On August 16, 2022, President Biden signed Public Law No. 117-169, ‘‘An Act to provide for reconciliation pursuant to title II of S. Con. Res. 14.’’, colloquially known as the Inflation Reduction Act of 2022 (the “IRA”). The IRA contains several notable tax changes: a corporate alternative minimum tax based on financial statement income; an excise tax on stock buybacks; a research credit offset against payroll taxes for small businesses; a two-year extension of the section 461(l) limitation on excess business losses of non-corporate taxpayers; substantial increases in IRS funding levels; and extensive changes in energy tax incentives, including the reinstatement of Superfund taxes on petroleum products in 2023. This client alert focuses on the new corporate alternative minimum tax and stock buyback excise tax. A separate client alert will address the new energy tax incentives.
Corporate Alternative Minimum Tax
New subsection 55(b)(2), applicable for tax years beginning after December 31, 2022, imposes a 15 percent corporate alternative minimum tax (the “CAMT”) based on the adjusted financial statement income (“AFS income”) of certain large corporations, defined as applicable corporations. Applicable corporations are defined generally to be corporations with at least $1 billion in average pre-tax net income reported on such corporation’s consolidated financial statements and measured over the three-year period prior to the applicable tax year. Solely for purposes of determining whether a corporation is an applicable corporation, and not for purposes of measuring income subject to the corporate CAMT, a corporation’s income is aggregated with the income of corporations under at least 50% common ownership with that corporation, as determined under section 52 of the Code. Domestic corporations that are part of foreign-parented multinational groups with at least $1 billion in average pre-tax net income are subject to a separate $100 million threshold to be considered an applicable corporation; that is, the domestic corporation (together with related domestic corporations) must itself have more than $100 million in average income for the relevant period.
A corporation’s adjusted financial statement income generally starts with the net income or loss reported on a corporation’s applicable financial statement, as determined under section 451(b) of the Code and the regulations thereunder. These rules generally treat as a single corporation all members of a US consolidated group, and provide rules for allocating consolidated financial statement income to non-group members. The CAMT requires other notable adjustments to AFS income:
- With respect to non-group members (other than Controlled Foreign Corporations – “CFCs”), only dividends received from, and gains and losses recognized with respect to, such non-group members are taken into account.
- A partner in a partnership takes into account its distributive share of the AFS income or loss reported by the partnership.
- An owner of a disregarded entity takes into account the AFS income of such entity.
- A U.S. shareholder of a CFC takes into account its pro rata share of such CFC’s AFS income or loss, without regard to exemptions under subpart F, GILTI, or section 245A, except to the extent that the adjustment results in a loss for the year, in which case the amount of the loss is carried over to the succeeding taxable year.
- With respect to taxpayers that are foreign corporations, such foreign corporation determines its AFS income by applying the principles of section 882 (that is, taking into account only income that is effectively connected with a U.S. trade or business).
- AFS income is increased by U.S. federal taxes paid as well as creditable foreign taxes, if the taxpayer elects to credit those taxes.
- Finally, AFS income is reduced by accelerated depreciation under sections 167 and 168 of the Code, and increased by depreciation claimed on the taxpayers financial statements. This is a change from prior version of the CAMT, and would greatly reduce one source of book-tax disagreement that would have increased the CAMT’s reach to taxpayers in capital-intensive industries.
The CAMT liability is the amount by which the tentative minimum tax exceeds the taxpayer’s regular tax liability, including its BEAT liability under section 59A of the Code. The tentative minimum tax equals 15% of an applicable corporation’s adjusted AFS income.
The CAMT would allow financial statement Net Operating Losses to reduce AFS income, which could be carried forward indefinitely. General business credits and foreign tax credits would be available to offset the CAMT amount, to the extent allowed under certain special rules. Finally, a credit would be allowed against regular tax for prior-year CAMT liability.
