Inflation Reduction Act includes 15% corporate minimum tax on book income

Editor: Susan Minasian Grais, CPA, J.D., LL.M.

On Aug. 16, 2022, President Biden signed into law the Inflation Reduction Act, P.L. 117-169. For applicable corporations that report over $1 billion in profits to shareholders, the act includes a 15% corporate alternative minimum tax based on book income.

The corporate alternative minimum tax was introduced in the House Ways and Means Committee’s Build Back Better Act (BBBA) proposal in November 2021 (House BBBA). It was then modified by the Senate Finance Committee in its December 2021 BBBA proposal (Senate BBBA). The tax, which applies to tax years beginning after Dec. 31, 2022, is primarily a revenue raiser.

15% minimum tax and applicable corporations

An appliable corporation is liable for the corporate alternative minimum tax to the extent that its “tentative minimum tax” exceeds its regular U.S. federal income tax liability (computed before taking into account general business credits) plus its liability for the base-erosion and anti-abuse tax (BEAT). An applicable corporation’s tentative minimum tax is 15% of its adjusted financial statement income to the extent the tax exceeds the corporate alternative minimum tax foreign tax credit for the tax year. The corporate alternative minimum tax applies to any corporation (other than an S corporation, regulated investment company, or real estate investment trust) whose average annual adjusted financial statement income exceeds $1 billion for any three consecutive tax years preceding the tax year. When determining adjusted financial statement income for the $1 billion qualification test, the act generally treats adjusted financial statement income of all persons considered a single employer with a corporation under Sec. 52(a) or (b) as adjusted financial statement income of the corporation.

For a corporation that is a member of a foreign-parented multinational group, (1) the three-year average annual adjusted financial statement income must be over $1 billion from all members of the foreign-parented multinational group (without regard to certain adjustments as specified in Sec. 59(k)(2)(A)), and (2) the corporation must have average annual adjusted financial statement income, determined without regard to loss carryovers, of $100 million or more. A foreign-parented multinational group means two or more entities if (1) at least one entity is a domestic corporation and another is a foreign corporation; (2) the entities are included in the same applicable financial statement; and (3) the common parent of those entities is a foreign corporation (or the entities are treated as having a common parent that is a foreign corporation).

Three-tax-year period

For purposes of determining whether a corporation has average annual adjusted financial statement income in excess of $1 billion and is subject to the corporate alternative minimum tax, the three-tax-year period means any three consecutive tax years preceding the tax year in which the tax applies (beginning with three-tax-year periods in which the third year of the period ends after Dec. 31, 2021). For example, to determine whether a calendar-year corporation is subject to the corporate alternative minimum tax for 2023, the three-tax-year period includes calendar years ending Dec. 31, 2020; Dec. 31, 2021; and Dec. 31, 2022. For corporations (or a predecessor) existing less than three tax years, the act substitutes the number of years the corporation has existed for three. Any tax year less than 12 months must be annualized.

Exceptions

The corporate alternative minimum tax does not apply to corporations that have either changed ownership or fallen below the adjusted financial statement income threshold for a specified number of consecutive years (to be determined by Treasury), conditioned upon Treasury’s also determining that it would be inappropriate to continue subjecting the corporation to the tax. The exception no longer applies if the corporation meets the three-year average adjusted financial statement income test for any tax year beginning after the year for which the determination applies.

Adjusted financial statement income

The act adds new Sec. 56A, which defines “adjusted financial statement income” of a corporation (taxpayer) as the taxpayer’s net income or loss reported in the taxpayer’s applicable financial statement — as defined in Sec. 451(b)(3) — with adjustments for certain items. If a taxpayer’s financial results are reported on the applicable financial statement for a group of entities, the act treats that consolidated financial statement as the taxpayer’s applicable financial statement. Special rules apply for cooperatives, Alaska Native corporations, and mortgage servicing companies.

Although the act requires Treasury to issue regulations and/or other guidance as necessary on adjustments to adjusted financial statement income, Sec. 56A(c) requires the following general adjustments:

