Chapter 6 Notes
The Section 179 deduction
Intended as a benefit to small business, a simplification measure and an incentive for small business to invest in new business assets.
In 2004, allows qualifying taxpayers the option to expense up to $102,000 of otherwise depreciable acquisitions of tangible personalty (not real property).
Increased to $105,000 in 2005
Amount is phased out as acquisitions exceed $410,000 ($420,000 in 2005)
Amount expensed is limited to taxable income of trade or business conducted by the taxpayer. Any amount in excess of the taxable income can be carried over
Extended through 2007 under 2004 tax act
Additional first-year depreciation
The 179 deduction is taken before any regular or additional first year depreciation
After September 11, Congress instituted a new incentive called additional first year depreciation. Originally 30%, it was increased to 50% for property placed in service after May 5, 2003 and before January 1, 2005.
Has not been extended
Regular depreciation rules apply after 179 deduction and first year depreciation (if applicable)
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Basic rules for corporate tax credits
A variety of business credits are available.
Most are considered a general business credit and limited to the lesser of:
1. regular tax liability minus the tenative minimum tax (an AMT concept)
2. regular tax liability minus (25% of regular tax in excess of $25,000)
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The Corporate Alternative Minimum Tax
Overview
The objective and the rationale for the individual and corporate AMT are the same. The calculations are similar although some of the adjustments are different, the tax rate is different, the exemption amount is different and the AMT credit works differently.
The Small Corporation Exemption
The Taxpayer Relief Act of 1997 (TRA 97) repealed the AMT for small corporations for tax years beginning after December 31, 1997. For a corporation in existence on January 1, 1994, a small corporation is one that has average annual gross receipts of not more than $5 million for the three-year period beginning after December 1993 (1994, 1995 and 1996). A corporation will continue to be classified as a small corporation if its average annual gross receipts for the three-year period preceding the current tax year and any intervening three-year periods do not exceed $7.5 million. But, once you fail the gross receipts test, the corporation is not eligible to be classified as a small corporation in future years.
A corporation created after 1997 will automatically be classified as a small corporation in the first tax year of existence.
To qualify for the second year, the corporation’s gross receipts for the first year must be less than $5 million. To qualify for the third year, the corporation’s average gross receipts for the first two years must be less than $7.5 million. To qualify for the fourth year, the corporation’s average gross receipts for the first three years must be less than $7.5 million.
Example 1:
Q Corp. was formed in 1994, and had the following gross receipts:
1994 $3,000,000
1995 $4,000,000
1996 $5,000,000
1997 $6,000,000
1998 $7,000,000
1999 $8,000,000
2000 $9,000,000
2001 $4,000,000
Is Q Corp. exempt in 1994, 1995, 1996, and 1997?
Is Q Corp. exempt in 1998, 1999, and 2000?
Is Q Corp. exempt in 2001?
Is Q Corp. exempt in 2002?
Example 2:
X Corp. was formed in 1998, and had the following gross receipts:
1998 (six month tax year) $2,000,000
1999 $3,000,000
2000 $4,000,000
2001 $17,000,000
2002 $1,000,000
Is X Corp. exempt for 1998?
Is X Corp exempt for 1999?
Is X Corp. exempt for 2000?
Is X Corp. exempt for 2001?
Is X Corp. exempt for 2002?
Is X Corp. exempt for 2003?
Calculation:
Like individuals, corporations begin with taxable income (before the NOL deduction), add or subtract adjustments, add preferences, subtract the alternative tax NOL deduction and the AMT exemption to arrive at the AMT base.
The exemption for corporations is $40,000, phased out at a 25% rate as AMTI exceeds $150,000. The exemption is entirely phased out when AMTI exceeds $310,000.
The AMT base multiplied by the appropriate flat rate (20%), less the AMT foreign tax credit equals the tentative minimum tax. The excess of tentative minimum tax over the regular income tax is the taxpayer's AMT.
AMT Formula for Corporations
Regular Taxable Income
Plus: Regular Tax NOL deduction
Plus or minus: AMT adjustments
Plus: Tax Preferences
Equals: AMTI before Alternative Tax Net Operating Loss Deduction (ATNOLD)
Minus: ATNOLD
Equals: AMTI
Minus: Exemption
Equals: Alternative Minimum Tax Base
Times: 20% rate
Equals: Tentative minimum tax before foreign tax credit
Minus: Alternative minimum tax foreign tax credit
Equals: Tentative minimum tax
Minus: Regular tax liability before credits minus regular foreign tax credit
Equals: Alternative minimum tax (if amount is positive)
Adjustments
AMT adjustments are the result of rules requiring recomputation of certain items of income and deduction for AMT purposes. As a result, unlike preference items, which only increase AMTI, an adjustment can cause an increase or a decrease. In addition, and for the same reason, AMT basis in affected assets will differ from regular income tax basis, and adjustments to gain or loss on disposition are required.
