Signed, sealed, delivered: Biden signs Inflation Reduction Act enacting “new” corporate minimum tax

Kyle Colonna, Ellen McElroy, Michael Resnick
Eversheds Sutherland (US) LLP
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Eversheds Sutherland (US) LLPOn August 16, 2022, President Biden signed the Inflation Reduction Act of 2022 (the IRA) into law. Among the most notable IRA provisions is a 15% corporate alternative minimum tax on corporations with book profits exceeding $1 billion effective for taxable years beginning after December 31, 2022 (the AMT). Originally a provision of the now-defunct Build Back Better Act, the AMT was revived by Senators Chuck Schumer and Joe Manchin earlier this month. The AMT managed to survive the budget reconciliation process, including a “vote-a-rama” in the Senate (i.e., a procedure in which Senators propose an unlimited amount of amendments to budget-related bills). The corporate AMT applies only if the 15% rate applied to a designated corporation’s financial statement income exceeding $1 billion with adjustments is greater than the corporation’s regular US Federal income tax liability plus any base erosion anti-abuse tax (BEAT). According to the Joint Committee on Taxation, approximately 150 of the world’s largest companies may potentially be subject to the AMT.1 Consequently, there are a range of issues to consider in applying this new tax.

This alert provides a high-level overview of the AMT with preliminary observations and potential implications. As practitioners and taxpayers have the opportunity to digest the new statute, it will be interesting to see what major issues arise, where clarification is needed, and what direction is provided by the IRS and Treasury in issuing implementation guidance.

Overview:

Section 10101 of the IRA2 generally imposes a 15% corporate minimum tax on the adjusted financial statement income of an applicable corporation with global profits in excess of $1 billion over three consecutive tax years. An applicable corporation is liable for the AMT to the extent its tentative minimum tax exceeds its regular US Federal income tax liability plus its liability for the base erosion anti-abuse tax (BEAT). In other words, the IRS will now require applicable corporations to compute two separate calculations for Federal income tax (FIT) purposes, paying the greater of either the AMT or the regular tax liability plus any BEAT. 

The statute 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 meets the “average annual adjusted financial statement income test” for one or more tax years ending after December 31, 2021. A corporation satisfies this test if its average annual adjusted financial statement income for the three-taxable year period ending with the relevant taxable year exceeds $1 billion. 

The liability for the AMT results from the excess of 15% of the adjusted financial statement income for the taxable year over the corporate AMT foreign tax credit for the taxable year. It may seem confusing but an applicable corporation that is subject to the AMT receives a credit that can be used to offset its regular federal income liability in a future tax year when it is subject to the regular corporate tax provisions; however, this credit cannot be used to reduce its future AMT liability. 

As with most recent tax legislation, the devil will be in the details regarding the true impact of the AMT. As a threshold matter, the AMT is imposed on an applicable corporation with “average annual adjusted financial statement income” exceeding $1 billion. Also, any foreign-parented multinational groups that include at least one US domestic corporation may be subject to the AMT if the US domestic corporation exceeds a modified AFSI threshold of $100 million, and the average annual adjusted financial statement income of the foreign-parented multinational group exceeds $1 billion. 

The AFSI threshold is based on an applicable corporation’s “adjusted financial statement income” or “AFSI.” To determine AFSI, an applicable corporation must review the net income or losses reported on its “applicable financial statement” or “AFS.” The term, AFS is defined in Section 451(b)(3) and it is based on a concept first established by the IRS in administrative guidance addressing income recognition and subsequently codified with the Tax Cuts and Job Act, when Section 451(b)’s income recognition provisions were enacted. 

The term, applicable financial statement, generally refers to an audited GAAP or IFRS financial statement used for SEC reporting purposes. An AFS also includes other financial reports, which may encompass for example, reports prepared to secure credit, statements used to provide financial information to shareholders, and reports maintained by private companies in anticipation of becoming public. Although these reports do not rise to the level of an audited financial statement, they are considered an AFS for AMT purposes.

