Simplification proposal could ease complexities of AMT for some businesses.

The individual and corporate alternative minimum tax (AMT) provisions require complex tax computations and apply to large numbers of taxpayers. In April 1997, the Treasury Department proposed a package of income tax simplification measures, including a proposal to eliminate the AMT for corporations with less than $5 million in average annual gross receipts. However, the package did not include any changes to current law for individual AMT payers, who are expected to grow in number from 600,000 in 1997 to 6.2 million in 2006 (based on joint Committee on Taxation estimates). Large corporations would also continue to face substantial complexity under the current AMT rules. In addition, a Treasury simplification proposal relating to the computation of the foreign tax credit (FTC) likely would increase the tax burdens of many AMT payers.

Compliance Costs and Tax

Planning

Tax complexity under the AMT arises in several ways. Compliance burdens relate to computing the AMT and recordkeeping requirements. Also, by taxing certain items excluded from the regular tax base and by eliminating or reducing certain deductions, the AMT creates incentives for taxpayers to conduct their affairs differently than under the regular tax. For instance, a high-income taxpayer who ordinarily might benefit from investing in tax-exempt bonds might find that taxable bonds offer a higher after-tax return. A corporation that ordinarily would borrow to finance purchases of equipment might find that, after taking into account the AMT, a lease offers a better opportunity. Under the AMT, the corporation's interest payments effectively are deducted at only a 20% tax rate and depreciation ahowances on equipment are taken more slowly.

As a result of the AMT, corporations must keep track of depreciation under several different systems: assets purchased before 1987 are disregarded for purposes of the AMT depreciation adjustment, but not for purposes of computing adjusted current earnings (ACE); assets purchased after 1987 must have a separate AMT depreciation calculation deduction; depreciation for ACE is calculated differently for assets purchased prior to 1987, between 1987 and 1989, and between 1990 and 1993; and finally, assets purchased after 1993 require no additional depreciation calculation for ACE. These different treatments of depreciation also give rise to separate calculations of inventory for AMT and ACE purposes.

The AMT also increases planning costs for non-AMT taxpayers. Because the AMT limits taxpayers' use of tax preferences, it is important that a taxpayer engaging in tax-preferred activities plan them in such a way so as to minimize the likelihood of incurring AMT.

The complexity of the AMT befuddles individuals, companies and many tax advisers. For instance, although most individual AMT returns are prepared by paid preparers, IRS audit data of a subset of taxpayers indicate that AMT miscalculations on individual returns resulted in net overpayments to the government by these taxpayers of $50 million in 1988. (For a critical analysis of the policies cited to support the AMT, see Lyon, Cracking the Code: Making Sense of the Corporate Alternative Minimum Tax, Brookings Institution, 1997.)

AMT Simplification

The Treasury simplification proposal, if enacted, would be welcome news to the many small companies that currently must labor through the AMT calculations, even when no additional tax is due. Under the proposal, companies with gross receipts averaging less than $5 million in the three prior years would be excluded from the AMT in the current year. If a company had accumulated AMT credits, it could use these to offset up to one-half of its regular tax liability.

In 1992, although only about 28,000 corporations paid AMT, an additional 400,000 non-amt companies filed their AMT calculations with the Service, and many more calculated their AMT and determined they were not required to file. The Treasury proposal would eliminate AMT liability for about 6,000 corporations, and greatly reduce recordkeeping burdens for other companies. Companies that would be exempted from paying AMT currently, but that expect to exceed the $5 million threshold in the future, might find it useful to continue to maintain AMT records. If, in the future, the company was required to calculate AMT, it would have to go back to prior years to determine correctly its AMT liability.

The Treasury simplification package also contains a proposal to simplify the FTC computation under the AMT. To compute the FTC, certain deductions must be allocated and apportioned between domestic and foreign sources. The allocation of expenses to foreign sources may reduce a taxpayer's ability to fully use FTCs.

Under current law, the FTC limitation must be calculated separately under the regular tax and the AMT. The Treasury proposal would allow a taxpayer to allocate these expenses for AMT purposes in the same manner as under the regular tax. While this would reduce the number of separate calculations necessitated by the AMT, it might come at the expense of higher taxes for taxpayers with excess FTCs. This is because the allocation of deductions under the AMT generally results in a greater apportionment of deductions to domestic sources. This simplification measure, if enacted, could be a trap for the unwary.

Conclusion

A welcome proposal that would eliminate the AMT for small corporations draws attention to the continuing complexity of the AMT for both individuals and larger corporations. Unless Congress adopts more sweeping proposals to reform or repeal the AMT, tax professionals must prepare to assist their AMT clients. Failure to index for inflation the exemption amount from the AMT calculation with cause the number of individual AMT taxpayers to rise by tenfold over the next 10 years. In the absence of true AMT simplification for larger companies, services that minimize these companies' compliance costs and help them understand the effects of alternative transactions on AMT liability will continue to be in demand.