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ATNOLs and charitable contribution carryovers: which takes precedence?

Due to the most recent economic downturn, many corporate taxpayers accumulated significant carryovers of net operating losses (NOLs), alternative minimum tax (AMT) net operating losses (ATNOLs), and charitable deductions. As these corporations recover and generate taxable income, the use of these carryover items is becoming more prevalent, and one of the issues arising is the interplay of the 10% limit on charitable deductions and the 90% limit on ATNOLs.

General Overview of the Law

The issue involves primarily three Code sections and their corresponding regulations: Sec. 170 (charitable contributions), Sec. 172 (NOL deduction), and Secs. 55 and 56 (AMT).

Sec. 170(b)(2)(A) generally limits the amount of a corporation's charitable deduction to no more than 10% of the corporation's taxable income. Furthermore, Sec. 170(b)(2)(C) states that taxable income for this purpose is computed without regard to the charitable deduction itself, NOL carrybacks, capital loss carrybacks, and the Sec. 199 deduction. Sec. 170(d)(2) provides for a carryover period of five tax years for charitable deductions a corporation makes in a tax year that exceed the 10% limit. In determining which charitable contributions are deductible in a given tax year, current-year contributions take priority over carryover contributions. The 10% limit on charitable deductions also applies in computing a corporation's alternative minimum taxable income (AMTI).

Secs. 172(c) and (d) define an NOL as the excess of allowable deductions over gross income, with specified modifications. Pursuant to Sec. 172(b)(2) and the regulations thereunder, the amount of the NOL that is absorbed in a carryover year equals the taxable income for that year determined with certain modifications (modified taxable income). Modified taxable income is determined without taking into account the NOL, and deductions that are limited to a percentage of taxable income are recomputed without regard to the NOL.

Sec. 56(d)(2)(A) generally requires a taxpayer to compute its ATNOL in the same manner as its NOL, with appropriate modifications for AMT adjustments and preference items. Sec. 56(d)(1)(A) limits the amount of ATNOL that may be deducted to the lesser of the ATNOL or 90% of AMTI computed without regard to the ATNOL deduction or the Sec. 199 deduction.

Ambiguous Ordering Rules

Based on the Code provisions cited above, a corporation's 90% limit on its ATNOL deduction must be based on income that includes the charitable deduction, while the corporation's 10% limit on its charitable deduction must be based on income that includes the ATNOL deduction. However, there is no statutory ordering rule that specifies which deduction takes priority, leaving uncertain how they both should be applied.

In June 2012, the IRS Office of Chief Counsel issued Chief Counsel Advice (CCA) 201226021, which gives some insight on the issue. According to the CCA, simultaneous linear equations have been used in analogous situations and may be appropriate in this situation. However, due to the lack of clear guidance in the Code or regulations, taxpayers may use any reasonable approach to determine the proper amount of each deduction. One such approach, which is also used by a major tax preparation software vendor, is examined below.

Interplay of Charitable and ATNOL Deductions

The following facts apply to the examples below with respect to Corporation X:

* Current-year charitable contributions = $50,000

* Charitable contribution carryover (for regular tax and AMT purposes) = $450,000

* NOL carryover = $7 million

* ATNOL carryover = $5 million

* AMT preference items = $50,000

* Taxable income before charitable deduction and NOL carryover = $1 million
  Example 1: Corporation X has taxable income of $1 million before
  the charitable deduction, with no NOL or ATNOL carryovers. As
  illustrated in Exhibit 1, the charitable deduction limits for
  regular tax and AMT purposes differ slightly, based on the
  corresponding computation of taxable income. For regular tax
  purposes, the $50,000 of current-year charitable contributions is
  first applied, with $50,000 of the prior-year carryover then
  applied. For AMT purposes, the additional $5,000 charitable
  deduction is applied against the charitable contribution
  carryover.

  Example 2: Assume the same facts as Example 1, except that
  Corporation X has an NOL carryover of $7 million and no ATNOL
  carryover. As illustrated in Exhibit 2, there is no regular tax
  charitable deduction because the NOL carryover fully offsets
  taxable income. Based on the calculation of modified taxable
  income, the charitable deduction that would have been otherwise
  allowed as a deduction absent the NOL carryover will "convert"
  to an NOL, with a corresponding reduction in the charitable
  contribution carryover. Therefore, the $100,000 charitable
  deduction in Exhibit 2 converts to an NOL carryover.

