President Biden Signs the Inflation Reduction Act with the New Book Minimum Tax Effective Beginning in 2023
On August 16, 2022, President Biden signed into law the Inflation Reduction Act, which includes a new minimum tax on corporate book income (BMT). The BMT was first introduced in the Build Back Better Act (BBBA) passed by the House in 2021. The BMT imposes a 15 percent alternative minimum tax (AMT) on the adjusted financial statement income (AFSI) of certain large corporate taxpayers. The BMT is generally limited to corporations whose average consolidated AFSI over three years is greater than $1 billion. Once a corporation reaches this statutory threshold, it remains subject to the BMT until the U.S. Department of the Treasury (Treasury) determines otherwise.
We will discuss the corporations that will be subject to the tax, the determination of AFSI, the changes compared to the BBBA version, and the role of Treasury in implementing the tax.
The BMT is a corporate alternative minimum tax under section 55 and is imposed only on "applicable" corporations whose average annual consolidated AFSI over a three-taxable-year period exceeds certain thresholds (three-year test). The definition of "applicable corporations" explicitly excludes S-corporations, Regulated Investment Companies (RICs), and Real Estate Investment Trusts (REITs). For such applicable corporations, they face a 15 percent tax on their AFSI (less certain foreign tax credits) to the extent it exceeds their regular tax liability, plus the base erosion and anti-abuse tax (BEAT).
Determination of AFSI for Purposes of the Three-Year Test
A corporation is an "applicable corporation" that is subject to the BMT in a taxable year if it meets the three-year test for any year prior to such taxable year. The three-year test requires that a corporation's average annual AFSI over three years exceeds $1 billion. Therefore, for calendar year 2023, the first year in which the BMT is in effect, it appears that an applicable corporation meets the three-year test in its 2022 taxable year, i.e., based on its average AFSI for the tax years 2020, 2021, and 2022.
For purposes of the three-year test, the taxpayer must include the AFSI of any affiliates treated as a single employer under section 52(a) or (b). As such, the taxpayer must include the AFSI of any corporations that are members of its controlled group under section 1563 (modified to a 50 percent stock ownership test). The AFSI of affiliated insurance companies, the AFSI attributable to any U.S. trade or business of affiliated foreign corporations, and the pro rata share of the AFSI of a taxpayer's controlled foreign corporations (CFCs) would all be included under this rule.
In addition, solely for purposes of determining whether a corporation is an applicable corporation, AFSI is determined without certain adjustments described below relating to financial statement net operating losses, defined benefit plans, and income from partnerships. Special rules apply to corporations in existence for less than three years and to the treatment of AFSI for a short taxable year.
Foreign-Parented Multinational Groups
A two-part test applies to U.S. subsidiaries or branches of a foreign-parented group that reports on a consolidated financial statement. First, the three-year average AFSI of the U.S. subsidiaries or branches must exceed $100 million in the aggregate. Second, the three-year average AFSI for the foreign-parented group — including all worldwide income (not limited to income of U.S. subsidiaries, U.S. branches, or CFCs) — must exceed $1 billion.
Applicable Corporation Status
Once a corporation becomes subject to the tax, it remains subject to the tax until: (1) it has a change in ownership or it no longer meets the three-year average AFSI test for a certain number of years (to be determined by Treasury), and (2) Treasury determines it would be inappropriate. This exception does not apply if the corporation meets the AFSI threshold for any future three-year period.
Definition of Applicable Financial Statement (AFS)
The financial statement that must be used for purposes of the BMT is defined by reference to section 451(b)(3), which sets forth a priority list to determine the AFS as follows:
- A 10-K filed with the U.S. Securities and Exchange Commission (SEC)
- A Generally Accepted Accounting Principles (GAAP)-certified audited financial statement used for non-tax purposes
- A GAAP-certified financial statement filed with a federal agency for non-federal tax purposes
- An international financial reporting standards (IFRS) financial statement filed with the equivalent of the SEC
- Any other financial statement permitted by regulations
In addition, the bill requires that "appropriate adjustments" be made when the financial statement year covers a period other than the taxable year.
Determination of AFSI
AFSI is defined as the net income or loss of the taxpayer set forth on the taxpayer's AFS, as adjusted under the rules provided in the new section 56A summarized below. AFSI is determined without regard to federal income taxes or, for taxpayers claiming the benefits of the foreign tax credit, creditable foreign income taxes, i.e., it is pre-tax financial statement income.
Rules Applicable to Related Groups of Entities
- If the financial results of a taxpayer are reported on the AFS for a group of entities, that AFS is treated as the AFS of the taxpayer.
- If the taxpayer files a consolidated return, the AFSI for the year shall take into account items on the taxpayer's AFSI that are properly allocable to members of "such group" included on the return.
- For affiliated corporations not included on a consolidated return, AFSI includes dividends and other amounts includible (or deductible as a loss) with respect to such corporation, except for amounts included as subpart F or global intangible low-taxed income (GILTI).
- See discussion below regarding the overlap with CFC income
- AFSI includes the AFSI of any of the taxpayer's disregarded entities.
- For partnerships, AFSI is adjusted to only take into account the taxpayer's distributive share of AFSI of the partnership.
- As noted above, solely for purposes of determining whether a corporation meets the three-year test, the net income or loss reflected on the partnership's AFS is included, rather than the partner's distributive share.
Rules Applicable to Foreign Income
- For U.S. shareholders of CFCs, AFSI includes the taxpayer's pro rata share of the net income or loss stated on the CFC's AFS. To the extent that a taxpayer's aggregate share of CFC income results in a loss, it does not reduce AFSI, but can be carried forward to the next taxable year to offset future net CFC income.
- As noted above, for purposes of determining whether a foreign-parented U.S. subsidiary or branch meets the three-year test, the AFSI of the entire foreign group includes all worldwide income of the group, not limited to the pro rata share of CFC income.
- We expect that Treasury will issue guidance to prevent the double counting of CFC income in AFSI. Otherwise, the rules for determining AFSI from foreign subsidiaries could be interpreted to include both the pro rata share of CFC income and actual dividends received from the CFC. Such a double inclusion does not seem intended.
- A foreign corporation with a U.S. trade or business is treated as a separate domestic corporation owned by the foreign corporation for purposes of the BMT.
- In the case of a foreign corporation, AFSI is determined using "the principles of section 882" (relating to Effectively Connected Income (ECI)).
- As noted above, for purposes of determining whether a foreign-parented U.S. subsidiary or branch meets the three-year test, the AFSI of the entire foreign group includes all foreign income, not just ECI.
- The statute does not state whether U.S. tax treaties are taken into account to determine whether a foreign corporation has a U.S. taxable presence or to determine the income of foreign corporations included in AFSI.
- In determining AFSI, creditable section 901 foreign tax credits (FTCs) generally must be added back to income. For taxpayers that do not claim FTCs for regular tax purposes, Treasury regulations will provide that foreign income taxes are taken into account to determine AFSI. Treasury regulations will also provide for proper treatment of current and deferred taxes, including timing.
- In addition to disregarding federal income taxes, AFSI is determined without regard to amounts that the taxpayer elects under sections 48D(d) or 6417 to treat as a payment against tax (i.e., "direct pay" amounts under the Creating Helpful Incentives to Produce Semiconductors for America Fund (CHIPS) Act or the Inflation Reduction Act).
- Special rules are provided for cooperatives, Alaska native corporations, and mortgage servicing income.
- For tax-exempt entities, AFSI only includes unrelated business income as defined under sections 513 and 514.
- Income, cost, or expense connected to a covered benefit plan that is included on the AFS is disregarded in determining AFSI.
- As noted above, for purposes of determining whether a corporation meets the three-year test, income or expense attributable to covered benefit plans is included in AFSI.
- Depreciation on section 168 property and amortization on section 197 wireless spectrum reported for tax purposes for the taxable year reduces AFSI, while depreciation or amortization that relates to the same property that is reported on the AFS is disregarded.
- The use of "tax" depreciation instead of "book" depreciation is a change compared to the BBBA version.
Net Operating Losses
After the adjustments noted above, AFSI may be reduced by the financial statement net operating loss (AFS NOL) for the taxable year. The AFS NOL is capped at 80 percent of the taxpayer's AFSI, with the remainder carried over to the following year. Unused AFS NOLs may be carried forward indefinitely but does not include any net operating losses stated on an AFS arising in taxable years before 2020.
For purposes of the three-year test, AFSI is determined "without regard" to the AFS NOL provision. As such, while a net operating loss occurring in one of the three test years may reduce the overall average AFSI during that period, a net operating loss occurring in a year prior to the three-year test period may not be carried forward to subsequent years for purposes of determining whether a taxpayer is an applicable corporation.
Foreign Tax Credits, General Business Credits, and Carryforwards
For taxpayers that claim FTCs for regular tax purposes, the book minimum tax is reduced by the Corporate AMT FTC, defined as: (i) the taxpayer's creditable foreign income taxes that are stated on its AFS and paid or accrued by the taxpayer, and (ii) the taxpayer's pro rata share of the aggregate creditable foreign income taxes paid or accrued by its CFCs, stated on the CFCs' AFS for the taxable year. The statute does not provide for a limitation on the utilization of "direct" taxes paid by the U.S. taxpayer, but it limits the aggregate amount of taxes paid by CFCs to 15 percent of the taxpayer's CFC net income. Any excess CFC taxes may be carried forward for five years.
The statute does not specifically state that foreign income taxes are disregarded for purposes of the 15 percent Corporate AMT FTC limitation for CFC taxes. However, as noted above, foreign income taxes are disregarded for purposes of determining the inclusion of CFC income in AFSI, and the determination of the 15 percent Corporate AMT FTC limitation on a pre-tax basis is more consistent with the statute's overall concept that the BMT is intended to be a 15 percent minimum tax on worldwide income.
For taxpayers that claim general business credits (GBCs), such GBCs may reduce their BMT in the same manner as they reduce regular tax liability, i.e., subject to the limitations of section 38(c).
Finally, any book minimum tax paid before GBCs may be credited against regular tax and BEAT payable in future periods.
The bill currently delegates important determinations regarding the three-year test and the determination of AFSI to Treasury. The items explicitly delegated to Treasury include:
- Exceptions to BMT: The number of consecutive years that a taxpayer must fall below the three-year test before no longer being subject to BMT, rules regarding a change in ownership, and any other appropriate exception to the BMT.
- Dividends and Income from Subsidiaries: The reduction of dividends received (or other income or loss) from a corporation not included on the taxpayer's consolidated return in determining AFSI.
- Foreign-Parented Multinational Group: Which entities should be included in a foreign-parented multinational group.
- Simplified Test: A simplified method for whether a corporation is an "applicable corporation."
- Foreign Taxes: The extent to which foreign taxes should be disregarded in determining AFSI and the treatment (including timing) of current and deferred taxes.
- Depreciation: Adjustments to AFSI to ensure that depreciated property "is accounted for in the same manner as it is accounted for" federal tax purposes.
- Other AFSI Adjustments: Including regulations or other guidance on corporate liquidations, reorganizations and partnership contributions and distributions.
The BMT will apply to tax years beginning after December 31, 2022.
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