1. © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Essentials of Taxation 1 Chapter 17 Business Tax Credits and Corporate Alternative Minimum Tax

2. 2 The Big Picture Mike, the CEO of Progress Corporation, has committed to helping revitalize the downtown area in his hometown. Mike is considering expanding his business and purchasing an old office building in a historic section of downtown. –The building will require substantial renovations. –Mike has heard that there are tax credits that might help reduce his costs. He would also like to –Hire inner-city workers, and –Help working families by providing on-site child care for working families. He is interested in learning whether his company might take advantage of any other tax credits offered by the Federal government that might reduce his costs. Read the chapter and formulate your response.

3. 3 Tax Credit VS. Tax Deduction Tax benefit received from a tax deduction depends on the marginal tax rate of the taxpayer –Tax benefit received from a tax credit is not affected by the taxpayer’s marginal tax rate Example: $1,000 expenditure: tax benefit of 25% credit compared to tax deduction at various marginal tax rates MTR 0% 15%35% Tax benefit if a 25% credit is allowed $250 $250 $250 Tax benefit if tax deduction is allowed –0– $150 $350

4. 4 General Business Credit (slide 1 of 2) Comprised of a number of business credits combined into one amount Limited to net income tax reduced by greater of: –Tentative minimum tax –25% of net regular tax liability that exceeds $25,000 Unused credit is carried back 1 year, then forward 20 years

5. 5 General Business Credit (slide 2 of 2) Includes the following: –Tax credit for rehabilitation expenditures –Work opportunity tax credit –Research activities credit –Low-income housing credit –Disabled access credit –Credit for small employer pension plan startup costs –Credit for employer-provided child care

6. 6 General Business Credit (slide 2 of 2) Includes the following: –Tax credit for rehabilitation expenditures –Work opportunity tax credit –Research activities credit –Low-income housing credit –Disabled access credit –Credit for small employer pension plan startup costs –Credit for employer-provided child care

7. 7 Rehabilitation Expenditure Credit (slide 1 of 3) Credit is a percentage of expenditures made to substantially rehabilitate industrial and commercial buildings and certified historic structures Credit rate –20% for nonresidential and residential certified historic structures –10% for other structures originally placed into service before 1936

8. 8 Rehabilitation Expenditure Credit (slide 2 of 3) To qualify for credit, building must be substantially rehabilitated meaning qualified rehab expenditures exceed the greater of: –The adjusted basis of the property before the rehab expenditures, or –$5,000 Qualified rehab expenditures do not include the cost of the building and related facilities or cost of enlarging existing building

9. 9 Rehabilitation Expenditure Credit (slide 3 of 3) Basis in structure is reduced by the credit amount Subject to recapture if rehabilitated property held less than 5 years or ceases to be qualifying property

10. 10 The Big Picture - Example 4 Tax Credit For Rehabilitation Expenditures (slide 1 of 2) Return to the facts of The Big Picture on p. 17-1. Assume that Progress spends $60,000 to rehabilitate a building (adjusted basis of $40,000) that had been placed in service in 1932. –Progress is allowed a credit of $6,000 (10% X $60,000) for rehabilitation expenditures. –The corporation then increases the basis of the building by $54,000. $60,000 (rehabilitation expenditures) - $6,000 (credit allowed).

11. 11 The Big Picture - Example 4 Tax Credit For Rehabilitation Expenditures (slide 2 of 2) If the building were a historic structure, –The credit allowed would be $12,000 (20% X $60,000), and –The building’s depreciable basis would increase by $48,000. $60,000 (rehabilitation expenditures) - $12,000 (credit allowed).

12. 12 Work Opportunity Tax Credit (slide 1 of 2) Applies to first 12 months of wages paid to individuals falling within target groups –Credit limited to a percentage of first $6,000 wages paid per eligible employee 40% if employee has completed at least 400 hours of service to employer 25% if at least 120 hours of service –Deduction for wages is reduced by credit amount

13. 13 Work Opportunity Tax Credit (slide 2 of 2) Targeted individuals generally subject to high rates of unemployment, including –Qualified ex-felons, high-risk youths, food stamp recipients, veterans, summer youth employees, and long-term family assistance recipients Summer youth employees: Only first $3,000 of wages paid for work during 90-day period between May 1 and September 15 qualify for credit

