ACE lite: Congress eases the AMT computation. It's still a wicked brew!
It's still a wicked brew!
Thanks to the Revenue Reconciliation Act of 1989, computing the alternative minimum tax (AMT) will be slightly simpler. After three years of coping with the arbitrary book income adjustment, corporate taxpayers for tax years beginning after December 31, 1989, will need to compute adjusted current earnings (ACE) to arrive at AMT income (AMTI). But the ACE calculations mandated by the Tax Reform Act of 1986 have been simplified by eliminating the present value and book comparisons.
Practitioners now must be prepared to implement the new simplified ACE computations. As they prepare, they should consider the planning opportunities available during the final year of the book income adjustment, to take advantage of any differences. (See exhibit 1 Comparison of book income to adjusted current earnings.) In addition, corporations must focus on ACE to make meaningful financial projections of future tax liability, to make accruals for purposes of Financial Accounting Standards Board Statement no. 96, Accounting for Income Taxes, and to make 1990 estimated tax payments.
Although the first ACE tax return for a calendar year corporation is not due until September 16, 1991, if it's extended, estimated payments for 1990 must take ACE into account. This means certain corporations could be affected as early as April 16, 1990. However, a special rule may defer the need for an estimated ACE computation until June 15, 1990.
A SEPARATE SET OF RECORDS
In order to determine ACE, corporations must prepare and maintain a separate set of records for certain types of income and expense that are accounted for differently under ACE. As exhibit 2 ACE computation schedule shows, the ACE calculation starts with AMTI before AMT net operating losses or the ACE adjustment (tentative AMTI), and then a series of adjustments is made to arrive at ACE. Tentative AMTI then is subtracted from ACE and 75% of this difference becomes the ACE adjustment. Although ACE is not equivalent to current earnings and profits, some of the adjustments used in computing ACE rely on E&P concepts.
ACE DEPRECIATION: THE OLD AND THE NEW
Perhaps the most complex and pervasive adjustment to ACE is the depreciation adjustment. As originally enacted in the 1986 TRA, depreciation would have been computed in four steps:
1. One of four appropriate classifications was selected for each asset.
2. Depreciation was calculated over the remaining life of each asset by a prescribed method.
3. The net present value of this stream of depreciation deductions was computed.
4. The result of this computation was compared with a similar computation prepared using the book method.
The adopted ACE depreciation method would have been the slower (lower net present value) of the two. This comparison would have been necessary for each asset or class of assets.
The new law simplifies the ACE depreciation computation significantly by eliminating the present value requirements and the book comparison. Now, to compute ACE depreciation, assets must be grouped into one of four classes and depreciated using the prescribed method for each group, depending on when the assets were placed in service.
Post-1989 acquisitions. Property placed in service in tax years beginning after 1989 is depreciated using the alternative depreciation system of Internal Revenue Code section 168(g). This requires straight-line recovery over the property's class life.
Modified accelerated cost recovery system (MACRS) property. MACRS property placed in service before 1990 tax years is depreciated based on the AMT adjusted basis of the property as of the close of the last tax year beginning before 1990. The straight-line method is used over the remainder of the recovery period (generally class life, as specified in section 168(g)).
Accelerated cost recovery system (ACRS) property. This method of depreciation is based on the property's regular tax adjusted basis as of the close of the last tax year beginning before 1990, using the straight-line method over the remainder of the recovery period (generally class life, as specified in section 168(g)).
Other property (property placed in service before 1981 and other property to which neither MACRS nor ACRS apply). Depreciation is determined in the same manner as for regular tax purposes.
Observation. Every corporation with depreciable assets will be subject to these new rules even if the AMT does not apply for the current year. In planning for ACE, the more impractical and costly approach will be to recreate historical accounts in years when the AMT actually applies. Practitioners will be better off if they prepare the ACE computation on an annual basis. See EXHIBIT 3 Example of 1990 ACE depreciation computation for a calendar-year corporation
ACE ADJUSTMENTS BORROWED FROM E&P
Exclusion items--income items that are excluded for regular tax or AMTI but are includable for E&P purposes--also are included in computing ACE, net of any allocable deductions. These are items such as tax-exempt interest income (net of allocable carrying costs) and the "inside buildup" of income in life insurance contracts (net of attributable premiums). An exception to this rule allows the exclusion of section 108 discharge of indebtedness income that is excluded for regular tax purposes. This rule differs from the book income treatment of forgiveness-of-indebtedness income. Now, under ACE, such income won't trigger an adjustment for AMT purposes.
Exclusion item deductions--expenses that reduce E&P but are nondeductible--are deductible for ACE only if they relate to exclusion income. Therefore, items such as federal income taxes, political contributions, penalties, disallowed interest expense, the disallowed portion of meals and entertainment expense and similar items do not reduce ACE even though these items reduce E&P.
