Corporate Minimum Tax
The corporate minimum tax is designed to ensure that certain large corporations will be subject to a minimum tax of 15% of their adjusted financial statement income, or book income.
This tax will be imposed on corporations whose “adjusted financial statement income” over a consecutive three-year period exceeds $1 billion. In most cases, “adjusted financial statement income” will be the income reported on audited financial statements used for SEC reporting or other non-tax purposes. If a corporation has not been in existence for three years or has a short taxable year, the Act has special rules to address them.
Special rules apply for purposes of determining the adjusted financial statement income of certain related corporations. Under an aggregation rule, income from all members of a controlled group is considered when determining whether a corporation is an applicable corporation. Further, income of corporations filing in a U.S. consolidated group is generally aggregated, and corporations under common control (based on 50% or greater ownership) of a partnership parent company may be aggregated if the partnership is engaged in a trade of business. The Act, as adopted, does not include the provisions proposed in earlier versions of the corporate minimum tax that would have extended such aggregation rules to require certain private equity funds to aggregate the book income of their portfolio companies. Adjusted financial statement income of a corporation also includes the corporation’s income from its disregarded entities, its distributive share of partnership income and its pro rata share of the income of its controlled foreign subsidiaries (CFCs) with respect to which the corporation is a U.S. shareholder.
If a domestic corporation is part of a multinational group, then there are different rules for determining if the domestic corporation will be considered an applicable corporation. Generally, the first step is to determine whether the total income for the entire foreign-parented group exceeds $1 billion. If it does, then the second step is to determine if the domestic corporation’s income, including its appropriate share of income from its CFCs, equals or exceeds $100 million. In addition, if a foreign company is actively engaged in a U.S. trade or business, that trade or business is treated as a separate U.S. subsidiary and, if it meets the two tests discussed in this paragraph, could be subject to the corporate minimum tax.
Generally, once a corporation satisfies the annual income test, the corporation’s status as an applicable corporation becomes permanent even if the corporation’s adjusted financial statement income drops below the threshold in future years. A change in status appears to only be available if the Treasury determines that continued treatment as an “applicable corporation” is not appropriate, which appears to be limited to situations where there is a change in control of the corporation or the adjusted financial statement income for the corporation is below $1 billion for several years in a row.
Adjusted financial statement income allows for adjustments for accelerated tax depreciation and the tax amortization of certain qualified wireless spectrum. A major difference between book and tax income is depreciation, so this could be a significant benefit to taxpayers. Further, adjusted financial statement income can be reduced by financial statement loss carryovers from other taxable years but are subject to a limitation equal to 80% of financial statement income (before such deduction), and such carryovers are limited to losses for taxable years ending after December 31, 2019.
The corporate minimum tax liability is the positive difference between the calculated corporate minimum tax (as reduced by certain foreign tax credits and general business credits) and the sum of the corporation’s regular income tax liability plus its liability for the base erosion and anti-abuse tax (BEAT). Payments of the corporate minimum tax can be used as a credit in future years to the extent the corporation’s regular corporate tax and its BEAT exceeds the corporation’s calculated corporate minimum tax.
This provision would become effective December 31, 2022.
The Organization for Economic Cooperation and Development (OECD) is planning to implement “Pillar Two,” which would impose a 15% minimum tax on the financial accounts of multinational groups with annual revenue in excess of €750 million. Although the two regimes sound similar, there are important differences, including imposition of Pillar Two on a jurisdiction-by-jurisdiction base, that may cause a corporation subject to the corporate minimum tax to be subject to additional tax under Pillar Two.
There was a version of the corporate minimum tax in the Tax Reform Act of 1986. The 1986 provision started with taxable income and required corporations to make certain book adjustments, such as disallowing accelerated depreciation as an adjustment. However, as time went on, Congress significantly reduced the impact of the provision until it was ultimately repealed in 2017.