Adjustments affecting both Corporate and Individual Taxpayers
Depreciation
TRA of 1997 reduces or eliminates the adjustment for depreciation of personal property placed in service after 1998 by providing that the MACRS recovery periods are to be used in computing AMT depreciation. If taxpayers choose to use 150% DB for MACRS purposes, there will be no adjustments for these assets.
However, for property placed in service before 1999, an adjustment is still necessary.
TRA of 1997 eliminated the adjustment for depreciation of real property placed in service after 1998 by providing that the MACRS recovery periods are to be used in computing AMT depreciation.
However, for property placed in service before 1999, an adjustment is still necessary.
LongTerm Contracts
Corporations must use the percentage of completion method for long term contracts.
As a practical matter, most taxpayers must use the percentage of completion method for regular tax as well and no adjustment is required.
However, for regular tax purposes, the completed contract method is still allowed for short-term contracts or small contractors (under 2 years and under $10 million average annual gross receipts), and home construction contracts.
Adjusted Gain or Loss
Since the adjusted basis of an asset can be different for regular tax and AMT, gain or loss recognized upon the disposition of an asset may vary.
Adjustments That Apply Only to Corporations
The Adjusted Current Earnings (ACE) Adjustment
Corporations (but not S corporations) are subject to an AMT adjustment equal to 75% of the excess of ACE over AMTI before the ACE adjustment.
The ACE adjustment can be either a positive or negative amount. AMTI is increased by 75% of the excess of ACE over unadjusted AMTI or AMTI is reduced by 75% of the excess of unadjusted AMTI over ACE. Any negative adjustment is limited to the aggregate of the positive adjustments under ACE for prior years. Unadjusted AMTI is AMTI without the ACE adjustment or the alternative tax NOL deduction.
Example 3:
X Corp. had positive adjustments (i.e. 75% of the excess of ACE over unadjusted AMTI) in 1998 through 2001 of $20,000. In 2002, unadjusted AMTI exceeds ACE by $30,000. By how much can X Corp. reduce unadjusted AMTI in 2002?
Preferences
Unlike the adjustments covered above, preference items can only increase AMTI. There is no downward adjustment when the preference amount exceeds the regular tax deduction, nor is any basis adjustment allowed.
Percentage Depletion
The deduction for percentage depletion in excess of the basis of the depletable property is a preference item. The computation is made on a propertybyproperty basis.
The preference does not apply to percentage depletion on oil and gas wells for independent producers and royalty owners as defined in section 613A(c).
Intangible Drilling Costs
Excess intangible drilling costs (IDC) above 65% of net income from the property constitute a tax preference.
Excess IDC is the excess of the current deduction over what it would be had the IDC been capitalized and straight-line recovery of intangibles has been used (generally over 120 months unless an election is made under Section 57(b)(2).
Interest on Private Activity Bond Interest
The interest on exempt private activity bonds is exempt from the regular income tax, but is a preference item for AMT purposes. Private activity bonds are bonds in which the proceeds are used by anyone other than a government unit. Examples include industrial development bonds, bonds used to finance sports arenas, student loan bonds, mortgage subsidy bonds, etc. Expenses of carrying the bonds are disallowed for regular tax purposes, but are netted against the interest for AMT purposes.
Credit for Prior Year Minimum Tax
Timing differences in the treatment of some income and deduction items for regular tax purposes and AMT purposes may provide inequitable results. For example, AMT may be paid on a portion of the gain from a construction contract (calculated using the percentage of completion method), while none of the gain is taxed for regular tax purposes (using the completed contract method).
In the year of completion, regular tax is paid on the entire gain from the construction contract while only the remaining gain is recognized for AMT purposes. The credit for prior year’s minimum tax is designed to reduce the regular tax liability by some or all of the AMT paid in previous years.
Example 4:
Perry Corporation uses the completed contract method to account for its construction contracts. During the current year, Perry enters into a contract to build a commercial facility and expects $200,000 in profit. The building is 40% complete at the end of year 1 and is to be finished in year 2. Assuming that Perry has no other taxable income in each of the 2 years, what is Perry’s tax liability in each year?
What is Perry’s regular tax and AMT in year 1?
What is Perry’s regular tax and AMT in year 2?
The credit is limited to the extent that the regular tax liability reduced by other nonrefundable credits exceeds the tentative minimum tax for the tax year. The credit may not be used to offset any future minimum tax liability.
All of the AMT paid by a corporation carries over (but not back) and can be used as an AMT credit to reduce the regular income tax in future years to what the tentative AMT for that year would have been.
Example 5:
A corporation’s total AMT liability for 2001 is $70,000. Assume the 2002 regular tax is $130,000 and the 2002 tentative minimum tax would be $90,000 if applied. How much of the AMT credit can be used in 2002?
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