Opportunity to minimize the effect of the corporate AMT.

For many corporate taxpayers, the calculation of the depreciation adjustment of the alternative minimum tax (AMT) and the resulting tax cost is a significant burden. Taxpayers currently have to compute two depreciation adjustments to arrive at alternative minimum taxable income. These include both the AMT and adjusted current earnings (ACE) adjustments. Further, as Congress pursues new sources of tax revenue, there is an increased possibility that the current corporate AMT tax rate of 20% will be increased. The effect of an increase to current as well as potential AMT taxpayers could be costly. For these reasons all taxpayers should evaluate their tax situations and look for opportunities to minimize their AMT or ACE depreciation adjustments.

One specific opportunity may be for taxpayers to elect out of the modified accelerated cost recovery system (MACRS) method of calculating depreciation and still retain an accelerated depreciation deduction without the harsh consequences of an AMT or ACE adjustment.

Sec. 168(f)(1) provides that the MACRS provisions of Sec. 168 do not apply to any property if the taxpayer elects to exclude the property. This rule was first introduced as part of the accelerated cost recovery system (ACRS) legislation of 1981. The original purpose of Sec. 168(f)(1) was relief from the required recovery periods of ACRS depreciation so that, in appropriate situations, taxpayers could elect a depreciation method not expressed in terms of years. For example, video arcade games were in the five-year ACRS recovery class, even though the useful life was probably closer to 24 months (or less). For this reason, many taxpayers sought to use the income forecast method to measure depreciation in accordance with the income produced by the asset, even though the method was not common at that time. The application of this provision became much more significant with the introduction of MACRS and the related AMT or ACE adjustments.

Property may be excluded from the MACRS rules if it can be depreciated under the unit of production method or any other method not expressed in terms of years. In addition, the method should be recognized as an industry practice, the annual usage must be maintained and the useful life (in production terms) must be estimated with some degree of accuracy. Prop. Regs. Sec. 1.168-4(b) states further that this election is to be made in the first tax year that a depreciation deduction would be available to a taxpayer and will remain in effect as long as the property is in the taxpayer's hands. This election can apply to some or all of the property (within a recovery class) placed in service during a tax year.

In Letter Ruling 9015014, the IRS addressed the issue of a Sec. 168(f)(1) election for certain construction equipment. in this ruling, the taxpayer stated that depreciating the purchased equipment over an eight-year life instead of the five-to-six-year life set forth in Rev. Proc. 87-56 would properly match the depreciation expense with the property's useful life. The taxpayer proposed the use of a depreciation method based on the hours the equipment was used during the year. The Service approved the method based on the following:

1. The operating hours method chosen by the taxpayer had long been recognized by the construction industry. Regs. Sec. 1.167(a)-1(b) provides in part that, for Sec. 167 purposes, an asset's estimated useful life is the period over which the asset may reasonably be expected to be useful to the taxpayer in the trade or business or in the production of income, This period is to be determined by reference to any experience with similar property, taking into account present conditions and probable future development. If the taxpayer's experience is inadequate, the general experience in the industry may be used until the taxpayer's own experience forms an adequate basis for making determinations.

2. The annual allowance for depreciation may not exceed the Regs. Sec. 1.167(b)-4 limitation of the amount available under double declining balance depreciation.

3. The property's depreciable basis had to be reduced by an appropriate salvage value. Regs. Sec. 1.167(a)-1(c)(1) defines salvage value as the amount (determined at the time of acquisition) that is estimated to be realized on sale or other disposition of an asset when it is no longer useful in the taxpayer's trade or business or in the production of income and is to be retired from service by the taxpayer.

This letter ruling and related regulations point to an opportunity for various taxpayers to use alternative depreciation methods. Other methods not expressed in terms of years include the unit-of-production, income forecast, operating days, miles driven and inspection methods. The taxpayer should be prepared to support any method chosen. Therefore, it is important that the taxpayer maintain adequate records, and that these records be consistent with prior years. In addition, because there is no published authority on some of the alternative methods, it is particularly important that the taxpayer's position be substantiated through careful analysis. It should be noted that the application of an elected method to prior year acquisitions (rather than current year acquisitions) will be a change in accounting method.

The mechanics of making the election are relatively simple. The election must be made by the due date (taking into account extensions) of the tax return for the tax year in which the election is to be effective. A separate election should be made for each affiliated corporation that joins in a consolidated tax return filing. Also, the tax return should include a statement indicating that the election is being made under Sec. 168(f)(1) and should identify the property to which the election applies. Once this election is made, it may be revoked only with IRS consent.