On September 13, 2024, Treasury and the IRS published proposed regulations (REG-122129-23) regarding the corporate alternative minimum tax (CAMT). These proposed rules generally adopt prior guidance issued through a series of notices since December 2022, with some changes and clarifications. However, they also introduce new rules that could further complicate tax planning and compliance. Although Treasury estimates that only 100 corporations will be subject to CAMT (and therefore pay their "fair share" of taxes), the broad application to foreign parented multinational groups (FPMGs) suggests that the actual impact, including undue complexity, could be much more far-reaching.
This alert highlights key rules that may influence taxpayers' imminent decisions on whether, when, and to what extent to rely on the proposed regulations. It also provides initial high-level observations on the potentially more significant rules, as well as certain taxpayer-favorable ones.
OVERVIEW
Beginning in 2023, a corporation (other than an S corporation, REIT, or RIC) becomes an applicable corporation and therefore subject to CAMT if, after applying aggregation rules, (1) its average annual adjusted financial statement income (AAAFSI) over a three-year period exceeds $1 billion or (2) it is a U.S. corporation with a three-year AAAFSI of at least $100 million and is part of an FPMG that satisfies the $1 billion threshold (the first in-scope test with certain adjustments) for the same period. As discussed further below, generally, once a corporation becomes an applicable corporation, it remains one until it satisfies certain statutory criteria, as further defined by Treasury and the IRS.
An entity's adjusted financial statement income (AFSI) is its financial statement income taking into account certain statutory adjustments and those specified by Treasury and the IRS under broad regulatory authority. These adjustments vary for assessing scope and determining CAMT liability. The proposed regulations favor regular tax rules in specific instances, predominantly for administrability (e.g., certain rules affecting foreign corporation stock) and policy reasons (e.g., certain rules affecting distressed companies). However, the overarching goal of increasing revenue often takes precedence over administrability.
TO RELY, OR NOT TO RELY?
Taxpayers can rely on the prior guidance for taxable years ending on or before September 13, 2024. For years ending after this date (and prior years), taxpayers may rely on "specified 2024 regulations" before the final regulations are published, provided they and certain related persons consistently follow all these proposed regulations in their entirety. For other proposed regulations applicable after the final regulations are published, taxpayers can choose which sections to apply, as long as they and certain related persons consistently follow those sections and all specified 2024 regulations.
Key aspects of the specified 2024 regulations include:
- Determining an applicable financial statement, certain AFSI adjustments, and applicable corporation status
- Defining the existence of an FPMG and related AFSI adjustments
- Reporting partnership information and determining partnership basis adjustments and AFSI
- Implementing anti-abuse rules
Proposed regulations effective after the final regulations are published cover:
- Determining AFSI adjustments for depreciable property, a partner's distributive share of partnership AFSI, corporate transactions, distressed companies, and CAMT attributes
- Applying CAMT to tax consolidated groups
Treasury and the IRS are considering transition-year adjustments to AFSI and CAMT attributes for prior inconsistent positions.
A&M Insight: Taxpayers should carefully evaluate the proposed regulations for both prior and future periods considering the following key points:
- Changes and Compliance Costs
- Consider that the final regulations may differ from the proposed regulations, in part due to potential challenges under Loper Bright, 1 and as noted above, may require further transition-year adjustments for inconsistent positions.
- Ensure information and documentation necessary for reliance on the proposed regulations are identified and maintained.
- Impact on Applicable Corporation Status
- Consider certain proposed regulations, such as those under the FPMG rules, that could adversely affect a taxpayer's applicable corporation status.
- Determine which rules could be beneficial, such as the simplified approach for determining in-scope status.
- Partnership Reporting Requirements
- Assess the potential information and reporting requirements now, even if not choosing to early adopt the proposed regulations (applies to partnerships and their partners).
- Prepare for further compliance costs considering the possibility that these requirements will be finalized.
THE 'APPLICABLE CORPORATION' PROBLEM: SCOPE CREEP
At first glance, it might seem that the universe of corporations that would become an applicable corporation is limited. However, the proposed regulations introduce two distinct rules (only one of which is statutorily provided and discussed in the previously issued guidance) that can unexpectedly classify a corporation as an applicable corporation. While the proposed regulations provide relief for smaller corporations with a simplified approach for determining if they are applicable corporations, they also make it exceptionally challenging for an applicable corporation to lose such a designation.
Broad Aggregation Rules
Unfortunately, the proposed regulations do not offer any relief from the broad "single employer" aggregation rules that apply in determining in-scope status, which is mandated by the statute.
