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Blake Christian

Six Counter-Intuitive Tax Planning Tips Revealed

Corporate alternative minimum tax.

December 11, 2007
by Blake Christian, CPA/MBT

The corporate Alternative Minimum Tax (AMT) (IRC Section 55) was first introduced in 1986, primarily in response to highly publicized reports that oil companies and other large, highly profitable business were reporting record profits, but paying little, if any income taxes.

Since the general public and many legislators at the time did not fully grasp the legitimate differences between Generally Accepted Accounting Principles (GAAP) accounting and tax reporting, complete with shorter depreciable lives, non-cash amortization and depletion deductions, expensing provisions and a variety of available tax credits, Congress had little trouble adopting the broader AMT tax base, with lower marginal rates to compare against every taxpayer’s “regular tax liability,” than imposing the higher of the two systems.

As reported in The New York Times, to prevent its soaring effect on taxpayers, several one-year patches have been enacted to keep it in check. This year the Democrats proposed a one-year patch, which the Republicans opposed “because of the Democrats' desire to find new revenues to offset the estimated $50 billion in A.M.T. receipts that would otherwise be collected,” reports The New York Times.

Today the AMT regime is alive and well and subjecting a large percentage of corporate taxpayers annually to its complex web. Over 34 percent of individual taxpayers (including S Corp shareholders) with adjusted gross incomes (AGIs) in excess of $200,000 will be subject to the AMT system for 2007, and looking at a larger group making $75,000 or more — over 60 percent of this group will be subject to AMT this year. While Congress is well aware of this problem, the next few months will give us a clearer picture about whether they have the fortitude to narrow the application of the AMT system.

In early November, the House passed a bill to make up the lost revenue currently caused by allowing hedge-fund managers to treat their fees as if they were capital gains, which are taxed at a lower rate than salaries. Senate Republicans, however, opposed it noting there was no reason to offset a tax that should never have been levied.

Will Your Firm Be Liable for AMT Tax?

Industries that are most likely to be subjected to the AMT include capital intensive corporations such as oil producers, mining companies, newspapers publishers, heavy manufacturers, construction companies, certain technology companies and other companies with large Schedule M-2 or Schedule M-3 book/tax decreases.

The AMT structure calculates “Alternative Minimum Taxable Income” (AMTI) by starting with “Regular” Taxable Income, then adding and subtracting a series of adjustments required under Sections 56 through 59. A $40,000 exemption is allowed as a deduction against the AMT tax base, and then a 26 percent marginal rate is applied to the first $175,000 of AMTI, with 28 percent applied to the AMTI in excess of $175,000. The combined AMT liability is then compared to the Regular Tax Liability and the higher of the two systems is required to be paid.

S and C Corporations

S Corporations and “small” C Corps with gross receipts of $7.5 million or less of annual gross receipts, and average three-year gross receipts not exceeding $5 million, are exempt from the federal AMT system. But note that the flow-through items from the S Corp can often create AMT issues at the shareholder level; therefore, the following corporate tax planning strategies are also relevant to minimizing the AMT exposure for the S Corp shareholders.

Typical add-backs (IRC Sections 56 through 59) required for the AMT system include:

  • Adjusted Current Earnings (ACE) — this is a net adjustment which attempts to capture the majority of the difference between: 1) taxpayer’s book income (measured by modified Earnings & Profits) and 2) compare it to the taxpayer’s AMTI
  • The excess of AMT depreciation over depreciation calculated using longer depreciable lives
  • Mining Exploration and Development Costs
  • A Portion of Net Operating Loss Deductions (generally leaving 10 percent AMTI subject to AMT)
  • Oil and Gas Depletion
  • Intangible Drilling Costs expensed vs. amortized over 10 years
  • Tax Exempt Interest earned on Private Activity Bonds
  • A portion of the excluded gains from the sale of Section 1202 “Small Business” Stock
  • Modified Passive Losses

Applying Lowest Overall Taxes Now and in the Future

Taxpayers anticipating being subject to the AMT this year need to apply some counter-intuitive tax planning techniques in order to ensure that they pay the lowest overall tax — not just in the current year, but also in future years.

  1. Accelerate Taxable Income — since the AMT rates are lower than the highest marginal “regular” tax rates (35%), permanent tax savings are possible by accelerating income into an AMT year. Note: This is most advantageous when the taxpayer anticipates being in an AMT position for multiple years and the AMT credit may not be used in the short-term.
  1. Elect longer MACRS lives — on depreciable assets, and possibly forgo Section 179 expensing (although not a preference, this will increase income).
  1. Elect to Amortize vs. Expense — preference items, including intangible drilling costs, circulation expenses, research and depreciation and mine development expenses.
  1. Consider Forgoing Tax Credits by electing to expense items rather than capitalize and generate a credit that may have limited use against the AMT (generally credits can only offset up to 90% of the AMT). Therefore, foreign tax credits, energy credits and R&D creditable equipment may be less valuable than writing off the underlying item. Obviously this strategy must be balanced against item 3) above.
  1. Delay Payment of “Recurring Items” — to push expense into the following year when marginal rate is higher.
  1. Evaluate Changes in Accounting Methods that might provide shorter and longer term benefits.

AMT associated with certain timing differences can create an AMT Credit, which is available to offset future Regular Tax liabilities. These potential credits need to be factored into the overall planning. However, as a practical matter, the use of these credits can be difficult to monetize without careful planning.

Conclusion

While most tax credits are somewhat limited in being able to offset the entire AMT, the recently extended Work Opportunity Tax Credit (WOTC) program (IRC Section 51) now allows full offset of AMT and Regular tax liabilities. The WOTC program has been expanded to include any employees between the ages of 18 and 40 living in any one of over 400 new “Rural Counties” throughout the U.S. Eight other classifications of employees, including certain veterans, ex-offenders and the economically disadvantaged, can also generate credits up to $2,400 annually for the employer in virtually any industry and businesses operating in any state.

Each year a growing number of taxpayers are being subjected to the AMT. Proper planning takes extensive analysis at year end, planning throughout the year, and crystal-balling into the future, to ensure that the taxpayer is not overpaying their tax in the current or future years.

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Blake Christian CPA/MBT, is a Tax Partner in the Long Beach Office of Holthouse, Carlin & Van Trigt, LLP and is Co-Founder of National Tax Credit Group, LLC.