A&M Tax Advisor Weekly
Just five days before the new year, Treasury and the IRS revealed their intentions to issue regulations that will govern how taxpayers should apply two new corporate tax provisions enacted by the Inflation Reduction Act (IRA) that are effective January 1, 2023: (1) the 15% corporate alternative minimum tax (CAMT) and (2) the 1% excise tax on certain share repurchases. The “interim guidance” issued December 27th, comes in the form of Notice 2023-2 (share repurchases) and Notice 2023-7 (CAMT), and tackles several critical issues, including the scope of the rules and the treatment of certain transactions, while not addressing several other key issues.
In this alert, we discuss certain items of the interim guidance for CAMT and stock repurchases and share some observations. Overall, while there are some taxpayer favorable rules (e.g., treatment of certain tax-free reorganizations and some relief for distressed companies under the CAMT rules), other guidance may wreak havoc for many corporate transactions (e.g., far-reaching stock repurchase rules) and add complexity to an already complicated tax regime. With more guidance needed and in the works, Treasury and the IRS are requesting comments on a myriad of issues. Until the proposed regulations are issued, which will generally apply beginning January 1, 2023, taxpayers may rely on rules in the notices.
Corporate Alternative Minimum Tax
Although corporations appear to have escaped an increase in the statutory income tax rate for at least the next two years (with a divided government), they must navigate a complex web of rules to determine if they are subject to the 15% minimum tax and the tax liability that will be due. The CAMT, which is based on financial statement income, poses countless questions, particularly given book-tax differences, and presents tremendous uncertainty given the statute’s broad grant of regulatory authority.
With some exceptions, a corporation is an “applicable corporation” subject to the CAMT if either: (1) its three-year average annual adjusted financial statement income (AFSI) exceeds $1 billion (applying an aggregation rule) or (2) it is part of a non-U.S.-parented group and the group exceeds the same $1 billion threshold and the U.S. entities and subsidiaries have a three-year average annual AFSI of at least $100 million for the same period (i.e., for the 2023 taxable year, the average annual AFSI is calculated based on taxable years 2020 through 2022). The statute provides some adjustments in computing AFSI, including replacing book depreciation with tax deductions for certain depreciable property (section 168 property) and applying a book net operating loss (only for purposes of computing the corporation’s CAMT liability).
Under the interim guidance, taxpayers would first need to apply step transaction principles to characterize their transaction. In the case of most nonrecognition transactions, each component of the transaction would be examined separately, rather than analyzing the transaction as a whole, for purposes of determining the CAMT implications. For these transactions, if a component does not cause the recognition of any gain or loss for tax purposes, then any book gain or loss associated with such component would not be taken into account in the AFSI calculation. Additionally, any corresponding financial accounting basis adjustments associated with nonrecognition components would not be taken into account for purposes of computing AFSI. Conversely, if gain or loss is recognized on a component for tax purposes, it appears that the corresponding book gain or loss would be included for CAMT purposes. However, if the transaction is not one of the enumerated nonrecognition transactions, all book gain or loss associated with the transaction would be included for CAMT purposes, even for components of the transaction in which the taxpayer does not recognize any gain or loss for tax purposes (although the notice requests comments with respect to these components).
A&M Insight: While the component-by-component approach could be taxpayer favorable compared to an overall transaction approach, it adds significant complexity, particularly in having to determine how a component of a transaction would be treated for book purposes when the transaction is otherwise only accounted for as a single transaction (or potentially as a totally different transaction). As a result of this proposed approach, taxpayers would have to maintain yet another set of books in order to comply with the CAMT.
Simplified Method, Mere Deferral
For simplification, Treasury and the IRS offer a safe harbor for corporations to test whether they would be subject to the CAMT for their first taxable year beginning after December 31, 2022. The modified test is based on whether the corporation’s financial statement income (with only limited adjustments) satisfies significantly lower thresholds (replacing the $1 billion threshold with $500 million, and for non-U.S. parented groups, also substituting the $100 million threshold with $50 million). If a corporation does not meet the safe harbor, it must determine whether it is an applicable corporation based on the standard test described above.
A&M Insight: Unfortunately, the safe harbor only provides limited transition relief (and potentially cost savings) for 2023 because a taxpayer that qualifies for the safe harbor would need to perform the full complement of complex calculations beginning in 2024, including calculating its AFSI for 2021 and 2022. While it would be helpful if the safe harbor was not limited to 2023, such that “smaller” corporations would not need to prepare all the required adjustments in determining annual AFSI, because that is not currently the case, taxpayers that do qualify for the safe harbor may still want to consider making the most of the transition period to prepare for the 2024 taxable year. Also, taxpayers should be mindful that the interim guidance is silent on reporting requirements for the safe harbor and the level of support needed for compliance, as well as the reporting requirements for any corporation determining whether it is an applicable corporation without using the safe harbor.