14. 14 The Big Picture - Example 6 Work Opportunity Tax Credit Return to the facts of The Big Picture on p. 17-1. In January 2015, Progress Corporation hires 4 members of a qualifying targeted group. –Each employee works 1,000 hours and is paid wages of $8,000 during the year. Progress’s work opportunity credit is $9,600 –($6,000 X 40%) X 4 employees. –If the tax credit is taken, Progress reduces its deduction for wages paid by $9,600. No credit is available for wages paid to these employees after their first year of employment

15. 15 Work Opportunity Tax Credit: Long-Term Family Assistance Recipient (slide 1 of 2) Applies to first 24 months of wages paid to individuals who have been long-term recipients of family assistance welfare benefits –Long-term is at least an 18 month period ending on hiring date

16. 16 Work Opportunity Tax Credit: Long-Term Family Assistance Recipient (slide 2 of 2) Maximum credit is a percentage of first $10,000 qualified wages paid in first and second year of employment –40% in first year –50% in second year Maximum credit per qualified employee is $9,000 –Deduction for wages is reduced by credit amount

17. 17 Research Activities Credit (slide 1 of 5) Comprised of three parts –Incremental research activities credit –Basic research credit –Energy research credit

18. 18 Research Activities Credit (slide 2 of 5) Incremental research activities credit –Credit amount = 20% × (qualified expenditures – base amount) Expenditures qualify if research relates to discovery of technological info intended for use in developing a new or improved business component for taxpayer –Expenditures qualify fully if research done in-house –Only 65% qualifies if research conducted by outside party (under contract)

19. 19 Research Activities Credit (slide 3 of 5) Tax treatment of R&E expenditures –Full credit and reduce expense deduction by credit amount –Full expense deduction and reduce credit by (100% × credit × max. corp. tax rate) –Full credit and capitalize research expenses and amortize over 60 months or more Amount capitalized is reduced by full amount of credit only if the credit exceeds the amount allowable as a deduction

20. 20 Research Activities Credit (slide 4 of 5) Basic research credit –Additional 20% credit is allowed on basic research payments in excess of a base amount Basic research payments - amounts paid in cash to a qualified basic research organization, such as a college or university or a tax- exempt organization operated primarily to conduct scientific research –Basic research is any original investigation for the advancement of scientific knowledge not having a specific commercial objective The definition excludes basic research conducted outside the United States and basic research in the social sciences, arts, or humanities

21. 21 Research Activities Credit (slide 5 of 5) Energy Research Credit – –This credit is intended to stimulate additional energy research –Credit amount = 20% of amounts paid or incurred by a taxpayer to an energy research consortium for energy research

22. 22 Disabled Access Credit Credit available for eligible access expenditures made by small businesses –Includes amounts paid to remove barriers that would otherwise make a business inaccessible to disabled and handicapped individuals –Facility qualifies if placed in service before November 6, 1990 Credit amount –50% × expenditures that exceed $250 but not in excess of $10,250 Thus, max. credit is $5,000 –Basis in asset is reduced by credit amount

23. 23 Disabled Access Credit Credit available for eligible access expenditures made by small businesses –Includes amounts paid to remove barriers that would otherwise make a business inaccessible to disabled and handicapped individuals –Facility qualifies if placed in service before November 6, 1990 Credit amount –50% × expenditures that exceed $250 but not in excess of $10,250 Thus, max. credit is $5,000 –Basis in asset is reduced by credit amount

24. 24 Credit For Pension Plan Startup Costs Small businesses can claim nonrefundable tax credit for admin costs of establishing and maintaining a qualified retirement plan –Small business has < 100 employees who have earned at least $5,000 of compensation Credit amount = 50% of qualified startup costs limited to max credit of $500 per year for 3 years –Deduction for startup costs is reduced by amount of credit

25. 25 Credit For Employer-Provided Child Care (slide 1 of 2) Employers can claim a credit for providing child care facilities to their employees during normal working hours –Limited to $150,000 per year Credit amount: –25% of qualified child care expenses –10% of qualified child care resource and referral services

26. 26 Credit For Employer-Provided Child Care (slide 2 of 2) Deductible qualifying expenses must be reduced by the credit amount Basis of qualifying property must be reduced by credit amount Credit may be subject to recapture if child care facility ceases to be used for qualifying purpose within 10 years of being placed in service

27. 27 The Big Picture - Example 13 Credit For Employer-provided Child Care (slide 1 of 2) Return to the facts of The Big Picture on p. 17-1. During the year, Progress Corporation constructs a child care facility for $400,000 to be used by its employees’ preschool-aged children. –In addition, Progress incurs $100,000 in salaries and other administrative costs associated with the facility.