  Example 3: Assume the same facts as Example 2, except that
  Corporation X also has an ATNOL carryover of $5 million. As
  illustrated in Exhibit 3, one approach to the interplay between
  the 10% limit on the charitable deduction and the 90% limit on
  the ATNOL deduction is to apply the 10% charitable contribution
  limit first. The 10% limit on the charitable deduction for AMT
  purposes would first be calculated on taxable income without
  regard to the charitable deduction and the NOL carryover (Step
  1). This result would then be factored into the computation of
  the 90% limit on the ATNOL deduction (Step 2). Per Sec. 172(h)(2)
  and the regulations thereunder, the NOL to be absorbed would be
  calculated based on modified taxable income as defined above.
  Similarly, the ATNOL would be computed under the same rules.
  Consequently, the ATNOL would be the modified AMTI computed
  before the 90% limit on the ATNOL. The 10% limit on the
  charitable deduction is thus calculated on the difference between
  this amount and the AMTI before the charitable deduction and the
  ATNOL (Step 3). Finally, the recomputed 10% limit on the
  charitable deduction is factored into the computation of AMTI,
  less the ATNOL as computed above (Step 4).

Exhibit 1: 10% charitable contribution limit with no NOL or
ATNOL carryovers

                             Regular tax      AMT

Taxable income before        $ 1,000,000  $ 1,000,000
charitable contribution
deduction and NOL carryover

AMT preference items                 N/A     $ 50.000

Subtotal                     $ 1,000,000  $ 1,050,000

10% limit                          x 10%        x 10%

Charitable deduction           $ 100,000    $ 105.000

Exhibit 2: 10% charitable contribution limit with NOL
carryover only

                                   Regular tax      AMT

Taxable income before charitable    $ 1,000,000          $
deduction and NOL carryover                      1,000,000

NOL carryover                     $ (1,000,000)       $ --

AMT preference items                        N/A   $ 50.000

Subtotal                                   $ --          $
                                                 1,050,000

10% limit                                 x 10%      x 10%

Charitable deduction                       $ --  $ 105,000

Charitable contributions              $ 100,000       $ --
converted to NOL carryover

Exhibit 3:10% charitable contribution limit with NOL and ATNOL
carryovers

Step 1: Compute 10% charitable            AMT
contribution limit before charitable
or ATNOL deductions

Taxable income before charitable        $ 1,000,000
deduction and NOL carryover

AMTI before charitable deduction and    $ 1,050,000
ATNOL

Difference                               $ (50,000)

10% limit                                     x 10%

AMT charitable deduction for              $ (5,000)
purposes of computing the 90% ATNOL

Step 2: Calculate 90% ATNOL with 10%
limit on charitable deduction

Taxable income before charitable        $ 1,000,000
deduction and NOL carryover

AMT preference items                       $ 50,000

AMT charitable deduction                  $ (5,000)  from Step
                                                     1

AMTI before ATNOL                       $ 1,045,000

                                              x 90%

90% ATNOL                               $ (940,500)

Step 3: Recompute 10% charitable
contribution limit with ATNOL before
90% limit

AMTI before charitable deduction and    $ 1,050,000
ATNOL

ATNOL                                 $ (1,045,000)  from Step
                                                     2

Difference                                  $ 5,000

10% limit                                     x 10%

AMT charitable deduction                      $ 500

Step 4: Form 4626, Alternative
Minimum Tax--Corporations,
presentation

Taxable income before charitable        $ 1,000,000
deduction and NOL carryover

AMT preference items                       $ 50,000

AMT charitable deduction                    $ (500)  from Step
                                                     3

AMTI before ATNOL                       $ 1,049,500

90% ATNOL                               $ (940,500)  from Step
                                                     2

AMTI                                      $ 109,000


In this example, since the 10% limit on the charitable deduction takes precedence, the ATNOL deducted on Form 4626, Alternative Minimum Tax--Corporations, is 90% of AMTI computed with the 10% limit on the charitable deduction as calculated in Step 1. With this approach, the ultimate ATNOL deduction is less than the 90% limit generally allowed. This result is also affirmed by the simultaneous linear equations as shown in CCA 201226021.

Note: Depending on what ordering rules are followed, as well as the particular fact patterns, tax practitioners will get varying results.

Ensuring Proper Interplay of the Rules

The uncertainty surrounding the ordering rules of the 10% limit on the charitable deduction and the 90% limit on the ATNOL deduction has been affecting more corporate taxpayers as the economy recovers and these corporations start generating current-period taxable income. Corporations affected by these rules should know how their tax preparation software is computing the deductions to ensure that it is appropriately accounting for the interplay between the rules. It should also be noted that this item does not address any implications of when an NOL carryover is being limited by Sec. 382. Corporations should consult their tax advisers if this situation applies to them.

From Jeff Kondraschow, CPA; Chan-Yu Wang, CPA; and Kevin Powers, CPA, Oak Brook, Ill.
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Title Annotation:alternative minimum tax net operating losses
Author:Kondraschow, Jeff; Wang, Chan-Yu; Powers, Kevin
Publication:The Tax Adviser
Date:Sep 1, 2013
Words:1497
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