The Inflation Reduction Act (IRA) enacted on August 16, 2022, created a new corporate alternative minimum tax (AMT) for taxable years beginning after December 31, 2022. On December 27, 2022, the Treasury Department and the Internal Revenue Service issued interim guidance in the form of Notice 2023-7, addressing how the new corporate AMT applies to partnership interests, consolidated return groups, and other significant events that affect corporations, including merger and acquisition activities and excepted cancellation of debt income.
The AMT is equal to 15% of the excess of adjusted financial statement income (AFSI) over the corporate AMT foreign tax credit. AFSI is a financial statement of net income, with adjustments. The AMT applies only to an “applicable corporation,” which is a corporation other than an S corporation, RIC, or REIT with an average annual AFSI exceeding $1 billion over a three-year period that concludes with a taxable year ending after December 31, 2021, but prior to the taxable year of computation.
For example, calendar-year corporations in 2023 will determine if their average AFSI exceeds $1 billion for the taxable years ending in 2020, 2021, and 2022. The AFSI average does not have to be computed for the three immediately preceding years, and therefore once a corporation is deemed an “applicable corporation,” it will remain as such until either (i) a change of control occurs or (ii) sufficient time has passed that it is no longer appropriate to apply the AMT. The statute reserves the right to define these conditions in forthcoming Treasury regulations.
Aggregation rules apply for purposes of determining applicable corporation status. Under these provisions, corporate AFSI is aggregated, with persons treated as a single employer under Internal Revenue Code Sections 52(a) and 52(b), which would include controlled group members and trades or businesses under common control. This expansion would include the activity of non-corporate entities such as partnerships that operate under common control. Although the Thune amendment to the IRA appears to have eliminated the aggregation of private equity funds to their portfolio companies, the notice does not address whether future regulations will take a different approach to private equity partnerships as engaged in a trade or business. These aggregation rules are solely for assessing applicable corporation status and are not applied in computing the AMT once a corporation is classified as an applicable corporation.
Foreign-parented multinational groups have an additional modified approach to the status test. In defining whether or not an applicable corporation is present, the $1 billion AFSI average assessment is made with respect to all members of the group, including foreign corporations, and all U.S. members of the group must exceed a $100 million threshold over a similarly defined three-year period. Each of the two prongs has unique modifications to how AFSI is determined. Notably, in computing the AFSI of U.S. members, foreign subsidiaries of U.S. members are included in assessing the $100 million threshold.
Notice 2023-7 is intended to address time-sensitive items that will be addressed further in forthcoming regulations. The notice provides the following points of clarity.
The AMT applies to a consolidated return group as though it were a single entity both for determining applicable corporation status and for computing the AMT liability. This application logically follows the single-entity concepts of the consolidated return regulations both for determining applicable corporation status and the AMT liability each year. Thus, intercompany transactions between those entities included in a consolidated return group should be eliminated, and thus, ultimately deferred until those assets leave the consolidated return group. Conversely, for transactions between an includable and non-includable entity, (i.e., a U.S. and a foreign entity that may have been eliminated for AFS purposes), those transactions must be recognized for AMT purposes.
For transactions involving corporations and partnerships that are wholly tax-free for federal tax purposes (for example under the provisions of Sections 332, 337, 351, 354, 355, 357, 368, 721, 731 and 1032) such application will also apply in determining AFSI even if the transaction resulted in the recognition of gain or loss for financial reporting purposes. This would generally result in a taxpayer-favorable adjustment that lowers AFSI. However, the treatment of partially tax-free transactions as a result of nonqualifying property, i.e., “boot” being transferred, is yet to be addressed.
With respect to M&A activity spinoffs, or transactions involving target groups or members of target groups being acquired: (i) applicable corporation status of the target is terminated by the transaction, (ii) AFSI of a target group or an allocable portion for a target member is added to the AFSI calculation of the purchasing group, and (iii) for remaining group members in the case of a target member acquisition, AFSI is not adjusted to remove the target member’s allocable AFSI for periods preceding the transaction. These principles apply similarly to distributing and controlling group members in a spin-off or split-off transaction.
In adjusting AFSI for income incurred on troubled debt, the federal principles under Section 108 in which cancellation of debt (COD) income may be excluded for insolvency or bankruptcy are applied, which would generally be a taxpayer-favorable adjustment lowering AFSI (i.e., COD income for AFS purposes but not for AMT purposes). However, attribute reduction for AMT purposes would occur similarly to the general federal tax treatment of excepted COD income, resulting in the need for separate tracking of attributes for AFS purposes. The determination of how this reduction would be specifically applied requires additional guidance.
In computing depreciation for AFSI purposes, taxpayers may make a book-to-tax adjustment recognizing an expense for tax depreciation with respect to the property to which Section 168 applies, and for depreciation properly capitalized to inventory and recovered as a component of costs of goods sold for the property sold during the year. The adjustment is allowed for Section 168 property placed in service in any taxable year, including years beginning before the effective date of the corporate AMT. Further, the Notice clarifies that amounts deducted as repairs for tax purposes but capitalized as an improvement for financial reporting purposes do not qualify as an adjustment for AFSI, because those expenditures do not constitute depreciation under Section 168.
As with previous iterations of the corporate AMT, the alternative depreciation framework also requires taxpayers to adjust gain or loss on disposals to account for the AMT depreciation taken for AFSI purposes. The notice introduces a safe harbor “simplified method” for making an applicable corporation status determination in the first taxable year ending after December 31, 2022. Under this method, AFSI is computed based on financial statement income with limited adjustments, with the aforementioned income thresholds being halved. For example, domestically owned corporations will apply a $500 million threshold, and foreign-parented multinational groups will apply a $500 million threshold to domestic and foreign member AFSI, as opposed to a $1 billion threshold, and a $50 million threshold to domestic AFSI, as opposed to $100 million.
The notice concludes with a significant list of issues on which the Treasury Department and the IRS are requesting comments. These include how the change of control and status duration conditions referenced above should be defined, how AMT-specific attributes should be handled in troubled debt transactions and when members leave a consolidated return group, and how the computation of AFSI should account for other comprehensive income items, among a number of other issues.