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Corporate alternative minimum tax.

The corporate alternative minimum tax (AMT) is designed to assure that the taxpayer with substantial economic income will not be able to avoid taxes merely by using available tax exclusions, deductions, and credits.

A corporation qualifying as a "small corporation" is not subject to the alternative minimum tax. A small corporation is a corporation that for its first tax year beginning after 1996 has average annual gross receipts not exceeding $5,000,000 for the preceding three-year period (if the corporation was in existence less than three years, then the test will be applied to whatever period it was in existence). Annualization of receipts is required for any short taxable year. Once a corporation qualifies as a small corporation, it will continue to be treated as a small corporation as long as its average gross receipts for the three-year period preceding the taxable year do not exceed $7,500,000.

Gross receipts include total sales (net of returns and allowances) and all amounts received for services. In addition, gross receipts include any income from investments, and from incidental or outside sources. For example, gross receipts include interest, dividends, rents, royalties, and annuities, regardless of whether such amounts are derived in the ordinary course of the taxpayer's trade or business. Gross receipts are generally not reduced by the cost of goods or property sold.

The following discussion applies only to those corporations that do not qualify as a "small corporation" and therefore are subject to the alternative minimum tax.

As it applies to corporations, the AMT requires that the corporate tax base be determined with certain adjustments and increased by specific tax preferences. Two of the more common tax preference items are accelerated depreciation and certain tax-exempt interest. In the process of determining the alternative minimum taxable income (AMTI) of a C corporation, 75 percent of the amount by which adjusted current earnings (ACE) exceed the tentative AMTI is added to the tentative AMTI (or 75 percent of the amount by which the tentative AMTI exceeds ACE is subtracted from the tentative AMTI). The resulting amount is then reduced by an exemption of $40,000 less 25 percent of the excess of AMTI over $150,000. The resulting tax base is multiplied by 20 percent to determine the tentative minimum tax. The corporation then pays a tax equal, in effect, to the greater of this amount or its regular tax.

Although ACE is not equivalent to current earnings and profits (E&P), some of the adjustments used in computing ACE rely on E&P concepts. For example, life insurance will increase ACE, since under generally accepted accounting principles E&P are increased by: (1) yearly cash value increases in excess of annual premiums; and (2) death proceeds (including outstanding loans) in excess of basis increased for cash value increases previously included in AMTI. Proceeds from disability income and buy-out policies payable to the corporation are also included in ACE.

Conversely, if premiums are paid for term insurance, or the cash value increase is less than the annual premium, there is a decrease of ACE that reduces exposure to the AMT. However, redemption of the deceased or disabled owner's stock in the same year as the proceeds are received will not avoid an increase in ACE.

The existence of the AMT does not mean that all, or even most, life insurance cash values or death proceeds will be subject to the tax. Much depends upon the corporation's taxable income, tax preference items, and other factors (e.g., S corporations are not subject to the ACE adjustment). Only a portion of cash value increases and death proceeds will be potentially exposed to this tax, since cash value increases will be partially offset by premiums; and death proceeds will be offset by cash values. Even when there is exposure, generally the maximum rate is 15 percent (i.e., a 20 percent tax on 75 percent of ACE). With many corporations payment of the tax will be an acceleration of rather than an increase of tax liability, since it then becomes a credit available to offset a portion of the corporation's tax liability in future years (unlimited carry forward). However, this credit may be useless to the closely held or professional corporation that will have little, if any, taxable income.
Impact Of Alternative Minimum Tax
On Life Insurance Death Benefits
Payable To C Corporation

                                 Death Benefit
Income       100,000    250,000    1,000,000    2,500,000    5,000,000

0              7,000     31,375      150,000      375,000      750,000
               7,000     31,375      150,000      375,000      750,000
25,000        12,000     37,625      155,000      380,000      755,000
               8,250     33,875      151,250      376,250      751,250
50,000        17,000     43,875      160,000      385,000      760,000
               9,500     36,375      152,500      377,500      752,500
100,000       28,250     56,375      170,000      395,000      770,000
               6,000     34,125      147,750      372,750      747,750
250,000       80,750     87,500      200,000      425,000      800,000
                          6,750      119,250      344,250      719,250
500,000      170,000    170,000      250,000      475,000      850,000
                                      80,000      305,000      680,000
1,000,000    340,000    340,000      350,000      575,000      950,000
                                      10,000      235,000      610,000
2,000,000    680,000    680,000      680,000      775,000    1,150,000
                                                   95,000      470,000

Note: This chart assumes the C corporation is not exempt from the
alternative minimum tax (AMT) as a "small corporation." Small
figure represents that portion of the income tax that is
attributable to the death benefit (i.e., additional tax imposed
under the AMT calculations). The corporation is assumed to have no
tax preference items. No adjustments are made for cumulative
premiums paid and for possible annual cash value increases in
excess of premiums paid (i.e., "basis for ACE"). As an example of
how to use this chart, assume a corporation has $500,000 of taxable
income in a given year and also receives a death benefit payment of
$1,000,000. The corporation will owe federal income taxes of
$250,000 of which $80,000 is attributable to the effect of the AMT
and the receipt of the life insurance death benefit. If this
corporation received the same $1,000,000 death benefit but had
$2,000,000 of taxable income, the corporation would owe $680,000 in
taxes, none of which would be attributable to the death benefit and
the AMT. This chart also indicates that a corporation with taxable
income of $1,000,000 could consider increasing its key person life
insurance on a key employee from $100,000 to $250,000 without
additional exposure to the AMT (i.e., the income taxes remain at
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Copyright 2010 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Terms & Concepts
Publication:Field Guide to Estate, Employee, & Business Planning
Date:Jan 1, 2010
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