A&M Insight: Due to these aggregation rules, companies may need extensive access to financial information from tangentially related corporations to determine whether they are subject to CAMT. This requirement could be administratively challenging for both taxpayers and the government. Additionally, there are longstanding questions about the application of the single employer test for private investment funds, including private equity and venture capital funds, which the proposed regulations do not address (see discussion of non-CAMT implications in our prior alert).2 However, based on the newly introduced concept of the "deemed foreign corporation" (as discussed below), the application of the single employer aggregation may be less relevant.
Deemed Foreign Corporation Rule
The proposed regulations introduce a new rule which broadens the scope of the FPMG rules and presumably the aggregation rules. Under the statute, the FPMG rules require the common parent of the group to be a foreign corporation. However, the regulations expand this scope by creating the "deemed foreign corporation." Specifically, if a non-corporate entity for which no other entity has a "controlling interest," owns (directly or indirectly) (1) a foreign trade or business (other than through a domestic corporation) or (2) a controlling interest in a foreign corporation, it is treated as a deemed foreign corporation.
A&M Insight: Understanding the potential magnitude of the deemed foreign corporation rule is crucial. This rule could apply to any entity, including domestic partnerships such as a private equity or venture capital fund. For instance, if a widely-held domestic private equity fund owns 100% of the equity of both a foreign corporation and a domestic corporation, the domestic partnership is treated as a foreign corporation for purposes of the FPMG rules. Therefore, the three entities could be viewed as being part of an FPMG, thereby increasing the likelihood that the domestic corporation will be classified as an applicable corporation under the $100 million in-scope test, rather than the $1 billion in-scope test. This significantly broadens the scope of corporations subject to CAMT.
Ability to Shed Applicable Corporation Status
The proposed regulations provide much-needed guidance on when an applicable corporation can finally shed that status. In essence, an applicable corporation can shed its status if it either: (1) experiences a "change in ownership" or (2) does not meet the in-scope test for five consecutive taxable years ending with the taxable year (the Consecutive Year Test). For this purpose, a corporation experiences a change in ownership if, after the transaction that potentially gave rise to a change in ownership, the corporation is no longer related to the corporation's former "parent" entity and its AFSI is no longer included in the parent's AFSI for purposes of the in-scope test.
A&M Insight: Unfortunately, the rules governing when a corporation can shed its applicable corporation status are complex and not particularly taxpayer friendly. Notably, it appears that a parent corporation cannot experience a change in ownership and thus can only shed its status by meeting the Consecutive Year Test. Additionally, the application of the Consecutive Year Test is more stringent than it may initially appear. For instance, if a corporation has a huge spike in AFSI in one year, it could take up to seven years to shed its status, as the in-scope tests are based on a three-year average. The proposed regulations seem intent on capturing as many taxpayers as possible and do not adequately account for reasonable changes in circumstances, such as a one-time income inclusion or an emergence from bankruptcy, in allowing taxpayers to shed their applicable corporation status.
SELECTED HIGH-LEVEL OBSERVATIONS
Distressed Companies Remain Troubled
The proposed regulations make some progress in addressing issues faced by distressed companies by acknowledging that the amount of cancellation of indebtedness (COD) income for financial statement purposes can differ from that amount for regular tax purposes. However, they still do not consider that the timing of recognizing COD income may also differ. Additionally, the proposed regulations inconsistently rely on financial accounting liabilities and regular tax liabilities when applying rules related to insolvency and attribute reduction. These issues could increase administrative burdens and cash tax for distressed companies.
Partnership Compliance Only Gets More Complicated
Just as partnerships have started to acclimate to the centralized partnership audit regime (BBA) and the new Schedule K-2 and K-3 requirements, the IRS has announced that it is intensifying its scrutiny of partnership returns (IR-2024-166). The proposed CAMT regulations will only exacerbate the situation by imposing onerous recordkeeping and reporting requirements, as well as potential penalties for non-compliance. These new proposed rules effectively discard many familiar partnership tax principles, adding another layer of complexity for partnerships and their partners.
'Cliff Effect' for Corporate Transactions
The proposed regulations could have significant consequences for certain corporate transactions and reorganizations (outside the tax consolidated group and foreign corporation context). For example, under the so-called "cliff effect" rule for certain transactions in which a CAMT entity is a party to a transaction, any recognition of gain or loss for tax purposes would subject the transaction to CAMT. This rule puts significant pressure on structuring transactions to ensure complete non-recognition is achieved. However, if a CAMT entity is purely a shareholder in a transaction, regular tax rules govern (i.e., tax-deferral but recognition on any boot received), with special rules for computing CAMT gain or loss.
