section 52 grouping rule on the designation of “relevant company”
In addition to guidance clarifying the duration of an entity’s “applicable corporation” designation, much detail is needed to understand the nature and scope of the section 52 aggregation rule on determining whether an entity is an “applicable company”. For example, the IRS will need to clarify whether holding companies that are owned by a private entity fund are treated as related for purposes of Section 52(a) or (b) and the Treasury regulations thereunder. Additionally, guidance is needed to understand how the three-year AFSI test applies when entities leave or join a Section 52 group. Additionally, taxpayers who are shareholders of a CFC will need to understand how the rule pro rata sharing applies to CFCs that are part of the same Section 52 affiliate of a US shareholder for purposes of determining applicable corporate status.
Interaction of partnership tax rules
With specific regard to the issues faced by entities classified as partnerships for U.S. federal income tax purposes, a significant amount of guidance is required to address the treatment of partnerships for purposes of determining the applicable company status, as well as adjustments to the AFSI necessary to properly take into account the rules and principles of sub-chapter K. In addition, it will be extremely important to clarify the definition of “distributive share” of the AFSI for the purposes of the CMT and business partners, as well as to provide clarification regarding the reporting of information by partnerships that have business partners, who are or may be subject to the CMT.
As CMI is effective for tax years beginning after December 31, 2022, there is no doubt that implementation and clarification guidance is needed for taxpayers to fully understand the scope of the new tax. While this alert highlights some issues where guidance would be helpful, it will be prudent for taxpayers to engage with the IRS and Treasury, provide letters of comment, and voice concerns, as c Now is the pencil hitting the paper, the fingers hitting the keys, and the “devil” in these details is a guide being written.