• Taxpayers must make unspecified adjustments when the applicable financial statement covers a period other than the tax year.
• For a consolidated group, adjusted financial statement income includes items from the group’s applicable financial statement that are properly allocable to members of the group.
• For a corporation not included on a consolidated return with the taxpayer (e.g., an unconsolidated subsidiary), the taxpayer includes in adjusted financial statement income only dividends received from the corporation and other amounts required to be included in gross income or deductible as a loss (other than amounts included under Secs. 951 and 951A).
• For a taxpayer that is a partner in a partnership, adjusted financial statement income includes only the taxpayer’s distributive share of adjusted financial statement income of the partnership.
• For a U.S. shareholder of a controlled foreign corporation (CFC), adjusted financial statement income includes the shareholder’s pro rata share of items taken into account in computing the net income or loss on the CFC’s applicable financial statement, with adjustments similar to those applicable in computing the taxpayer’s adjusted financial statement income. Any negative adjustment for a CFC (or aggregate negative adjustment for multiple CFCs) must be carried forward to the next succeeding tax year.
• Adjusted financial statement income for a foreign corporation is determined under the principles of Sec. 882 (regarding effectively connected income).
• For a taxpayer with a disregarded entity, adjusted financial statement income includes the disregarded entity’s adjusted financial statement income to the extent it is not otherwise included on the taxpayer’s applicable financial statement.
• The taxpayer must adjust adjusted financial statement income to disregard federal income taxes or income, war profits, or excess profits taxes (within the meaning of Sec. 901) imposed by a foreign country or possession of the United States. No adjustment is required for income, war profits, or excess profits taxes imposed by a foreign country or possession of the United States if the taxpayer chooses not to claim foreign tax credits for the tax year.
• Adjusted financial statement income is adjusted to disregard tax refunds attributable to elections made under Sec. 48D(d) and Sec. 6417.
• For taxpayers with “covered benefit plans”:
  • Adjusted financial statement income is adjusted for:
    • Single-employer qualified defined benefit pension plans;
    • Qualified foreign plans under Sec. 404A; and
    • Other defined benefit plans providing post-employment benefits.
  • Adjusted financial statement income is determined by:
    • Disregarding any income, cost, or expense that is connected with the covered benefit plan and otherwise included in the taxpayer’s applicable financial statement;
    • Increasing adjusted financial statement income for any income that is connected with the covered benefit plan and included in gross income under federal income tax principles; and
    • Decreasing adjusted financial statement income for any deductions that are connected with the covered benefit plan and allowed under federal income tax principles.
• A tax-exempt entity’s adjusted financial statement income includes only the adjusted financial statement income of its unrelated trade or business, or adjusted financial statement income from debt-financed property to the extent that income qualifies as unrelated business taxable income.
• Adjusted financial statement income is reduced by (1) tax depreciation deductions allowed under Sec. 168 and (2) tax amortization deductions allowed under Sec. 197 only for qualified wireless spectrum.
  • “Qualified wireless spectrum” is defined as wireless spectrum that is used in the trade or business of a wireless telecommunications carrier and was acquired after Dec. 31, 2007, and before the date of enactment.
  • Adjusted financial statement income does not include book depreciation and amortization with respect to such property (so the reduction to adjusted financial statement income equals the tax depreciation and amortization noted previously).

Note: The adjustments for defined benefit pensions and partnership distributive shares apply only to a corporation that is subject to the corporate alternative minimum tax for determining its adjusted financial statement income to compute the corporate alternative minimum tax amount. In contrast, when applying the adjusted financial statement income three-tax-year qualification test, adjusted financial statement income is determined without regard to these adjustments (i.e., adjusted financial statement income is based on defined benefit pension amounts included in book income and partnership income that must be aggregated under Sec. 52).

Deduction for financial statement net operating loss

The act allows taxpayers to deduct financial statement net operating losses (NOLs) from adjusted financial statement income. The deduction equals the lesser of:

• The aggregate amount of financial statement NOL carryovers to the tax year; or
• 80% of adjusted financial statement income “computed without regard to the deduction allowable under” new Sec. 56A(d).

“Financial statement net operating loss” means the net loss on the corporation’s applicable financial statement for tax years ending after Dec. 31, 2019. The act contemplates that a taxpayer may carry forward a financial statement NOL indefinitely.

Corporate alternative minimum tax foreign tax credit

The corporate alternative minimum tax foreign tax credit may reduce the corporate alternative minimum tax (if the taxpayer chooses to credit foreign taxes for regular U.S. federal income tax purposes) (Sec. 59(l)). The corporate alternative minimum tax foreign tax credit equals the sum of:

• The taxpayer’s pro rata share of applicable foreign taxes paid or accrued by CFCs (for which the taxpayer is a U.S. shareholder) and included in the CFCs’ applicable financial statements (or, if less, 15% of the amount determined under Sec. 56A(c)(3)); and
• The applicable foreign taxes paid or accrued by the taxpayer and taken into account in the taxpayer’s applicable financial statement. In other words, the “indirect” corporate alternative minimum tax foreign tax credit in respect of creditable foreign income taxes paid or accrued by CFCs is limited to 15% of the taxpayer’s pro rata share of its CFCs’ income; the “direct” corporate alternative minimum tax foreign tax credit in respect of creditable foreign income taxes paid or accrued by domestic corporations is not.