ES Observation: Similar to the concerns raised following the Tax Cuts and Jobs Act’s enactment of Section 451(b), which aligns income recognition for Federal income tax purposes with revenue recognition for financial accounting purposes, the AMT is likely to receive criticism for similar reasons. Financial accounting serves a distinct and disparate purpose (i.e., accurate reporting of information to creditors, shareholders and the financial markets) than tax accounting (i.e., equitable collection of revenue) and relying on financial accounting information for tax purposes places those purposes at odds with each other. Furthermore, there is a concern that large companies may seek to lobby the Financial Accounting Standards Board, an independent organization that establishes financial accounting provisions, to change how book income is determined to ensure they fall below the $1 billion threshold. 
To the extent that FASB provisions are ambiguous, companies will need to evaluate whether earnings can be managed so that reported income can reduce outstanding tax liability under the new provision. Also, to the extent that financial reporting of certain items is so modified, companies will need to consider whether confirming accounting method changes are required to ensure proper application of the provision.
It will also be important to consider adjustments to minimize possible distortions between taxable income and financial statement revenue. There are a number of temporary differences (e.g., bad debt reserves, accrued employee bonuses, differences in book vs. tax depreciation and amortization) as well as permanent differences (e.g., 50% disallowance for meals, stock issuance costs, tax-exempt interest income, non-deductible fines and penalties), which may make certain companies more likely subject to the AMT. Beyond the potentially distortive impact that temporary and permanent differences present, frequently-used footnotes and supplemental corporate disclosures that may be material to taxpayer’s financial statements will be additionally complicating factors in drafting further guidance to effectuate this new provision.

AFS net income is merely the starting point in calculating AFSI for purposes of the AMT. After confirming the appropriate amount of net income reported on an applicable corporation’s AFS, the taxpayer must then walk through the various provisions of the new statute and make appropriate adjustments to determine its AFSI. The statute provides a number of adjustments to AFS net income reflecting tax deductions and credits, as summarized in the table below:

Notable Adjustments to AFS Income to Determine AFSI Amount
Topic Details
AFSI for Amounts Included in Different Tax Years Statute merely provides for appropriate adjustments to be made; Treasury and IRS will be expected to provide guidance regarding this adjustment.
AFSI for an Applicable Corporation that Files as part of a Consolidated Financial Statement The statute provides that the rules of Section 451(b)(5) are controlling, which states that if the financial results of a taxpayer are reported on the AFS for a group of entities, the group’s statement shall be treated as the AFS of the taxpayer.
Adjustments for an Applicable Corporation that is Part of a Consolidated Group AFSI for such group for such taxable year shall take into account items on the group’s AFS that are properly allocable to members of such group, and exclude income items of any non-member affiliates that are included on the AFS but not on the consolidated return. If the applicable corporations receive dividends from a non-member affiliate, or otherwise takes into account income or deductions with respect to the non-member affiliate, the dividends and other amounts are also taken into account in computing AFSI.
Adjustments for an Applicable Corporation that is a Partner in a Partnership AFSI of the applicable corporation shall be adjusted to only take into account the applicable corporation’s distributive share of AFSI of such partnership.
Adjustments to Consider for Certain Items of Foreign Income If for any taxable year, an applicable corporation is a US shareholder of one or more CFCs, the AFSI of the applicable corporation with respect to the CFC shall be adjusted to take into account the applicable corporation’s pro rata share of items taken into account in computing the net income or loss set forth on the AFS of each CFC (with the pro rata share determined under rules similar to Section 951(a)(2). Significantly, if this adjustment would result in a negative amount being taken into account for a taxable year, the negative adjustment is disallowed and carried forward and taken into consideration in the succeeding tax year. Additionally, if the applicable corporation is a foreign corporation, the principles of Section 882 with respect to effectively connected income apply for purposes of determining the foreign corporation’s AFSI.
Adjustments for US FIT and Foreign Incomes Taxes AFSI does not take into account US FIT and foreign income taxes.
Adjustments with Respect to Disregarded Entities AFSI shall be adjusted to take into account any AFSI of a disregarded entity owned by an applicable corporation.
Adjustments with Respect to Defined Benefit Pensions AFSI shall be adjusted to disregard any amount of income, cost or expense that would otherwise be included on the AFS in connection with any covered benefit plan, increased by any amount of income in connection with any such covered benefit plan that is included in the gross income of the applicable corporation otherwise, and reduced by the deductions allowed with respect to any such covered benefit plan.
Adjustments Related to Depreciation AFSI shall be reduced by depreciation deductions allowed under Section 167 with respect to tangible property subject to Section 168 to the extent of the amount allowed as deductions in computing taxable income for the year, including bonus depreciation, and adjusted to disregard any amount of depreciation expenses taken into account on the applicable corporation’s AFS with respect to such property. 
Adjustments Related to Qualified Wireless Spectrum AFSI shall be reduced by amortization deductions allowed under Section 197 with respect to qualified wireless spectrum to the extent of the amount allowed as deductions in computing taxable income for the taxable year, and adjusted to disregard any amount of amortization expense that is taken into account on the applicable corporation’s AFS with respect to such qualified wireless spectrum (notably, wireless spectrum must be used in the trade or business of a wireless telecommunications carrier, and have been acquired between December 31, 2007, and August 16, 2022.
Adjustment for Financial Statement Net Operating Loss (NOL) AFSI shall be reduced by an amount equal to the lesser of the aggregate amount of financial statement NOL carryovers to the taxable year, or 80% of AFSI computed without regard to the deduction otherwise allowed for financial statement NOLs.
Adjustment for AMT Foreign Tax Credit If the applicable corporation chooses to credit foreign taxes for regular US FIT purposes, the AMT foreign tax credit may reduce the AMT, with the AMT foreign tax credit equaling the sum of (1) the applicable corporation’s pro rata share of applicable foreign taxes paid or accrued by CFCs which the applicable corporation is a US shareholder and included in the CFC’s AFS (or, if less, 15% of the applicable corporation’s pro rata share of its CFC’s income), and (2) the applicable foreign taxes paid or accrued by the applicable corporation and taken into account in the applicable corporation’s AFS.
Adjustment for General Business Credits General business credits are limited to 75% of the applicable corporation’s net income tax that exceeds $25,000, with net income tax equaling the sum of (1) the applicable corporation’s regular US FIT liability (including the BEAT) and (2) the tax imposed by Section 55 (including the AMT).

