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Avoiding the AMT depreciation adjustment.

Editor's note: This case study has been adapted from PPC Tax Planning Guide--Closely Held Corporations, 15th Edition, by Albert L. Grasso, Joan Wilson Gray, R. Barry Johnson, Lewis A. Siegel, Richard L. Burris, James A. Keller, Gary W. Brown and Kim L. Saunders, published by Practitioners Publishing Company, Fort Worth, Tex., 2002 ((800) 323-8724; www.ppcnet.com).

Facts: Xenon Corp., a calendar-year C corporation, was formed on Nov. 1, 2002; it filed its first return for the two-month period ending Dec. 31, 2002. * On Jan. 10, 2003, Xenon purchased $100,000 of assets in each of the regular modified accelerated cost recovery system (MACRS) personal property asset classes (i.e., the three-, five-and seven-year classes). These are the first fixed assets Xenon purchased. * The corporation has a very limited administrative staff. Jacqueline Burns, its sole shareholder and president, wants to keep the financial and tax accounting requirements simple. * Xenon's tax adviser has made Jacqueline aware of the alternative minimum tax (AMT), both from a tax liability and an administrative standpoint. Xenon will likely have a relatively small regular tax liability for the next several years. However, AMT may be a problem, because Xenon intends to use the completed-contract accounting method on several long-term contracts. Issue: What elections can Xenon make to avoid or minimize the potential AMT depreciation adjustment resulting from the asset purchases?

Analysis

Corporations are exempt under Sec. 55(e)(1)(C) from the AMT for their initial year. They will be exempt from AMT in their second year if they pass a $5 million test under Sec. 55(e)(l)(B) based on their initial-year receipts. (For short tax years, receipts must be annualized.)

Xenon would be exempt from AMT for 2002, its first tax year. If it does not meet the $5 million test for 2003, in its second year, it will be subject to AMT in that year. According to Sec. 55 (e) (2) (A), the excess-depreciation adjustment applies only to property placed in service after the change date (defined as the first day of the tax year for which the taxpayer ceases to meet the small-corporation exemption). As a result, Xenon will have to include an excess-depreciation adjustment for property placed in service after 2002.

The following rules under Secs. 56(a)(1)(A) and 168(c) apply to property placed in service after 1998: 1. For property otherwise eligible for MACRS (200% declining-balance (DB) method), electing to use AMT depredation for both regular tax and AMT purposes requires use of the AMT 150% DB method for both tax calculations. The normal MACRS recovery periods can also be used for both.

2. No election is needed to avoid two computations for MACRS 27.5-year real property (residential rental property) or MACKS 39-year real property (i.e., most other depreciable real estate). Such property is depreciated using the straight-line method for both MACRS and AMT depreciation purposes; the recovery periods are the same for both.

If Xenon elects to use AMT depreciation for both regular tax and AMT purposes for 2003 and thereafter, there is no AMT adjustment for excess depreciation, because the regular tax and AMT depreciation amounts will be the same. Xenon will need to retain only one set of fixed-asset-depreciation records; however, for 2003 (and, most likely, later years), the depreciation deduction allowed for regular tax purposes will be less than the amount that would have been allowed had Xenon used the MACRS 200% DB method.

The election to use AMT depreciation for regular tax purposes would have no effect on Xenon's ability to make the Sec. 179 election to expense depreciable property purchased during the year or to take the additional first-year 30% bonus depreciation on the adjusted basis of qualified property.

Conclusion

Jacqueline needs to decide which of the following is more important to her current operations:

1. Elimination of the potential for the AMT excess-depreciation adjustment and a reduction of administrative requirements by having to maintain only one set of fixed-asset-depreciation records; or

2. Availability of larger depreciation deductions under the MACKS depreciation method.

Xenon's tax adviser should be able to help Jacqueline make this decision by showing her the differences in the depreciation deductions available for the next several years and their projected effect on the corporation's future tax liabilities.

Forms, Elections and Implementation

If the AMT depreciation system is elected for both regular tax and AMT purposes, the election should be made with the return filed for calendar-year 2003. The election must be made each year for the property placed in service during that year, by attaching the proper statement to the return and completing Form 4562, Depreciation and Amortization.
Albert B. Ellentuck, Esq.
Of Counsel
King and Nordlinger, L.L.P.
Arlington, VA
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Title Annotation:alternative minimum tax
Author:Ellentuck, Albert B.
Publication:The Tax Adviser
Date:Jan 1, 2003
Words:787
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