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US Inflation Reduction Act – Corporate Minimum Tax And Stock Repurchase Excise Tax – Income Tax



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If you thought the recent price increase at your neighborhood
store was inflation’s last flop, think again. The Inflation
Reduction Act (“IRA”), which was signed into law by
President Biden on August 16, 2022, is estimated to raise $739
billion over the decade. The IRA is financed primarily by several
targeted tax increases. Revenues will go toward initiatives
designed to combat climate change, reduce the nation’s debt,
and, hopefully, reduce inflation. The IRA is a starkly diminished
version of the proposed “Build Back Better Act,” which
passed the House in 2021 but never received a vote in the Senate.
Most of the tax proposals in the Build Back Better Act didn’t
make it into the new bill, but a few did.

As discussed in more detail below, among the significant tax law
changes in the IRA1 are: 

  1. A 15% minimum tax rate (“corporate minimum tax”) on
    the adjusted financial statement income (“AFSI” or
    “adjusted book income”) of corporations with average
    annual adjusted book income of $1 billion; and

  2. A 1% excise tax on certain corporate stock repurchases.

15% Corporate Minimum Tax on Adjusted Book Income

A corporate alternative minimum tax was imposed in various forms
beginning in 1969—and repealed in 2017. For most of that
period, the tax base was not financial statement income but the
regular income tax base with various preferences added back.

The new corporate minimum tax will apply to “applicable
corporations,” defined as those with $1 billion or more in
annual adjusted book income (as opposed to adjusted taxable
income), calculated over a three-year period average. Corporations
connected through greater than 50% ownership are generally
aggregated to calculate the $1 billion adjusted book income
threshold. A US corporation that is a member of a foreign-parented
group will only be an applicable corporation if the group’s
average AFSI is $1 billion or more and the average
adjusted book income of the US corporations of the group, together
with any effectively connected income of the foreign corporations
(as reflected for AFSI purposes), is $100 million or more. Once a
corporation becomes an applicable corporation subject to the
corporate minimum tax, it remains an applicable corporation
(subject to certain exceptions) even if the income test is no
longer met in subsequent years. For corporations in existence for
less than three years, the minimum tax will be based on the
earnings in the years of existence. The corporate minimum tax
excludes Subchapter S corporations, RICs, and REITs. It has been
estimated that the new provisions will apply to about 150 companies
and are expected to raise $313 billion in taxes over 10
years.2

When applicable, the corporate minimum tax for a particular year
would be the greater of the amounts computed under the regular US
corporate federal income tax or the corporate minimum tax. The
corporate minimum tax is generally equal to 15% of the
corporation’s AFSI. Book profits are the profits that
corporations are required to report publicly to shareholders and
potential investors and are often much larger than the profits they
report to the IRS for tax purposes. Taxpayers are generally
allowed to credit the corporate minimum tax paid in a prior year
against their regular tax liability in a future year to the extent
the regular tax liability exceeds the amount of its minimum tax for
the future year.

Because the corporate minimum tax effectively focuses on book
income (subject to several adjustments) rather than taxable income,
deductions that may have been available in computing a
corporation’s regular US tax liability may be effectively
denied in computing book profits, potentially resulting in higher
overall US corporate federal income tax liabilities.

As a result of the corporate minimum tax being based on
financial, rather than tax, accounting principles, the law creates
several new concepts that taxpayers will need to adapt to. These
include the concepts of “adjusted financial statement
income” or “AFSI” and new definitions and
standards for determining an “applicable corporation”
that is subject to the corporate minimum tax. As noted, AFSI starts
with the income reported on the taxpayer’s financial
statements (e.g., SEC Form 10-K or other Annual Report) and can be
reduced by newly defined “financial statement net operating
losses,” depreciation allowances (significantly, tax
—and not financial statement—depreciation with respect
to tangible property is used to calculate AFSI), and certain
general business credits under Section3 38 (subject to
limitations), including the R&D credit.

Other than the specific adjustments provided in the statute,
AFSI would not take into account provisions applicable in the
calculation of the regular income tax (e.g., Section 163(j)
limitations on interest deductions, Section 382 limitations on loss
carryforwards).

