McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Chapter 6 6 Business Incentive Provisions

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-3 Incentives Exemption of certain types of income from tax Increased or accelerated deductions Credits Preferential tax rates

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-4 Popular Tax Incentives Limited expensing of depreciable assets Additional first year depreciation Research activities credit Renewal Communities, empowerment zones and enterprise communities

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-5 Popular Tax Incentives Low income housing credit New markets credit Disability access credit Deduction and credit for alternative- burning fuel vehicles

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-6 General Business Credit Encompasses all credits previously listed plus some additional Limitation: Lesser of Net regular tax liability minus tentative minimum tax 25% of regular income tax in excess of $25,000 Carryovers: One year back 20 years forward

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-7 Alternative Minimum Tax Theory: Ensure that taxpayers with economic income do not excessively exploit “loopholes” and pay some tax

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-8 AMT Formula Taxable Income + Net operating loss deduction + AMT preferences ± AMT adjustments - AMT net operating loss deductions Alternative minimum taxable income AMT exemption AMT base X AMT rate Tentative minimum tax - Regular tax Alternative minimum tax

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-9 AMT Preferences Interest from private activity municipal bonds Excess percentage depletion from oil and gas wells Excess intangible drilling costs Accelerated depreciation from pre-1987 real property

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-10 AMT Adjustments Depreciation Amortization of mining and exploration costs Gain or loss on depreciable property Income from long term contracts Installment sales Adjusted current earnings

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-11 Adjusted Current Earnings Adjustment 75% of difference between adjusted current earnings and taxable income after AMT adjustments and preferences Theory: ensure that economic income is taxed Adjustment can be negative up to the prior positive adjustments in previous years

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-12 Adjusted Current Earnings Starting point: taxable income after AMT preferences and adjustments Items that affect economic income but not taxable income added or subtracted Includes both permanent and temporary differences

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-13 Items Affecting Adjusted Current Earnings Tax exempt interest (other than from private activity bonds) 70% dividends received deduction Life insurance proceeds Increase in cash surrender value of life insurance Amortization or organization expenses LIFO reserve Nondeductible related party losses

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-14 AMT Net Operating Loss Deduction Computed taking into account AMT preferences and adjustments Limited to 90% of income before net operating loss

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-15 AMT Exemption $40,000 Phases out at a rate of 25% of alternative minimum tax base above $150,000 Completely phased out at alternative minimum base of $310,000

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-16 AMT Rates and Credits Flat 20% rate Only credit is foreign tax credit Limited to 90% of tentative minimum tax

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-17 Minimum Tax Credit Created in any year taxpayer pays AMT Credit against regular tax Cannot reduce regular tax below tentative minimum tax Can be carried forward indefinitely

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 6-18 Effect of AMT on Incentives May reduce effect of accelerated deductions or income exclusions since these may generate preferences of adjustments