Taxpayers whose pro rata share of creditable foreign income taxes paid or accrued by CFCs exceeds 15% of their pro rata share of the CFCs’ income may carry the excess forward for five years.

General business credits

The act limits general business credits to 75% of the taxpayer’s net income tax that exceeds $25,000 (with no limit against the first $25,000). Net income tax is the sum of the taxpayer’s regular U.S. federal income tax liability (including BEAT under Sec. 59A) and the tax imposed by Sec. 55 (including the corporate alternative minimum tax).

Credit for prior-year minimum tax liability

The act adjusts the rules in Sec. 53 to provide a minimum tax credit for applicable corporations. Under modified Sec. 53, the net minimum tax (i.e., the tax imposed by Sec. 55) for all prior tax years beginning after 2022 can generally be carried forward and utilized as a credit against the taxpayer’s regular tax liability, including any BEAT liability.

Treasury to issue regulations

The act directs Treasury to issue regulations and other guidance for the purpose of carrying out various provisions, including:

• Sec. 59(k) (defining an applicable corporation), including guidance on a simplified method for determining whether a corporation is an applicable corporation and guidance clarifying the rules for a corporation that experiences a change in ownership;
• Sec. 56A(c) (determining adjusted financial statement income) to provide for adjustments to adjusted financial statement income, including adjustments to prevent the omission or duplication of any item, and adjustments with respect to corporate liquidations and reorganizations and partnership contributions and distributions; and
• Sec. 59(l) (regarding the corporate alternative minimum tax foreign tax credit).

Senate colloquies

On Aug. 6, 2022, several U.S. senators engaged in colloquies with Sen. Ron Wyden, D-Ore., the chair of the Senate Finance Committee, on the Senate floor to formally discuss several aspects of the corporate alternative minimum tax. Generally, a colloquy is a formal scripted conversation among members of Congress that can become part of the Congressional Record. Colloquies can be used for various purposes, including to draw attention to or clarify the intent of a particular issue or provision in a bill. The impact of a colloquy on federal agencies, including Treasury, and their power to make policy decisions is not always clear.

In a colloquy with Sen. Bob Menendez, D-N.J., Wyden confirmed that regulations addressing potential issues with foreign income taxes in nonconforming foreign tax years would be in line with the legislative text and the Senate’s intent for companies to be able to appropriately utilize foreign tax credits in the corporate alternative minimum tax. In a colloquy with Sen. Ben Cardin, D-Md., Wyden clarified that Treasury may issue regulations under the corporate alternative minimum tax to address potential issues with the ordering of the calculation of the credit under Sec. 53 and BEAT under Sec. 59A. In another colloquy with Cardin, Wyden clarified that “other comprehensive income” is not included in financial statement income for corporate alternative minimum tax purposes.

Implications

The act will require applicable corporations to compute two separate calculations for federal income tax purposes and pay the greater of the corporate alternative minimum tax or their regular tax liability (regular tax liability plus BEAT liability). Companies should assess their structures to identify applicable corporations, taking into account the special rules for common employer groups and foreign-parented multinational groups. Comprehensive modeling can help applicable corporations consider any potential increase in their federal income tax liability. Modeling is especially critical post-TCJA, given the many complex and interrelated foreign and domestic tax provisions that can affect a corporation’s tax liability, including the corporate alternative minimum tax, BEAT, Sec. 163(j), foreign-derived intangible income, global intangible low-taxed income, and the Organisation for Economic Co-operation and Development’s base-erosion and profit-shifting Pillar 2.

Additionally, a number of issues remain outstanding across income tax disciplines. These range from mergers and acquisitions to income tax accounting methods to international tax issues. It is the authors’ understanding that Treasury is working on guidance to address many of these issues (e.g., preventing the duplication or omission of income or loss when applying the adjusted financial statement income qualification test or determining adjusted financial statement income for computing the corporate alternative minimum tax). Pending guidance, companies will have to take positions and file returns based solely on the statute as enacted.

Editor Notes

Susan Minasian Grais, CPA, J.D., LL.M., is a managing director at Ernst & Young LLP in Washington, D.C. Contributors are members of or associated with Ernst & Young LLP. For additional information about these items, contact Ms. Grais at 202-327-8788 or susan.grais@ey.com.