In addition, ACE can't be reduced by any item that is not deductible for E&P purposes. Apparently, net operating losses and dividends are the only deductible items for regular tax or AMTI that aren't deductible for E&P. However, an important exception is the corporate dividends received deduction, which is generally allowable against ACE (for 20%-or-more corporate investors). This exception is permitted so long as it's attributable to the distributor's income, which is subject to tax.
Because it's not exactly clear which E&P items are taken into account in computing ACE, the new law requires the Internal Revenue Service to provide more specific guidance no later than March 15, 1991.
OTHER SPECIFIC ADJUSTMENTS
Certain other adjustments to E&P provided in section 312(n) also apply for purposes of computing ACE. These are
* Intangible drilling costs paid or incurred in tax years beginning after 1989. These must be capitalized and amortized over 60 months. The new law repealed the present value and comparison to book requirements for intangible drilling costs, depletion and mineral exploration and development costs. Because mineral costs already are required to be amortized over 120 months under the AMT, no new or additional ACE adjustment for these costs will be required.
* Circulation and organizational expenditures paid or incurred in tax years beginning after 1989 must be capitalized and treated as part of the basis of the assets to which they relate.
* Lifo inventory adjustments. ACE is increased or decreased by the amount of any increase or decrease in the last-in first-out recapture amount (excess of first-in first-out inventory amount over the Lifo inventory amount).
* Installment sales treatment is allowable for ACE purposes, and therefore no adjustment is needed--provided interest is paid on the deferred tax liability in accordance with section 453A(a).
* Long-term contracts. The new law drops percentage-of-completion accounting for long-term contracts as an adjustment to ACE. This is consistent with the general repeal of the completed-contract method of accounting.
* Inventory capitalization. The new law also repeals a separate inventory capitalization method based on E&P concepts. Now section 236A is available for ACE without a separate determination.
Additional adjustments, not required for E&P purposes, also must be made for purposes of computing ACE:
* Disallowance of loss on exchange of debt pools. No loss is allowed on the exchange of pools of debt obligations having substantially the same effective interest rates and maturities.
* Acquisition expense of life insurance companies. Life insurance companies must capitalize and amortize the acquisition expenses of any policy in accordance with generally accepted accounting principles.
* Depletion. For property placed in service in tax years beginning after 1989, depletion must be determined under the cost depletion method.
* Certain ownership changes. For corporations that have experienced a change of ownership (within the meaning of section 382) after a 1989 tax year, the basis of the property of the corporation may not, for ACE purposes, exceed the allocable portion of the purchase price that was paid for the corporation.
Observation. The de minimis rule contained in section 382 applies for ACE purposes, so built-in losses less than $10 million or 15% of the fair market value of the assets of the company (whichever is lower) will not trigger an asset write-down.
MINIMUM TAX CREDIT EXTENDED
Equally significant to ACE simplification, Congress extended the corporate minimum tax credit to the total corporate AMT liability effective for tax years beginning after December 31, 1989. Under the 1986 TRA, the minimum tax credit was available only for AMT attributable to "deferral" items, preferences or adjustments arising from temporary differences that represented deferral rather than permanent reduction of tax liability. Under the new law, even exclusion items will generate the minimum tax credit for corporations.
1990 ESTIMATED TAX PAYMENTS
Despite the Revenue Reconciliation Act's simplification, ACE still will require a significant recordkeeping effort. The first quarter federal estimated tax payment can be based on the prior year's liability. However, only corporations that paid a tax liability or that did not have a short tax year in 1989 qualify. In addition, the subsequent installments for large corporations (those having taxable income of $1 million or more in any of the three prior years) must be based on current taxable income. This means computing ACE for estimated tax purposes for the second installment (due June 15, 1990, for calendar-year companies). See exhibit 2 ACE computation schedule.
ACE is here, and it probably will stay for the foreseeable future. Practitioners should familiarize themselves with the new computation and be able to advise their clients how best to comply. Obviously, investing in good fixed-asset software will make the number crunching more bearable. A solid product should be able to read a fixed-asset file converted to some standardized format (for example, an ASCII file) so data such as original cost and placed-in service dates won't have to be reentered manually. If information needed for regular tax and AMT depreciation is included in the file, the ACE computation could be prepared almost "hands-free."
Computing ACE will be simpler under the new rules now that the present value and book comparisons have been eliminated. The practitioner needs to watch for potential planning opportunities. Former strategies designed to minimize book income may not be appropriate after 1989 and corporations should seek to exploit discrepancies between book income and ACE. Finally, next to the practitioner's planning advice, comprehensive fixed asset software will be the client's best friend in coping with the new ACE rules. [Exhibits 1 to 3 Omitted]
SAMUEL P. STARR, CPA, LLM, is a partner in the national tax office of Coopers & Lybrand, Washington, D.C. He is a member of the American Institute of CPAs corporate alternative minimum tax task force and has published several articles on the subject. DAVID C. GREEN, CPA, is a tax manager in the Coopers & Lybrand, Parsippany, New Jersey, office. He is a member of the AICPA.
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|Author:||Green, David C.|
|Publication:||Journal of Accountancy|
|Date:||Feb 1, 1990|
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