Editor: Albert B. Ellentuck, Esq.
The alternative minimum tax (AMT) does not apply to small business corporations (Sec. 55(e)). A corporation qualifying for small business corporation status avoids both the administrative burden and the potential additional tax liability of the AMT.
Meeting the Gross-Receipts Test to Qualify as a Small Business Corporation
A small business corporation is defined as a corporation having three-year average annual gross receipts not exceeding $5 million for its first tax year and not having three-year average annual gross receipts exceeding $7.5 million for any later year (Sec. 55(e)). That is, to qualify, the corporation's average gross receipts for all three tax-year periods ending before the current tax year must be $7.5 million or less.
Example 1. Calculating the gross-receipts test:ABC Inc. has been in existence since Jan. 1, 2007, and uses a calendar year end. Its gross receipts for the previous years are shown in Exhibit 1.
ABC is exempt from AMT for 2007 since that was its first year in existence (Sec. 55(e)(1)(C)). It qualifies as a small business corporation for 2008 since its average gross receipts for the first three years (or portion thereof) of existence are less than $5 million (Sec. 55(e)(1)(B)).
ABC will continue to qualify for the AMT exemption in 2009 and later years if the average gross receipts for the previous three years (or portion thereof) do not exceed $7.5 million (Sec. 55(e)(1)(A)). Therefore, ABC remains qualified as a small corporation for 2009 through 2013. However, for 2014, ABC will no longer qualify for the exemption since its average gross receipts for the previous three-year period exceeded $7.5 million. It does not matter that ABC's gross receipts for 2014 were less than $7.5 million.
Meeting the Gross-Receipts Test Annually
The gross-receipts test must be met annually. Once average gross receipts exceed $7.5 million, the corporation will never again qualify for the small business corporation exemption, even if average gross receipts fall below $7.5 million in future years.
Example 2. Failing the gross-receipts test:Assume the same facts as in Example 1. Because ABC became subject to the AMT for 2014, it will continue to be subject to it in all subsequent years. Therefore, whenever possible, it is extremely important to manage the level of receipts for the year in question to ensure that the corporation continues to qualify in the following years.
Controlling Income to Meet the Gross-Receipts Test
Pro forma calculations can be made prior to year end for corporations in danger of losing their small business exemptions from the AMT due to failing the Sec. 55(e) gross-receipts test. Based upon such calculations, actions such as deferring income can be considered to keep average gross receipts to no greater than $7.5 million.
Avoiding Controlled-Group Status to Meet the Gross-Receipts Test
The gross receipts of the members of a controlled group must be combined when performing the $5 million and $7.5 million gross-receipts tests. The rules under Sec. 1563(a) (with certain modifications) are used to determine which entities must aggregate gross receipts when computing the test. For this purpose, controlled groups are defined as (Secs. 55(e), 448(c), and 52(a)):
Example 3. Structuring ownership of multiple corporations to meet the gross-receipts test:R, D, S, and E (none of whom are related) are starting a manufacturing operation and a retail business that they plan to operate in two corporations. They anticipate the two corporations will (1) have combined first-year gross receipts over $10 million and (2) generate significant amounts of AMT adjustments/preferences.
- Parent-subsidiary controlled groups: One or more chains of corporations connected through stock ownership with a common parent corporation if:
- Stock possessing more than 50% of the total combined voting power of all classes of stock entitled to vote or more than 50% of the total value of shares of all classes of stock of each of the corporations, except the common parent corporation, is owned by one or more of the other corporations; and
- The common parent corporation owns stock possessing more than 50% of the total combined voting power of all classes of stock entitled to vote or more than 50% of the total value of shares of all classes of stock of at least one of the other corporations, excluding, in computing such voting power or value, stock owned directly by such other corporations.
Brother-sister controlled groups: Two or more corporations if five or fewer persons who are individuals, estates, or trusts own stock possessing:
- At least 80% of the total combined voting power of all classes of stock entitled to vote or at least 80% of the total value of shares of all classes of the stock of each corporation; and
- More than 50% of the total combined voting power of all classes of stock entitled to vote or more than 50% of the total value of shares of all classes of stock of each corporation, taking into account the stock ownership of each person only to the extent the stock ownership is identical in each corporation.
By structuring ownership of Corp A and Corp B as shown in Exhibit 2, these corporations will not be considered brother-sister corporations. Thus, the receipts of the two corporations will not have to be aggregated; each corporation will calculate the gross-receipts test based only on its receipts.
Warning:This ownership structure should be recommended only after all factors have been evaluated, including the potential income of each corporation. R and D will not be satisfied with owning a corporation that is projected to generate less income than the one owned by S and E.
Example 4. Failing the gross-receipts test as brother-sister corporations:Assume the same facts as in the previous example, except ownership of the two corporations is structured as shown in Exhibit 3.