ES Observation: Whether applying consolidated return principles to the calculation of AFSI or the treatment of partnerships and consideration of certain items of foreign income, it will be important to thoroughly review how the AMT calculation applies to an applicable corporation’s specific facts and circumstances. There are a host of potentially favorable adjustments, e.g., AFS net income may be reduced by tax depreciation deductions and tax amortization deductions for qualified wireless spectrum, to the extent an applicable corporation otherwise has such deductions. Although 100% bonus depreciation begins to phase out ratably by 20% each year starting in 2023, the increased benefit is worth particular consideration due its additional impact on AFSI. Additionally, it will be important to consider the various new credits provided in the IRA that qualify as general business credits and, otherwise, may favorably impact an applicable corporation’s AFSI calculation. Further, the potentially taxpayer-favorable deduction for financial statement NOLs as well as consideration of the AMT foreign tax credit will bear close scrutiny. These limitations and clarifying provisions offer significant relief to corporations potentially subject to the AMT.

It is important to note that a number of significant book-tax adjustments are not included in adjustments for purposes of determining AFSI, including: limitations on interest expense deductions under Section 163(j); limitations on deductions for certain employee remuneration that exceeds $1 million under Section 162(m); limitations on loss carryforwards under Section 382 and amounts that may be included in taxable income in a prior period under the all events test or Section 451(c).

In addition to determining the amount of AFSI taking into account various adjustments, particularly items that are included or excluded from an applicable company’s AFS net income, an additional statutory detail, which may have significant effect, is the aggregation rule provided in Section 59(k)(1)(D), which determines an applicable corporation’s status for this purpose. Solely for purposes of determining whether an entity is an applicable corporation for purposes of the AMT, all AFSI of persons treated as a single employer under Sections 52(a) and (b) shall be treated as adjusted financial statement income for purposes of determining whether the $1 billion threshold has been exceeded.

ES Observation: The version of the AMT originally agreed to by Senators Chuck Schumer and Joe Manchin included language that incorporated Section 469(c)(5), regarding research and development activities, and Section 469(c)(6), regarding production of income activities under Section 212. In addition, for purposes of determining whether an entity meets the $1 billion threshold, the AMT treats groups of entities as a single entity by reason of applying Sections 52(a) and (b). Senators Thune and Sinema were concerned that portfolio companies controlled by private equity funds may be subject to the AMT as proposed by Senators Schumer and Manchin because private equity funds could be included in the aggregated groups under Section 52 by virtue of treating Section 212 activities as a trade or business. In response, Senators Thune and Sinema offered amendments to strike the language that referenced Section 212.