If the applicable corporation is a US shareholder of one or more
controlled foreign corporations (“CFCs”), the AFSI will
not include the Subpart F or GILTI inclusions of the applicable
corporation or any dividends received from the CFCs. Rather, the
AFSI will include the applicable corporation’s pro rata share
of the CFCs’ income and expense items, adjusted under rules
similar to those applicable in determining AFSI. If the aggregate
CFCs’ result is negative for a taxable year, the AFSI is not
reduced by that negative CFC adjustment, but, rather, the CFC loss
is carried forward and may reduce a positive CFC adjustment in a
future year. The applicable corporation will also be entitled to a
“corporate AMT foreign tax credit” with respect to
foreign taxes paid or accrued by the applicable corporation or its
CFCs. For US groups with low-taxed foreign operations, the
alternative minimum tax may result in a higher US tax bill: the
rate of tax will now be 15% instead of the 10.5% rate on GILTI
under the regular income tax.

A last-minute change in the legislation removed the aggregation
of income of separate corporations owned by the same investment
fund or partnership, providing relief for private equity funds and
their portfolio companies.

The new corporate minimum tax will be particularly onerous to
companies with significant stock-based compensation and research
and development expenses as these items often create the most
significant book/tax differences. In addition, only book losses
from 2020 and later years may be taken into account and then only
to offset up to 80% of book income. Book losses may be carried
forward but may not be carried back. Book losses are not taken into
account for purposes of the $1 billion and $100 million income
tests used in determining whether a corporation is an applicable
corporation.

This new corporate minimum is effective for tax years beginning
after December 31, 2022. Therefore, taxpayers will need to adjust
quickly to the imposition of this new tax.

The Stock Repurchase Excise Tax

Distributions and stock buybacks are both ways that corporations
transfer profits to shareholders. Shareholders typically pay income
tax on corporate distributions. Stock buybacks, on the other hand,
are intended to increase the stock price while not immediately
resulting in income (to the non-selling shareholders). The 1%
excise tax will reduce, but not eliminate, this advantage.

The IRA’s 1% excise tax on certain corporate stock
repurchases is effected through the creation of a new Chapter 37
and corresponding Section 4501 in the Internal Revenue Code. The
excise tax is imposed on “Covered Corporations”
repurchasing their shares directly or through a “Specified
Affiliate.” A “repurchase” is defined as a
“redemption” under Section 317(b) (i.e., an acquisition
by a corporation of its own stock from its shareholders in exchange
for property) or any transaction determined by the IRS to be
“economically similar” to a redemption.

The tax is generally equal to 1% of the fair market value of the
stock repurchased by the Covered Corporation or the Specified
Affiliate. However, there is an offset rule under which the fair
market value of the repurchased stock is reduced by the fair market
value of any stock issued by the covered corporation during the
same taxable year.

A Covered Corporation is any US corporation publicly traded on
an established securities market. A Specified Affiliate is (a) any
corporation whose stock, as determined by vote or value, is
directly or indirectly owned more than 50% by the Covered
Corporation or (b) a partnership whose capital interest or profits
interest is directly or indirectly owned more than 50% by the
Covered Corporation. The excise tax is not deductible for federal
income tax purposes. The Covered Corporation (not the stockholder
or the Specified Affiliate) pays the tax.

The excise tax does not apply under several circumstances: (a)
if the stock buyback is part of a nontaxable corporate
reorganization qualifying under Section 368(a) where no gain or
loss is recognized; (b) if the repurchased stock, or any amount
equal to the repurchased stock, is contributed to an
employer-sponsored retirement plan, employee stock ownership plan,
or similar plan; (c) if the total value of the repurchased stock in
a taxable year does not exceed $1 million; (d) if the repurchase is
by a securities dealer in its ordinary course of business; (e) if
the repurchase is by a RIC or a REIT; or (f) if the repurchase
qualifies as a dividend for federal income tax purposes.

It is worth noting that the scope of the excise tax may extend
beyond public company share buyback programs and could potentially
apply to other corporate transactions, especially in light of the
regulatory authority granted to the IRS to extend its application
to transactions that are “economically similar” to a
redemption. It is not clear that this result was intended in all
cases. For example:

  • Preferred stock redemptions: There is no exception for
    repurchased stock that is not publicly traded. Therefore, the
    repayment at maturity of non-publicly traded stock of a Covered
    Corporation would be subject to the excise tax, even in the case of
    mandatorily redeemable preferred stock that had been issued prior
    to the effective date of this provision. The statute contemplates a
    grant of regulatory authority to the IRS to “address special
    classes of stock and preferred stock,” so it is conceivable
    some relief may be afforded in regulations.