Applicable Corporation Status Shifts
As a general matter, once a corporation becomes an applicable corporation, it will remain an applicable corporation until, as determined by Treasury, it had a “change in ownership” or a specified number of consecutive years in which it would not be an applicable corporation if it was retested. The guidance offers potential insight into what might be considered a change in ownership by providing that an applicable corporation that is acquired in certain typical M&A transactions sheds its applicable corporation status (but not its CAMT history).
A&M Insight: Based on the guidance, applicable corporations that would no longer qualify as an applicable corporation may benefit from M&A transactions as the loss of its applicable corporation status could immediately generate cash savings. However, it is also possible the acquisition of such a corporation could subject the acquiring corporation to the CAMT if it was not already subject to it. So careful modeling must be performed to appreciate the implications an M&A transaction has, not only for CAMT liability purposes, but also applicable corporation status going forward.
Tax on Share Repurchases
Since the IRA was enacted this past summer, significant concerns have mounted about how broadly the tax on share repurchases might apply — potentially sweeping in what some might consider transactions not necessarily within the spirit of the policy aimed at curtailing the extent to which cash-rich corporations buy back their stock instead of investing in their businesses or their employees. In the interim guidance, Treasury and the IRS adopt a more comprehensive view of transactions considered to be repurchases than taxpayers hoped for, despite the broad grant of regulatory authority. The guidance, among other things, also clarifies that the tax on share repurchases would be reported and paid annually.
Under the statute, if a corporation has at least one class of stock that is traded on an established securities market, a 1% excise tax is imposed on its share repurchases during the taxable year based on the fair market value of that stock less the value of any stock issued (the netting rule). Stock is treated as repurchased when the transaction is a redemption for tax purposes or economically similar as determined by Treasury. Some exceptions under the statute include:
Corporations whose stock repurchased during the year does not exceed $1 million (de minimis rule);
To the extent repurchases of the stock are followed by contributions of stock or an equivalent value of stock of the company to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan;
To the extent the repurchase is characterized as a dividend for tax purposes; and
To the extent the repurchase is part of a tax-free reorganization and no gain or loss is recognized by the shareholder on the repurchase.
Under the initial guidance, the following transactions would not be treated as repurchases:
Deemed redemptions in certain acquisitions by a related non-subsidiary corporation;
Payments made in cash in lieu of fractional shares in a tax-free reorganization or the settlement of an option or similar financial instrument if certain requirements are met;
Spin-off transactions; and
Certain distributions that are pursuant to a plan of liquidation.
The initial guidance also provides a wide-ranging list of transactions that would be considered economically similar to redemptions, and therefore treated as repurchases, including:
Recapitalizations (E reorganizations);
Reorganizations to effect mere changes, such as in form or place of location (F reorganizations); and
The guidance further provides that for these economically similar transactions, in computing the tax, the fair market value of the stock repurchases would be reduced to the extent that the repurchase is for qualifying property (stock or securities received without recognition of gain or loss). If this reduction occurs, then the stock treated as qualifying property would not be treated as an issuance for purposes of the netting rule to prevent a double benefit.
A&M Insight: Taxpayers will appreciate that the interim guidance provides some exceptions to what constitutes a repurchase and some reprieve for tax-free reorganizations considered repurchases (i.e., the fair market value of qualified property would not be subject to the tax). However, the net effect of the qualified property rule would be that in reorganizations in which no gain or loss is recognized, if the shareholders receive both stock of the acquiring corporation, as well as money or other property, that portion, commonly referred to as “boot” would be subject to the tax, which would be broader than the statutory text.
Additionally, the interim guidance provides that the de minimis rule would be tested before all other exceptions and the netting rule. This is significant because certain transactions would be treated as share repurchases irrespective of whether the fair market value of the repurchase may be offset by reductions for qualified property or by the stock issuances in the transaction. As a result, the likelihood of corporations exceeding the de minimis threshold significantly increases.
A&M Taxand Says
The year-end guidance gifts from Treasury and the IRS are a welcome start — but just the tip of the iceberg — as 2023 could be a year of free-flowing guidance on these complex corporate tax matters. Despite anticipated complications discussed in this alert, the CAMT clarifications begin to address the treatment of critical book-tax differences for tax-free reorganizations, as well as for corporations in bankruptcy or insolvency, which we plan to address in a later alert. For the share repurchase rules, companies will need to factor in the application of the excise tax to tax-free reorganizations involving boot (if the rules in the notice are adopted) and other common transaction structures, such as a part sale and part redemption transaction (commonly referred to as a Zenz transaction), when modeling return on investment and exit strategies for public companies or take private transactions. If you would like to discuss how the new corporate tax provisions could affect your business and tax planning and implications for transaction modeling, please feel free to reach out to Kevin M. Jacobs of our National Tax Office.