AMT Generally and AMT for BABs

Issue:

When is interest on tax-exempt bonds subject to the alternative minimum tax?

Discussion:

Pursuant to I.R.C. § 55, a tax is imposed (the “alternative minimum tax”) in an amount equal to the excess of the “tentative minimum tax” (TMT) over the taxpayer’s “regular” tax liability (reduced by certain tax credits) for a given taxable year.  If the TMT is greater than the regular tax liability, the alternative minimum tax is imposed in addition to the regular tax liability.  If the TMT is less than the regular tax liability, the taxpayer will not need to pay the alternative minimum tax.  The alternative minimum tax is in addition to the regular tax liability and not an “alternative” to the regular tax liability.

The calculation of TMT differs for noncorporate taxpayers and corporate taxpayers, and incorporates certain exemption amounts that may differ from year to year:

(a)       For noncorporate taxpayers, the TMT is equal to (i) 26% times the excess (up to $175,000) of the alternative minimum taxable income (AMTI) over a certain exemption amount, plus (ii) 28% times such excess over $175,000.[1]

(b)       For corporate taxpayers, the TMT is equal to (i) 20% times the excess of the AMTI over a certain exemption amount, less (ii) certain alternative minimum tax foreign tax credits.

The basic calculation for AMTI is the same for noncorporate and corporate taxpayers.  The AMTI is equal to the taxpayer’s “regular” taxable income for the taxable year, but is (a) adjusted based on additions and deductions required by I.R.C. §§ 56 and 58 and (b) increased by the amount of certain tax preference items described in I.R.C. § 57.  For the taxpayer, the goal is to reduce the AMTI as much as possible such that, under the TMT calculation, TMT turns out to be less than or equal to the regular tax liability.

One of the adjustments required by I.R.C. § 56 for individuals is the inclusion of tax-exempt interest received on “specified” private activity bonds.  In other words, even though such tax-exempt interest is not included in the “regular” taxable income, solely for purposes of determining AMTI, individuals must include such interest.  This inclusion increases the AMTI and therefore increases the likelihood of becoming subject to the alternative minimum tax.  This adjustment for tax-exempt interest is not required for tax-exempt interest on “governmental bonds” such as school district bonds or on “qualified 501(c)(3) bonds” such as certain charter school bonds.  Therefore, the individual does not need to increase AMTI by the interest it receives from, e.g., school district bonds or charter school bonds.

The foregoing adjustment for individuals does not apply to corporate taxpayers.  Instead, I.R.C. § 56 requires, among other adjustments, an increase in the corporation’s base AMTI by 75% of the excess of (a) the adjusted current earnings (ACE) of the corporation over (b) the base AMTI.[2]  ACE is equal to the base AMTI plus or minus certain other adjustments.  In other words, the corporate taxpayer starts with the base AMTI (which already includes some adjustments such as special calculation of net operating loss and other items that are not relevant to this memorandum) and adds 75% of any ACE adjustment above the base AMTI.  One of the ACE adjustments is an addition for tax-exempt interest on all non-housing bonds.[3]  This means that 75% of the tax-exempt interest on such non-housing bonds is added to the base AMTI.  When the AMTI increases as a result of this addition, there is a greater likelihood that the TMT will be larger than the taxpayer’s “regular” taxable income.  This ACE adjustment may therefore subject the taxpayer to the alternative minimum tax.

(Note that the alternative minimum tax discussion above relates only to tax-exempt interest.  Interest on, e.g., taxable build America bonds or tax credit bonds, is taxable and would never be excluded in the calculation of the taxpayer’s “regular” tax liability.  Therefore, no special AMTI or ACE adjustments are relevant for such taxable interest.)


[1] The $175,000 threshold is lowered to $87,500 for married individuals filing a separate return.

[2] ACE turns out to be less than the base AMTI, the Code permits the final AMTI to be reduced rather than increased, subject to certain thresholds.

[3] Interest on housing bonds was permanently excluded from this calculation in 2008.  Interest on all other bonds issued between 2009 and 2010 was temporarily excluded.  Bond counsel typically used special “TAX MATTERS/EXEMPTION” and tax opinion language for bonds issued during those years to refer to the temporary exclusion.

Special AMT Rules for Refunding Bonds:

Special rule for refunding bonds:  I.R.C. 57(a)(5)(iv) states that interest on “specified private activity bonds” (reduced by any deduction (not allowable in computing regular tax) which would have been allowable if such interest were includible in gross income) is an item of tax preference for purposes of AMT. “Private activity bonds” does not, however, include any refunding bond (whether current or advance) if the refunded bond (or in the case of a series of refundings, the original bond) was issued before August 8, 1986.  For this purpose, “refunding bond” is an issue the proceeds of which are used to pay principal, interest and call premium on the prior issue and the qualified administrative costs associated withe refunding.  Unlike Section 1313(a) of the 1986 TRA, there is no requirement that the par amount of the refunding bond be equal to or less than the par amount of the refunded bond.  See also Title VII, 2 of the 1986 Blue Book.

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