Based on this ownership structure, the corporations qualify as brother-sister corporations, and the receipts of the two corporations must be aggregated when computing the gross-receipts test.
A predecessor of an entity is considered the same as that entity for purposes of the gross-receipts test (Secs. 55(e)(1)(D) and 448(c)(3)).
Example 5. Gross-receipts test as predecessor/successor corporations:The sole shareholder of P Inc. anticipates that his corporation will fail the small business corporation gross-receipts test in the current year. To avoid the AMT, the shareholder plans to transfer P's business operations to two new corporations. By doing this, he thinks neither corporation is likely to have gross receipts in excess of $5 million or a three-year average of $7.5 million for several years.
A predecessor of an entity is considered the same as that entity for purposes of the gross-receipts test (Secs. 55(e)(1)(D) and 448(c)(3)). Thus, the new corporations are not exempt from the AMT since P does not qualify for the small business corporation exemption.
Losing the Small Business Corporation Exemption From AMT
A corporation that has been exempt from the AMT as a small corporation and then becomes subject to the AMT when it exceeds the gross-receipts threshold will remain liable for the AMT in all future years. The AMT is computed with the following modifications (where the "change date" is the first day of the first tax year in which the corporation ceases to meet the gross-receipts test):
- The adjustments for depreciation (Sec. 56(a)(1)) and pollution-control facilities (Sec. 56(a)(5)) apply only to property placed in service on or after the change date.
- The adjustment for mining exploration and development costs (Sec. 56(a)(2)) applies only to costs paid or incurred on or after the change date.
- The adjustment for long-term contracts (Sec. 56(a)(3)) applies only to contracts entered into on or after the change date.
- The adjustment for the AMT net operating loss deduction (Sec. 56(a)(4)) applies as if, in making adjustments to the NOL computation under Sec. 56(d)(2), the change date is substituted for Jan. 1, 1987, and the day before the change date is substituted for Dec. 31, 1986, each place it appears.
- The limitation on the allowance of negative adjustments based on adjusted current earnings (Sec. 56(g)(2)(B)) applies only to prior tax years beginning on or after the change date.
- The adjustment for depreciation in computing adjusted current earnings (Sec. 56(g)(4)(A)) does not apply.
- Other earnings and profits (E&P) adjustments and depletion (Secs. 56(g)(4)(D) and (F)) apply as if the day before the change date were substituted for Dec. 31, 1989, each place it appears.
The change date is defined as the first day of the first tax year for which the taxpayer ceases to meet the gross-receipts test (Sec. 55(e)). The preceding modifications do not apply to any property acquired by the corporation in a transaction to which Sec. 381 (dealing with carryovers in certain corporate acquisitions) applies or to any property received in a carryover basis transaction if that property was subject to modifications in the hands of the transferor (Sec. 55(e)(3)).
Example 6. Determining the consequences of failing the gross-receipts test:G Inc. is a calendar-year corporation that met the exemption as a small business corporation for 2013 but lost it in 2014. As of Dec. 31, 2013, the following would have yielded AMT tax adjustments had G not met the exemption for 2013: Excess MACRS depreciation over AMT depreciation-$4,000; adjustment for income on long-term contracts recognized on completed-contract method rather than percentage-of-completion method-$15,000.
Most AMT adjustment/tax preference items for the year the exemption is lost are treated as if that year is the first year of corporate existence. This will have the following impact on G:
- Most of G's assets placed in service before 2014 on which normal MACRS depreciation was taken will continue to produce a depreciation allowance in excess of the amount that would be allowed if the AMT 150% declining-balance (DB) method had been used. However, Sec. 55(e)(2) states that the adjustment for excess depreciation will apply only to property that is placed in service after the change date. As a result, G will not have to include an adjustment for excess depreciation on property placed in service before Jan. 1, 2014.
- G has long-term contracts from which income is recognized on the completed-contract method of accounting rather than the percentage-of-completion method. The difference in the income that would have been recognized under the percentage-of-completion method over that recognized on the completed-contract method is normally an AMT adjustment item. However, Sec. 55(e)(2) states that the adjustment will only apply for those contracts entered into after the change date. Therefore, G will not have to make this calculation and include any amount as an AMT adjustment for any contracts entered into before Jan. 1, 2014.
This case study has been adapted from PPC's Tax Planning Guide-Closely Held Corporations, 27th Edition, by Albert L. Grasso, R. Barry Johnson, Lewis A. Siegel, Richard Burris, Mary C. Danylak, James A. Keller, and Kimberly Drechsel, published by Thomson Tax & Accounting, Fort Worth, Texas, 2014 (800-323-8724; ppc.thomson.com).
|Albert Ellentuck is of counsel with King & Nordlinger LLP in Arlington, Va.