Excise Tax on Stock Buybacks
The Act imposes a 1% corporate excise tax on the fair market value of the stock of a “covered corporation” that is repurchased during the taxable year. In the Act, a covered corporation is defined as “any domestic corporation the stock of which is traded on an established securities market.” A repurchase for purposes of this provision is defined as a redemption within the meaning of section 317(b) of the Internal Revenue Code of 1986, as amended (Code) and anything the IRS will deem to be “economically similar” to a redemption. Section 317(b) of the Code defines a redemption as occurring where “the corporation acquires its stock from a shareholder in exchange for property whether or not the stock so acquired is cancelled, retired, or held as treasury stock.” This could produce interesting results if a transaction is treated as a redemption for tax purposes when it is not a redemption under corporate law. The Act gives the IRS the ability to release guidance on this provision, and taxpayers would benefit from clarifying guidance in this area.
The calculation of the tax is the fair market value of the total shares repurchased during the year minus the sum of the fair market value of stock issued during the year and the fair market value of stock issued to employees as compensation during the year. The time for measuring the fair market value of shares issued or repurchased is not specified, but presumably is based on the fair market value of the shares on the effective date of the relevant transaction. If this is the case, the excise tax could be applicable to a corporation even where there has been no net reduction in the corporation’s number of shares outstanding during the year. The excise tax is payable by the corporation redeeming the stock and is not deductible for U.S. federal income tax purposes.
In addition, repurchases by “specified affiliates” will be treated as a repurchase by the covered corporation. These affiliates are generally corporations or partnerships more than 50% owned directly or indirectly by the covered corporation. There are special rules that apply similar rules to publicly traded foreign corporations where the foreign corporation’s stock is repurchased by certain domestic affiliates or in certain situations where the foreign corporation is treated as an “expatriated entity” under the U.S. inversion regime.
There are several exceptions to the excise tax including: (1) to the extent that the stock repurchase is in connection with a tax-free reorganization in which no gain or loss is recognized on the repurchase by the shareholder; (2) stock that is repurchased (or an amount of stock equal to the repurchased amount) is contributed to an employer-sponsored retirement plan, employee stock ownership plan or a similar plan; (3) where the total repurchase amount during the taxable year does not exceed $1 million; (4) under regulations prescribed by the Secretary, where the repurchase is done by a corporation whose ordinary course of business includes dealings in securities; (5) repurchases by a regulated investment company or a real estate investment trust; and (6) to the extent the repurchase is treated as a dividend for federal income tax purposes.
This provision would become effective December 31, 2022.
Increased Funding for the Internal Revenue Service
The IRS will receive $80 billion in funding to be spent over the next ten years in addition to its annual appropriations. Over $45 billion is allocated to enforcement efforts, with the remaining funding to be used for other functions, including operations support (over $25 billion), business systems modernization (nearly $5 billion), taxpayer service (over $3 billion) and a task force to design a free IRS-run direct e-file system. The Act is silent on how the additional money will be spent on enforcement; however, in order to combat fear that the middle class are expected to be the target of increased audits, Treasury Secretary Janet Yellen sent a letter to IRS Commissioner Chuck Rettig which provides that the agency should not use the additional resources to increase audits on small businesses or households earning less than $400,000 each year. One goal of the additional funding is to help close the tax gap by generating an additional $124 billion in revenue (net of expenses) currently lost to fraudulent tax returns. It is important to note that this brings IRS funding up to prior levels before years of cuts by Congress. As professionals who work regularly with the IRS, we’ve been dismayed by recent allegations highlighted in the press that this much-needed funding will be used to militarize the IRS. We fear that such unsupported statements serve to undermine our voluntary compliance system and jeopardize the security of many hard-working IRS employees.
Other Provisions
The Act extends the limitation on excess business losses of noncorporate taxpayers. This provision was set to sunset in 2027 and has been extended to sunset in 2029. Although included in earlier versions of the legislation, proposed rules modifying the treatment of “carried interests” were not included in the Act. The Act also has several climate change initiative credits which are discussed in detail here.