April 12, 2005 | WebMemo on Taxes
If Congress considers broad tax reform later in the year, its legislation may include provisions to eliminate the individual and corporate alternative minimum tax (AMT). That would be welcome news for the more than 30 million taxpayers who are likely to face the individual AMT by 2010.
Opponents of tax reform will almost surely attack repeal of the corporate AMT as a giveaway to big corporations, but repeal of the corporate AMT could actually increase federal tax revenue. This is not "voodoo economics," but simple addition: Between 1995 and 2002, corporate AMT credits exceeded corporate AMT payments by nearly $4.3 billion.
In principle, the corporate AMT works much like the individual AMT and is similarly intended to ensure that profitable corporations pay at least some federal income tax. The corporate AMT is calculated using a different set of rules than the regular corporate income tax, and it applies a 20 percent tax rate to an alternative definition of taxable income. In general, the AMT applies an alternative tax rate to a more broadly defined measure of income and a more narrowly defined set of deductions.
The corporate AMT sets a floor for corporate taxation. A firm pays the AMT only if its regular income tax liability is less than its liability under the AMT rules-known as the "tentative minimum tax." When this "tentative" tax exceeds the firm's regular tax liability, the company has to pay the difference. Formally, this difference is the corporate AMT.
A firm's tax generally cannot fall below the AMT floor. But because much of the difference in tax liability under the two systems is caused by how the systems deal with timing, firms are allowed to take an AMT credit against their regular taxes in future years.
As an example of these timing differences, under both sets of tax rules, firms are allowed to fully depreciate the cost of their assets. Under the AMT, however, they have to depreciate some of their assets more slowly.
The two systems' treatments of net operating losses (NOL) also differ. Under the regular tax rules, companies are allowed to use NOL from current and previous years to reduce their taxable income to zero, provided the losses are large enough. Under the AMT rules, firms can reduce their "alternative minimum taxable income" (AMTI) with NOL, but NOL cannot exceed 90 percent of the AMTI.
Firms that incur AMT liability in a given year are allowed an AMT credit against their regular income tax in future years. Without this credit, companies would permanently lose their regular tax deductions even when they no longer have to pay the AMT. In the aggregate, these credits exceeded AMT payments by $4.3 billion between 1995 and 2002, the most recent year for which data are available. (See Table 1.)
How does the credit work? Suppose ABC Corporation's AMT liability was $1 million in 2004. If ABC owes $2 million in regular income taxes for 2005 and has no "tentative" minimum tax that year, it could reduce its regular income tax by $1 million, the amount of AMT it paid in 2004.
The only catch is that ABC cannot reduce its regular income tax below the AMT floor. If, for example, ABC owes $2 million in regular income taxes for 2005 and has a "tentative" minimum tax of $1.5 million, it can use only half of its AMT credit from 2004, or $500,000. It can then apply the unused remainder of its 2004 AMT credit to regular taxes in subsequent years.
The AMT credit leads to the following quirk: Over any period of time, a company that pays the AMT and claims all of its AMT credits will have paid the same amount as if there had been no AMT. Thus, the AMT does not raise corporate income taxes, but only accelerates them.
There is some evidence that the corporate AMT has not led to higher tax revenues. This question is difficult to research because firm-level corporate tax return data are not publicly available. Nonetheless, the IRS does publish some aggregate corporate income tax data, so a few general comparisons can be made.
In 1981, six years before the present-day corporate AMT went into effect, the aggregate federal income tax rate for corporations (after credits) amounted to 24.2 percent of taxable income. In 2002, this aggregate rate was 25.58 percent. The average rate over this entire time period was 26.13 percent, with a standard deviation of 1.45 percent. (See Table 2.)
In other words, the average corporate tax rate has remained stable over the past 24 years. This should be no surprise: The AMT was not really designed to raise tax revenue, only to accelerate it.
While the corporate AMT brings in little if any additional tax revenue, it still places an enormous administrative burden on corporations. Even ignoring these direct economic costs, it is likely that the corporate AMT's enforcement costs exceed its added revenue.
Those who define fairness as making profitable companies pay more in taxes-their "fair share"-should consider the corporate AMT a failure from the start. These critics are sure to argue for reform of the corporate AMT as an alternative to its elimination. But both sides of the reform debate should be able to find common ground. The corporate AMT and most tax reform proposals work by eliminating deductions and credits and applying a single lower tax rate to income. The major difference is that the corporate AMT accomplishes this by penalizing companies that have high ratios of capital investment to profits.
If those who favor reform, rather than elimination, of the corporate AMT really believe that firms avoid paying their fair share in income taxes by taking advantage of a host of deductions and tax credits, they should be willing to eliminate those deductions and credits from the tax code. This would remove the major justification for the AMT. Proponents of tax reform generally agree on this course as well, as a means of simplification.
The corporate AMT applies an alternative tax rate to a more broadly defined measure of income and to a more narrowly defined set of deductions. The problem is that the corporate AMT does this inefficiently, in terms of compliance and enforcement costs, and in a way that penalizes firms that have a high ratio of capital investment to profits. In the end, the corporate AMT serves only to burden firms with additional paperwork and accelerate their regular income tax liabilities.
Many advocates of tax reform want to broaden the tax base and lower tax rates, but they want to do this efficiently, for all businesses. The corporate AMT is the perfect target for tax reform because it is expensive and inefficient and only adds to the complexity of the tax code. In the context of broader tax reform, even those who believe that corporations do not pay their fair share in taxes ought to be able to support elimination of the corporate AMT.
Norbert J. Michel, Ph.D., is a Policy Analyst in the Center for Data Analysis at The Heritage Foundation.
Representatives Jim McCrery (R-LA) and Phil English (R-PA) have already introduced legislation (H.R. 1186) that would eliminate both the individual and corporate alternative minimum tax.
For a full discussion of the individual AMT, see Leonard Burman, William Gale, and Jeff Rohaly, "The Expanding Reach of the Individual Alternative Minimum Tax," Journal of Economic Perspectives,Vol. 17, No. 2 (Spring 2003).
If a firm's "tentative" minimum tax is less than its regular income tax liability prior to all credits (other than the foreign tax credit and the possessions tax credit), then no AMT is due.
The Taxpayer Relief Act (TRA) of 1997 eliminated the differences between the AMT and regular tax depreciation lives. But because firms can elect to use the same depreciation method for many types of property under both the regular and AMT rules, TRA 1997 effectively harmonized the depreciation rules under both systems for many types of property placed into service after 1998.
Technically, to determine the alternative tax net operating loss deduction (ATNOLD), the firm recalculates its regular net operating loss (NOL) under the AMT rules. The allowable ATNOLD cannot exceed 90 percent of AMTI (prior to the adjustment).
Prior to the Omnibus Budget Reconciliation Act of 1989, firms were allowed an AMT credit only with respect to those items that resulted from timing differences.
One of the few studies that have been able to match firm-level financial statement data to tax return data found some evidence that firms were able to reduce their AMT exposure in 1987 by managing their earnings. See Charles Boynton, Paul Dobbins, and George Plesko, "Earnings Management and the Corporate Alternative Minimum Tax," Journal of Accounting Research, Vol. 30, Studies on Accounting and Taxation, 1992, pp. 131-153.
The present-day corporate AMT was part of the Tax Reform Act of 1986.