Linking a minimum tax to the financial-statement income of a multinational corporation is, by nature, complex. At the very least, adjustments are required to reflect an entity based tax system, sources of income, and carry backs and carry forwards. At the margins, these adjustments leave open the possibility of a mismatch. On top of this, the new CAMT regime adds additional complexity by requiring adjustments for certain specific tax conventions, including accelerated depreciation to reduce adjusted financial statement income and allowing general business credits and foreign tax credits to reduce CAMT liability, among others. The introduction of these adjustments, while favorably reducing the impact of the CAMT in most cases, compound complexity. Not only do the adjustments themselves need to be taken into account, but implicitly introduce the need for collateral adjustments, including tax basis and similar items, and transition rules, none of which have been specifically provided for in the statute. Taxpayers need to track these impacts across tax years. Even taxpayers that normally do not find themselves in the CAMT will need to track large transactions and other events, to ensure that they have identified any differences between taxable income and adjusted financial statement income.
Treasury has a number of specific grants of regulatory authority and a broad general grant of authority. It behooves taxpayers to raise issues and concerns where guidance is necessary and may be forthcoming.
Stock Buyback Excise Tax
New section 4501 imposes a one percent excise tax on the fair market value of stock that is repurchased by a covered corporation. The amount of repurchased stock is reduced by the fair market value of stock issued by the covered corporation during the taxable year, or issued to employees or contributed to an employee retirement or stock option plan.
A covered corporation is any domestic corporation whose stock is traded on an established securities market, as defined under section 7704(b)(1), which includes both domestic and foreign securities exchanges that meet certain regulatory requirements under Treas. Reg. sec. 1.7704-1(b).
A repurchase is broadly defined as a redemption under section 317(b) or an economically similar transaction, as determined by Treasury. Section 317(b) defines a redemption as any acquisition by a corporation of its own stock from a shareholder in exchange for property, whether the acquired stock is cancelled, retired, or held as treasury stock. Under section 317(a), property includes money, securities, and any other property except the corporation’s stock or rights to acquire its stock.
There are a number of special rules in applying the excise tax on stock repurchases. Stock acquired by a specified affiliate of a covered corporation, if purchased from a person who is not the covered corporation or a specified affiliate, is subject to the excise tax. A specified affiliate is a corporation that is 50 percent owned (by vote or value), directly or indirectly, by a covered corporation.
In addition, a repurchase of stock by a domestic specified affiliate of an applicable foreign corporation is subject to the excise tax. An applicable foreign corporation is any foreign corporation the stock of which is traded on an established securities market. If the domestic specified affiliate acquires stock of the applicable foreign corporation, the specified affiliate would be deemed a covered corporation and the acquisition will be treated as a taxable stock repurchase. This will be a structural consideration in any stock buybacks by publicly traded foreign corporations.
Lastly, and importantly, special rules apply to treat expatriated entities as covered corporations in certain circumstances, for inversions occurring after September 20, 2021.
There are numerous exceptions to the application of the excise tax, namely, if:
- the repurchase is part of a tax-free reorganization (under section 368(a)), and no gain or loss is recognized by the shareholder by reason of the reorganization;
- the repurchased stock is, or an amount of stock equal to the value of the stock repurchased is, contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan;
- the total amount of repurchases within the year is less than $1 million;
- the repurchase is by a dealer in securities in the ordinary course of business;
- the repurchase is by a regulated investment company or a real estate investment trust; or
- the repurchase is taxed as a dividend to the shareholder.
In general, given that the excise tax applies only to corporations whose stock is traded on a public market, the determination of what constitutes a repurchase subject to the excise tax, and the amount of such tax, should be easily determined.
Uncertainties may arise in transactions involving non-traded stock where the transaction price might not establish fair market value. In these cases, valuations may be necessary.
Additionally, whether and to what extent a repurchase constitutes a dividend may be difficult or impossible to ascertain in the context of certain transactions, including market transactions (absent reporting by the selling shareholder), as is evidenced by the IRS's rulings in this area.
Also, transactions involving purchases of foreign corporation stock, whether of expatriated entities or not, should be carefully reviewed to ensure that such purchases don't inadvertently fall within the rules.
Treasury guidance will be necessary to identify any further exceptions, such as retirement of preferred stock occurring pursuant to its terms, and definitional guideposts on what may constitute economically similar transactions.
If you have any questions concerning the material discussed in this advisory, please contact the members of our Tax practice group.
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