Recently enacted H.R. 1, originally known as the Tax Cuts and Jobs Act, made changes to the corporate alternative minimum tax (AMT) that could provide an immediate regulatory capital boost to affected banks. Details of the new law’s application for companies subject to the Internal Revenue Code’s Section 382 “loss corporation” rules mean that some banks should not go too far too fast in adjusting their balance sheet taxes related to AMT credits.
Background
Under pre-H.R. 1 tax law, corporations annually paid the higher of their regular tax liability or their AMT liability. To the extent the AMT liability was higher, that difference became an AMT credit that could be carried forward indefinitely and used to reduce regular tax liability down to the AMT liability in each subsequent year. Under U.S. generally accepted accounting principles (GAAP), for financial reporting purposes, companies recorded the AMT credit carryforward as a deferred tax asset because its future realizability depended on a company having future regular tax liability in excess of AMT liability. If a company believed it was likely that its AMT liability would always exceed its regular liability, or that it would not have any future regular tax liability, it typically would record a valuation allowance against the AMT credit deferred tax asset.
H.R. 1 eliminated the corporate AMT for tax years beginning after Dec. 31, 2017, and changed the rules by which companies could realize any AMT credits carrying forward into their 2018 tax year. Starting in 2018, a company is allowed to reduce its regular tax liability by its amount of AMT credit carryforward. If its liability is not high enough to absorb its entire AMT credit, 50 percent of the remainder will be refunded. This rule continues for 2019 and 2020, and in 2021 any AMT credit carryforward remaining after reducing the 2021 regular tax liability to zero will be 100 percent refunded.
Three Big Questions
The potential refundability of the AMT credit under the new tax rules raised three financial reporting questions. Because GAAP requires that a company record the impacts of a tax law change on the company’s existing balance sheet taxes in the period that includes the law’s enactment date, in this case Dec. 22, 2017, the answers to these questions are significant for a bank’s Dec. 31, 2017, call report, as well as for any year-end Dec. 31, 2017, financial statements. The last question bears particular significance for banks because, under Basel III, deferred tax assets that represent a tax loss or credit carryforward cannot be counted in a bank’s regulatory capital. However, tax receivables can be counted in their entirety.
Could a company reverse any existing valuation allowances against AMT credit deferred tax assets? To the extent a company believes it is more likely than not that the new tax rules, especially the refunding provisions, will allow it to realize its AMT credits, it would be appropriate to reverse any related valuation allowances.
Should the AMT credit be discounted to reflect the time periods during which a company expects to realize the credits? In its Jan. 10, 2018, meeting, the Financial Accounting Standards Board (FASB) concurred with FASB staff’s preliminary view that these credits, whether presented as a deferred tax asset or a tax receivable, should not be discounted. FASB staff plans to memorialize this decision soon in a FASB staff Q&A.
Should AMT credit carryforwards be reclassified from a deferred tax asset to a tax receivable? FASB did not address this question specifically in its Jan. 10, 2018, meeting. However, the ability for 50 percent and finally 100 percent refunding of unused credits would make it possible for most companies to realize all of their AMT credits before 2022, even if they have no additional regular tax liability. Therefore, it appears reasonable for a bank, in its fourth quarter 2017 call report, to reclassify as a tax receivable some or all of any AMT credits that it expects to realize – either through reduction of regular tax liability or refund – by the end of 2021. Adequate disclosure of the company’s policy for classifying AMT credits should be made in audited financial statements. Also, FASB indicated it still will be necessary to disclose the amounts of AMT credit carryforwards, as is required for all tax attribute carryforwards.
Not so Fast, Loss Corporations
The tax accounting interpretations discussed earlier are great news, but they fail to consider that some banks’ AMT credits are subject to limitation because the credits existed when the bank was a loss corporation that experienced an ownership change under IRC Section 382. This situation typically arises when a banking group with AMT credits issued significant amounts of new stock or was acquired by another banking group.
As background, when a company experiences an ownership change, Section 382 imposes an annual limitation on the amount of pre-change tax losses and credits that can be realized post-change. Since the annual limitation is expressed in gross taxable income dollars, companion Section 383 applies, in general, to “gross-up” the limitation on credits. In other words, a bank in a 35 percent tax bracket needs $285 of annual limitation to allow use of $100 of credits ($100 / 35% = $285). Under H.R. 1, beginning in 2018, a bank will need $476 of annual limitation to allow use of that same $100 of credits ($100 / 21% = $476). If a company has losses, other credits, and AMT credits that all are subject to the same annual limitation, that limitation always is applied to AMT credits last (because, under pre-H.R. 1 tax law, they were the only item that did not expire).
Does Section 382 limit the ability to realize AMT credits under the new rules of H.R. 1? It appears that Section 382 still applies to limit the annual realizability of any AMT credits that were subject to its limitations. As a result, a bank might not be able to achieve 100 percent realization of Section 382-limited AMT credits during 2018 through 2021. Any remaining credits apparently still could be realized post-2021, but only to reduce regular tax liability in those subsequent years, subject to the continuing Section 382 limitations.
For example, assume a bank with $100 of AMT credits carrying forward into 2018, all of which are subject to a Section 382 limitation. Assume also that the bank has net operating loss (NOL) carryforwards subject to the same limitation. If, during 2018 through 2021, the bank applies its entire annual Section 382 limitation in order to use its NOL carryforwards, it will have no ability to use any of the AMT credits to reduce regular tax liability or to request a credit refund. The bank still will have the entire $100 of AMT credits carrying forward into 2022, which apparently it can apply to reduce its regular tax liability once the Section 382 limitation is available to allow it.
In this example, the bank likely should continue to carry the AMT credit as a deferred tax asset. Furthermore, if the bank were in a cumulative loss position, such that it could not support the expectation of future regular tax liability, it should consider whether to continue to carry a valuation allowance against the deferred tax asset.
Relief in Sight
On the whole, H.R. 1 provides welcome, prospective relief from the corporate AMT and a very favorable provision for recouping any AMT paid previously. Most banks should be able to rely on the new tax provisions to reclass existing AMT credit carryforwards as tax receivables and gain a regulatory capital boost in their Dec. 31, 2017, call reports. Banks with AMT credits subject to a Section 382 limitation should carefully consider the overriding effects of Section 382 on the new rules before doing the same.