  • LBO transactions: The excise tax may also affect
    certain common leveraged buyout (“LBO”) structures that
    involve a deemed stock redemption for tax purposes. In a typical
    LBO structure, a buyer company forms a transitory merger subsidiary
    for purposes of acquiring the target corporation through a reverse
    cash merger. The buyer company contributes cash to the merger
    subsidiary, and the merger subsidiary also borrows additional cash
    from a third-party lender. The merger subsidiary then merges into
    the target corporation with the target corporation surviving, and
    the target shareholders receive cash consideration for their target
    stock in an amount equal to the cash contributed by the buyer
    company plus the loan proceeds from the third-party borrowing.
    Because the merger subsidiary is disregarded as transitory for tax
    purposes, the target company is treated as having borrowed the
    third-party debt and distributed the loan proceeds to its
    shareholders in redemption of a portion of their target stock. If
    the target company is a Covered Corporation, it appears the excise
    tax may apply.

  • Tax-free reorganizations with boot: Under case law and
    IRS guidance, when a corporation acquires the stock or assets of
    another corporation in a tax-free reorganization in part for shares
    and in part for cash, the transaction is generally characterized as
    (1) first, all of the target shareholders exchange their target
    stock solely for stock of the acquiring corporation and (2) then,
    the acquiring corporation redeems a portion of the acquiring
    corporation stock received by the target shareholders for cash.
    See Comm’r v. Clark, 489 U.S. 726 (1989);Rev. Rul.
    93-61, 1993-2 C.B. 118. The redemption in (2) is treated as
    redemption for tax purposes so long as it is not characterized as a
    dividend under Section 302. In such case, it is unclear whether the
    excise tax would apply and under what circumstances (e.g., is the
    relevant determination whether the acquiring or the target company
    is a Covered Corporation?).

  • SPAC redemptions: A special purpose acquisition
    company (“SPAC”) often redeems some of its shareholders
    in connection with the de-SPAC transaction. For a domestic SPAC,
    that redemption would be subject to the excise tax. The cost of the
    excise tax may be mitigated under the offset rule given that,
    contemporaneously with the redemption, the SPAC will also often
    issue new shares for the private investment in public equity
    (“PIPE”).

  • Split-off transactions: In a tax-free split-off
    transaction, the parent corporation exchanges stock of a controlled
    subsidiary in exchange for a portion of the parent
    corporation’s outstanding stock. This exchange is technically
    a redemption. Although the split-off is generally undertaken in
    connection with a tax-free divisive “D reorganization,”
    it is unclear whether this exchange of parent stock for subsidiary
    stock should be considered part of the reorganization so as to
    benefit from the statutory exception to the excise tax.

This new excise tax applies to repurchases that occur after
December 31, 2022. As part of the IRA, Treasury has been granted
authority to promulgate regulations to carry out the purpose of the
new excise tax and to prevent its avoidance.

Looking Ahead

Given the numerous new concepts introduced in the Internal
Revenue Code by the IRA, including basing the corporate minimum tax
on book income rather than taxable income, regulations and other
guidance to be issued by the IRS and Treasury will play a central
role in determining how the new corporate minimum tax and the new
excise tax will actually be implemented. The compliance burden for
large corporations continues to increase. Some taxpayers may have
to calculate regular federal income tax, a separate BEAT liability,
the corporate minimum tax, and any liabilities under the
OECD’s “Pillar Two” rules while navigating the
coordination between each of these regimes (e.g., is the corporate
minimum tax a CFC Tax Regime for Pillar Two purposes?). Tax
professionals may also have to become experts in financial
accounting to build the bridge between tax and accounting that the
corporate minimum tax will require. Taxpayers should be prepared to
participate in the rulemaking process in order to influence how the
many details that need to be filled in via the regulatory process
are finalized.

Footnotes

1. Also discussed in the Mayer Brown Legal Updates
“US Inflation Reduction Act of 2022: Carbon Capture Use and
Sequestration Provisions”
(August 22, 2022),
“Offshore Wind and the US Inflation Reduction Act”

(August 19, 2022),
“The US Inflation Reduction Act, Solar and REITs”

(August 17, 2022),
“The Green Energy Tax Incentives of the Inflation Reduction
Act of 2022”
(August 2, 2022), and
“US Inflation Reduction Act Includes Changes to Carried
Interest Taxation”
(August 2, 2022) and the Tax Equity
Times Blog post
“Manchin’s BBB Redux-tion Act – The Inflation
Reduction Act of 2022”
(July 28, 2022).

2. JCT, memo to Senate Finance Committee Republicans
(July 28, 2022).

3. All section references are to the Internal Revenue
Code of 1986, as amended.

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This
Mayer Brown
article provides information and comments on legal
issues and developments of interest. The foregoing is not a
comprehensive treatment of the subject matter covered and is not
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legal advice before taking any action with respect to the matters
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