28. 28 The Big Picture - Example 13 Credit For Employer-provided Child Care (slide 2 of 2) As a result, Progress’s credit for employer- provided child care is $125,000. –($400,000 + $100,000) X 25%. The basis of the facility is reduced to $300,000 ($400,000 - $100,000), and The deduction for salaries and administrative costs is reduced to $75,000 ($100,000 - $25,000).

29. 29 Foreign Tax Credit (slide 1 of 2) The purpose of the foreign tax credit (FTC) is to mitigate double taxation since income earned in a foreign country is subject to both U.S. and foreign taxes –Credit applies to both individuals and corporations that pay foreign income taxes –Instead of claiming a credit, a deduction may be claimed for the taxes paid

30. 30 Foreign Tax Credit (slide 2 of 2) Amount of the credit allowed is the lesser of: –The foreign taxes imposed, or –The overall limitation determined using the following formula: Foreign-source TI × U.S. tax before credit Worldwide TI = Overall FTC limitation For individual taxpayers, worldwide taxable income is determined before personal and dependency exemptions Unused FTCs can be carried back 1 year and forward 10 years

31. 31 Alternative Minimum Tax (slide 1 of 2) Designed to ensure that corporations with substantial economic income pay at least a minimum amount of federal taxes Essentially, a separate tax system with a quasi- flat tax rate applied to a corporation’s economic income

32. 32 Alternative Minimum Tax (slide 2 of 2) If tentative alternative minimum tax > regular corporate income tax, corporation must pay regular tax plus the excess, the alternative minimum tax (AMT)

33. Small Corporation Exemption (slide 1 of 2) For tax years beginning after 1997, many small corporations are not subject to AMT A corporation initially qualifies as a small corporation in its first tax year in existence regardless of its gross receipts. After the initial year, the exemption applies if the corp. meets two requirements

34. Small Corporation Exemption (slide 2 of 2) The exemption applies if these 2 requirements are met: –The corp. was treated as a small corporation exempt from the AMT for all prior years beginning after 1997 –Annual average gross receipts for the 3 year period ending before its current tax year did not exceed $7.5 million $5 million if the corporation had only one prior tax year This provision exempts up to 95% of all C corps from the AMT

35. 35 AMT Formula for Corporations

36. 36 Tax Preference Items Percentage depletion in excess of the adjusted basis of property Tax-exempt interest on “private activity bonds”

37. 37 Adjustments for AMT (slide 1 of 2) Adjustments for AMT: –A portion of depreciation on property placed in service after 1986 –A portion of amortization claimed on certified pollution control facilities –Difference between percentage of completion and completed contract income –Difference between gain (loss) on sale of property for regular tax and AMT purposes

38. 38 Adjustments for AMT (slide 1 of 2) Adjustments for AMT: –A portion of depreciation on property placed in service after 1986 –A portion of amortization claimed on certified pollution control facilities –Difference between percentage of completion and completed contract income –Difference between gain (loss) on sale of property for regular tax and AMT purposes

39. 39 Adjustments for AMT (slide 1 of 2) Adjustments for AMT: –A portion of depreciation on property placed in service after 1986 –A portion of amortization claimed on certified pollution control facilities –Difference between percentage of completion and completed contract income –Difference between gain (loss) on sale of property for regular tax and AMT purposes

40. 40 Adjustments for AMT (slide 1 of 2) Adjustments for AMT: –A portion of depreciation on property placed in service after 1986 –A portion of amortization claimed on certified pollution control facilities –Difference between percentage of completion and completed contract income –Difference between gain (loss) on sale of property for regular tax and AMT purposes

41. 41 Adjustments for AMT (slide 2 of 2) Adjustments for AMT (cont’d): –Passive activity losses of certain closely held corporations and personal service corporations –A portion of the difference between “ACE” and “AMTI”

42. 42 ACE Adjustment (slide 1 of 2) Ace adjustment = 75% of difference between unadjusted AMTI and ACE –Can be positive or negative –Negative adjustment is limited to aggregate positive adjustments less previous negative adjustments

43. 43 ACE Adjustment (slide 2 of 2) Starting point for determining ACE is AMTI –AMTI is defined as regular taxable income after AMT adjustments and tax preferences (other than the NOL and ACE adjustments)

44. 44 Impact of Certain Transactions on ACE and E & P (slide 1 of 2)

45. 45 Impact of Certain Transactions on ACE and E & P (slide 2 of 2)