Following the Thune/Sinema amendment to the IRA, the scope of the application of the AMT to private equity funds arguably remains unclear. The plain language of Treas. Reg. § 1.52-1(c) does not appear to require the “common parent organization” to be directly conducting a trade or business. Treas. Reg. § 1.52-1(c) merely requires one or more chains of organizations that are conducting trades or businesses that are connected through ownership of a controlling interest with a common parent, provided that certain ownership conditions exist. The plain language of this Treasury Regulation does not reference any requirement that the common parent organization be engaged in a trade or business. However, the fact that Congress removed the language of the AMT referencing Section 469(c)(6), which, in turn, references Section 212, may suggest that the intent of Congress was for private equity funds to not be subject to the aggregation rules.

Accordingly, until Treasury and the IRS issue further guidance clarifying this issue, an argument can be made that the plain language of Treas. Reg. § 1.52-1(c) may require aggregation, irrespective of whether the common parent organization is directly conducting a trade or business.

Importantly, once a corporation exceeds the $1 billion threshold and becomes subject to the AMT, it generally remains an applicable corporation even if its AFSI falls below the $1 billion level. The legislative language provides that an applicable corporation’s status may be revised if: (i) there is an ownership change; (ii) the corporation fails the adjusted financial statement income test for consecutive years as provided by the IRS; or (iii) the corporation satisfies a safe harbor established by Treasury. The AMT is effective for taxable years beginning after December 31, 2022.

Additionally, while headlines indicate the AMT applies to corporations with an average annual adjusted financial statement income exceeding $1 billion, that threshold may be different for certain foreign-parented corporations due a similar aggregation rule as discussed above. A domestic corporation that is a member of a foreign-parented multinational group may be liable for the AMT if two statutory tests are satisfied. First, the AFSI of the group must exceed $1 billion with, solely for purposes of determining whether a corporation meets the average annual adjusted financial statement income test, the income of all foreign group members included in the determination. Second, provided the foreign-parented group’s AFSI exceeds $1 billion, then the AFSI of the domestic member must by itself exceed $100 million. If both tests are satisfied, then the AMT applies. For this purpose, a foreign-parented multinational group for a taxable year includes two or more entities if at least one entity is a domestic corporation and at least one entity is a foreign corporation, such entities are included in the same AFS with respect to such year, and either the common parent of the entities is a foreign corporation, or, if there is not a common parent, the entities are treated as having a common parent which is a foreign corporation. It is important to note that if a foreign corporation is engaged in a trade or business within the United States, such trade or business shall be treated as a separate domestic corporation that is wholly owned by the foreign corporation. Additionally, regulatory authority is explicitly requested to address applicable corporations for in this context.

ES Observation: This is an important clarification that bears noting. For foreign-parented multinational corporations, which by themselves may not approach the $1 billion threshold, to the extent that their AFSI alone exceeds $100 million, provided the foreign group’s AFSI exceeds $1 billion, the AMT will apply to a domestic entity of a foreign-parented multinational corporation. Consequently, foreign-parented corporations that are members of foreign groups with significant annual financial statement income, far exceeding their own, should carefully review the IRA’s final language to fully understand the potential applicability of the AMT.

Additionally, to the extent a corporation has been in existence for less than three taxable years, the AMT applies the average annual adjusted financial statement income test on the basis of the period during which the corporation has been in existence. Further, for any taxable year of less than 12 months, AFSI is required to be annualized by multiplying the adjusted financial statement income for the short period by 12 and dividing the result by the number of months in the short period. An applicable corporation with less than three taxable years of history may find the financial statement income test produces unexpected results.

ES Observation: Due to this annualization provision as well as the application of the average annual adjusted financial statement income test to applicable corporations in existence for less than three taxable years, it will be important for companies that regularly complete mergers, acquisitions, dispositions, and reorganizations, to apply these nuanced provisions carefully to ensure whether an entity that may not have been in existence for the three-taxable year period is liable for the minimum corporate tax. Further, any short taxable years that are a product of such transactions need to be accurately considered in the minimum corporate tax calculation.

Because the AMT is based on average annual AFSI, corporate transactions may potentially affect the determinations of AMT. Moreover, GAAP and IFRS have special provisions that address corporate transactions, which will affect the determination of AFSI. For this reason, it is important to consider transaction representations, not only with respect to corporate income tax but also with respect to AFS treatment. Additionally, due diligence for corporate transaction should consider treatment of recent transactions, purchase price allocations, and tax sharing agreements, which may affect AMT determinations. 

1 JCT memo to Senate Finance Committee (August 1, 2022).

2 H.R. 5376.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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