Anti-Abuse Rules Aplenty
The proposed regulations introduce a plethora of new anti-abuse rules, making compliance even more challenging. Applying the standard CAMT rules is already complex and requires significant coordination between financial statement preparers and tax practitioners. The addition of these broad anti-abuse rules further complicates the landscape and raises questions about the purpose of the underlying financial statements. For instance, certain AFSI losses generated by related-party transactions are deferred or transactions are recharacterized or adjusted if they do not meet the arm's-length principle under regular income tax rules, even though they are accounted for in financial statements. This necessitates maintaining a separate set of books to track the adjustment amounts or carryforwards. Additionally, another anti-abuse rule disregards or recharacterizes arrangements made with a principal purpose of avoiding CAMT. The criteria for making this determination, especially due to the complexity of these rules, remains unclear.
Favorable CAMT Foreign Tax Credit Calculations
The proposed regulations provide a favorable approach for calculating the CAMT foreign tax credit (CFTC) for taxes incurred by controlled foreign corporations (CFCs):
- The CFTC is calculated on a net foreign earnings basis, as opposed to a country-by-country (CbC) or entity-by-entity basis.
- A CAMT entity may reduce the AFSI of a CFC by foreign taxes paid even if it chose not to take the foreign tax credit for regular tax purposes.
In addition, a CAMT entity's CFTC for foreign income taxes incurred directly (i.e., not by a foreign subsidiary) is not limited based on the amount of foreign income earned directly.
Administrable Approaches Proposed
The proposed regulations offer a more administrable approach for certain rules. For example, the rules for multinational groups largely follow regular U.S. tax rules. The proposed regulations also simplify the approach for tax consolidated groups by treating group members as a single entity. However, the proposed regulations do not import several of the potentially applicable regular income tax rules governing tax consolidated groups, and as a result, those groups could have unexpected results.
A&M TAX SAYS
Congress opted to adopt the financial-statement-based CAMT as a revenue raiser after failing to adopt Pillar 2, diverging from the historic income tax-based corporate alternative minimum tax which was repealed as part of the Tax Cuts and Jobs Act (TCJA). The lack of detailed statutory guidance has necessitated Treasury and IRS to release an extensive and complex set of proposed regulations. Notably, these regulations largely disregard public comments on prior guidance — reminiscent of the proposed regulations on the excise tax on share repurchases3 — raising concerns that the final CAMT regulations will largely rubber-stamp the proposed regulations.
With the proposed retroactive application of some of the regulations, the compliance burden increases for applicable corporations, prompting the IRS to extend penalty relief for underpayment of estimated taxes attributable to CAMT liability for taxable years beginning after December 31, 2023, and ending before January 1, 2025 (see Notice 2024-66). If the proposed rules are finalized substantially in their current form, the compliance burden will exponentially increase as the remaining regulations take effect. Corporations and partnerships will need to maintain an additional set of books, regardless of CAMT liability, to jump through the requisite hoops to determine applicable corporation status and potential CAMT liability, as well as integrate CAMT considerations into their transaction modeling and assessments. Moreover, significant issues remain unaddressed, such as the treatment of CAMT in determining a group's Pillar 2 top-up tax liability. For a detailed discussion on how the proposed CAMT regulations could impact your business and tax planning, please contact Kevin M. Jacobs or Josh Goldstein of our National Tax Office.
Contributors: Kenneth Brewer, Charles W. Cope, Logan M. Kincheloe, Steven Klig, Alon Kritzman, Yuval Ruppin, Bill Seaway, and Eric Soto.
Footnotes
1 Kevin M. Jacobs et al., "Supreme Court Overturns Chevron: Navigating the New Landscape for Tax Regulations and Judicial Review," Alvarez & Marsal, Tax Alert, July 2, 2024, https://www.alvarezandmarsal.com/insights/supreme-court-overturns-chevron-navigating-new-landscape-tax-regulations-and-judicial
2 Kevin M. Jacobs et al., "Proposed Aggregation Rule Could Turn Private Equity ROI Analysis Upside Down," Alvarez & Marsal, Tax Alert, November 17, 2021, https://www.alvarezandmarsal.com/insights/proposed-aggregation-rule-could-turn-private-equity-roi-analysis-upside-down
3 Kevin M. Jacobs et al., "'Can't Get [Much] Satisfaction' from Proposed Stock Repurchase Rules," Alvarez & Marsal, Tax Alert, April 19, 2024, https://www.alvarezandmarsal.com/insights/cant-get-much-satisfaction-proposed-stock-repurchase-rules
Originally published 1 October 2024
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