46. 46 Exemption Exemption amount for a corp = $40,000 –Reduced by 25% of excess of AMTI over $150,000 –Exemption is totally phased-out when AMTI reaches $310,000

47. 47 Minimum Tax Credit AMT paid in one year can be used as a credit against future regular tax liability that exceeds its tentative minimum tax –Indefinite carryforward –Cannot be carried back –Cannot offset any future minimum tax liability

48. 48 AMT Example (slide 1 of 4) Moreland Co. has the following income, etc. in 2015: Taxable income$100,000 Depreciation adjustment 18,000 Installment gain (not on inventory sale)80,000 Federal income tax provision on financial stmts. 75,000 Penalties and fines2,000 Private activity bond interest income (Issued 2007)25,000 Other tax-exempt interest20,000 –The depreciation adjustment is an AMT adjustment and the private activity bond interest is a tax preference for AMTI.

49. 49 AMT Example (slide 2 of 4) Calculation of AMTI before ACE: Taxable income$100,000 Plus: private activity bond income 25,000 Plus: depreciation adjustment 18,000 AMTI$143,000

50. 50 AMT Example (slide 3 of 4) Calculation of ACE Adjustment: AMTI before ACE$143,000 Plus: deferred installment gain 80,000 Plus: other tax-exempt income 20,000 Adjusted current earnings $243,000 Less: AMTI 143,000 Base amount for Ace Adjustment$100,000 Times rate: 75% ACE Adjustment (positive)$ 75,000

51. 51 AMT Example (slide 4 of 4) Calculation of AMT: AMTI before ACE$143,000 Plus: ACE Adjustment 75,000 AMTI$218,000 Less: Exemption 23,000 Alternative minimum tax base$195,000 20% rate × 20% Tentative minimum tax$ 39,000 Less: regular tax (22,250) AMT(TMT-Regular tax) $ 16,750 Total cash paid = Regular tax + AMT = $ 39,000

52. 52 Individual AMT (slide 1 of 3) AMT applicable to individuals is similar to the corporate AMT with several important differences –The individual AMT rate is slightly progressive, with rates at 26% on first $185,400 ($92,700 for married, filing separately) of AMTI and at 28% on any additional AMTI –The alternative rate on net capital gain of 0% or 15% applies

53. 53 Individual AMT (slide 2 of 3) –The AMT exemption and phaseout amounts are tied to the individual’s filing status for the year –Individuals make no AMT adjustment for ACE –Taxes, misc. itemized deductions subject to the 2% floor, the standard deduction and personal and dependency exemptions are not allowed –Medical expenses are allowed only to the extent that they exceed 10% of AGI (instead of a 7.5% for those at least age 65)

54. 54 Individual AMT (slide 3 of 3) –Interest expense deductions are limited to Qualified residence interest Interest on certain student loans, and Investment interest (subject to limitations) –The 3% phaseout of itemized deductions for certain high-income taxpayers does not apply in computing the individual AMT –Determination of the minimum tax credit is more complex for individual taxpayers The credit applies only to AMT generated as a result of timing differences

55. 55 Refocus On The Big Picture (slide 1 of 4) Tax credits are used by the Federal government to promote certain social and economic objectives. –Credits are dollar-for-dollar reductions in tax liability. Progress Corporation qualifies for the following tax credits. –A 10% tax credit for rehabilitating a building placed in service before 1936 (see Example 4). –The work opportunity tax credit (see Example 6). –The credit for employer-provided child care, equal to 25% of qualified child care expenses (see Example 13). Mike might also want to take advantage of the disabled access credit. –Designed to encourage small businesses to make their facilities accessible to disabled individuals.

56. 56 Refocus On The Big Picture (slide 2 of 4) What If? Mike has heard horror stories about the alternative minimum tax (AMT) and is concerned about its potential impact on his company. What if Mikes company is subject to the AMT?

57. 57 Refocus On The Big Picture (slide 3 of 4) What If? If Progress Corp. is subject to the AMT, the company’s general business credits are limited to –Regular income tax, less the greater of Tentative minimum tax, or 25% X (regular income tax - $25,000) –Thus, much of the tax benefit may be lost or require a carryback or carryover to another tax year. Credits subject to this limit include –The tax credit for rehabilitation expenditures, –The work opportunity tax credit, –The disabled access credit, and –The credit for employer-provided child care.

58. 58 Refocus On The Big Picture (slide 4 of 4) What If? However, many small corporations are exempt from the AMT. –Before Mike proceeds with his plans, his exposure to the AMT should be determined.

59. © 2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 59 If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr. Donald R. Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta