A special tax break effectively allows certain C corporations to cash out of research and alternative minimum tax credit carryforwards. This provision was enacted in 2008 and extended through 2009. This posting reviews the key factors in deciding whether to take advantage of the new provision. If the provision was elected in 2008, it will automatically apply to 2009 unless an affirmative election out is made.
Overview
As part of the Housing and Economic Recovery Act of 2008, P.L. 110-289 (signed by the president on July 30, 2008), Congress enacted a special tax benefit under §168(k)(4) that allows corporations to claim a refundable tax credit in lieu of 50% bonus depreciation for certain capital investments made during the period April 1, 2008 through December 31, 2008 (or through December 31, 2009, for certain long-lived and transportation property). The American Recovery and Reinvestment Tax Act of 2009 extended the provision for certain capital investments made during the period January 1, 2009 through December 31, 2009 (or through December 31, 2010, for certain long-lived and transportation property).
As explained below, the method for calculating the new refundable credit under §168(k)(4) is complicated. Guidance in Rev. Proc. 2009-33 explains the property eligible for the election, the time and manner for making the election, and the computation of the increase in the business credit and AMT credit limitations if the §168(k)(4)(H) election is made or not made.
Refundable Credit
In essence, §168(k)(4) permits corporations in a loss position to capture the intended economic benefits of bonus depreciation by converting into cash a portion of their carryforward research credits and/or alternative minimum tax (AMT) credits. The price of electing this new refundable credit, however, is that the corporation must use straight-line depreciation for property that otherwise would be eligible for bonus and modified accelerated cost recovery system (MACRS) depreciation. Election of the refundable credit by one member of a controlled group could have significant tax consequences for other members of the same controlled group.
The new credit is provided indirectly through an increase in the credit utilization limitations described in §38(c) (relating to the general business credit) and §53(c) (relating to the AMT credit), with such increases treated as refundable overpayments of tax. (See §168(k)(4)(F) and Rev. Proc. 2008-65, §2.04.)
The credit amount computed under §168(k)(4) is the lowest of the following three amounts:
1. The “bonus depreciation amount,” meaning 20% of the additional depre-ciation that the taxpayer would have been entitled to claim for the tax year as a result of applying §168(k)(1)to eligible qualified property placed in service between April 1, 2008 and Decem¬ber 31, 2009 (2010 for certain long-lived and transportation property);
2. 6% of the taxpayer’s accumulated re¬search credit carryforward amounts and AMT credits generated from tax years beginning before 2006; or
3. $30 million.
Computation of the Credit
The credit amount is a function of several factors—that is, the credit is computed by reference to both the bonus depreciation amount for certain property placed in service by the taxpayer after March 31, 2008, and the taxpayer’s aggregate carryforward research and AMT credit amounts from tax years beginning before 2006. In addition, in no event may the §168(k)(4) credit amount exceed $30 million. Consequently, to reach this $30 million cap, a taxpayer is required to place in service eligible qualified property for which §168(k)(1) otherwise would yield additional first-year depreciation totaling $150 million (20% of $150 million = $30 million). The taxpayer must also have aggregate carryforward research and/or AMT credits totaling $500 million from tax years beginning before 2006 (6% of $500 million = $30 million).
Example 1: During March 2009, a calendar-year taxpayer placed in service eligible qualified property costing $10 million with a five-year depreciable life (and the taxpayer made no additional investment in eligible qualified property). First-year depreciation generally allowed by applying §168(k)(1) to such property would equal $6 million [i.e., $5 million of bonus depreciation (50% x $10,000,000) plus $1 million of MACRS depreciation on the remaining basis (20% x $1,000,000 based on half year applicable convention), using the 200% declining balance method). In contrast, MACRS depreciation allowed for such property for the first year (without regard to §168(k)(1) bonus depreciation) would equal $2 million (20% x $10,000,000). Thus, the “bonus depreciation amount” is $800,000 [20% X ($6 mil¬lion – $2 million)]. The rationale underlying this calculation is that it is roughly equivalent to the net economic benefit provided by the reenactment of §168(k)(1) to a profitable company making the same investment, which could result in additional first-year depreciation of $4 million and thus $800,000 of tax savings if the company were subject to the AMT. Recall that for corporations (other than small corporations) the tentative minimum tax for the tax year is 20% of alternative minimum taxable income (AMTI).
The $30 million cap for taxpayers electing the new refundable credit serves to limit the overall revenue loss to Treasury, as does the rule in §168(k)(4)(C) that the credit amount cannot exceed 6% of the taxpayer’s aggregate research and AMT carryforward credits from tax years beginning before 2006. In essence, the new refundable credit represents a partial acceleration or monetization of deferred tax assets already earned by the electing corporations, rather than a new form of corporate relief.
A Worksheet for Calculating the Refundable Minimum Tax Credit and Research Credit Amounts is available here.
Example 2: ABC Corp, a calendar year C corporation, purchases $500,000 of new 5-year equipment during July 2008, which qualifies for the 50% bonus depreciation amount.
- Calculate Bonus Depreciation: $500,000 x 50% = $250,000
- Calculate Regular Depreciation: ($500,000 cost - $250,000 bonus depreciation) x 20% regular first year depreciation (assume half yr convention) = $50,000
- Add Steps 1 and 2: $250,000 + $50,000 = $300,000
- Calculate Regular Depreciation: $500,000 x 20% = $100,000
- Isolate Bonus Portion of Depreciation: $300,000 - $100,000 = $200,000
The refundable credit limit based on 20% of $200,000 or $40,000. This is the “bonus depreciation amount. Working backwards, ABC Corp would be required to have $666,66 of research credit and alternative minimum credit carryovers to be able to take advantage of the full $40,000 bonus depreciation amount (i.e., $666,666 x 6% = $40,000).
Assume ABC Corp has $100,000 in research credit carryforward from taxable years beginning prior to January 1, 2006. The maximum refundable credit obtained from this provision would be $6,000 ($100,000 x 6%). This is the lowest of (1) the bonus depreciation amount which is $40,000; (2) 6% of the taxpayer’s accumulated re¬search credit carryforward amounts and AMT credits generated from tax years beginning before 2006 (6% x $100,000); or $30 million.
However, to generate the refundable credit, ABC Corp must place in service at least $75,000 of five-year property eligible for 50% bonus depreciation. This is because the refundable credit is limited to the lowest of the bonus depreciation amount (which is 20% of the excess of bonus depreciation over regular depreciation), 3% of the pre 2006 credit carryforward or $30 million. Since we know the $30 million limitation will not apply and we know that the 6% limitation is $6,000, we need to back into the bonus depreciation limitation as follows:
- $75,000 x 50% = $37,500
- $75,000 cost - $37,500 bonus depreciation) x 20% regular first year depreciation = $7,500
- $37,500 + $7,500 = $45,000
- $75,000 x 20% = $15,000
- $45,000 - $15,000 = $30,000
The bonus depreciation amount is 20% x $30,000 or $6,000; thus, ABC Corp must place in service at least $75,000 of eligible qualified property in 2009.
Eligible Qualified Property
Eligible qualified property generally has the same meaning as “qualified property” for bonus depreciation purposes (see §168(k)(2) and §168(k)(4)(D)), except that the modified placed-in-service period generally covers April 1, 2008 through December 31, 2009 (or through December 31, 2010, for certain long-lived and transportation property). Section 3 of Rev. Proc. 2008-65 (as modified by §7 of Rev. Proc. 2009-33) contains a detailed discussion of several placed-in-service issues, and §4.04 of Rev. Proc. 2008-65 explains the option available to taxpayers to make elections under both §168(k)(2)(D)(iii) and §168(k)(4) so that the refundable credit (and thus straight-line depreciation) applies to some classes of eligible qualified property, yet the taxpayer is allowed to claim MACRS (but not 50% bonus) depreciation for other classes of eligible qualified property.
Section 4 of Rev. Proc. 2009-33 explains the options available to taxpayers to make an election not to apply §168(k)(4) to extension property (this would be necessary if the taxpayer made the election to increase credits in lieu of claiming bonus depreciation for 2008, but did not want to do so for 2009). Section 6 of Rev. Proc. 2009-33 explains the options available to taxpayers to make an extension property election (this would be necessary if the taxpayer did not make an election to increase credits in lieu of claiming bonus depreciation for 2008, but wishes to do so for 2009).
Procedural Rules
A §168(k)(4) election applies to a corporation’s first taxable year ending after March 31, 2008, and to any subsequent taxable year. However, under §168(k)(4)(H)(i)(1), a corporation that made the §168(k)(4) election for its first table year ending after March 31, 2008, may elect not to have the election apply to extension property. It is important to note that the election out must be made on the 2009 tax return.
Under §168(k)(4)(H)(iii) , extension property means property that is eligible qualified property solely by reason of the Act's extension of §168(k)(2).
A corporate taxpayer generally must make the election not to apply §168(k)(4) to extension property by the due date (including extensions) of the federal income tax return for the taxpayer's first tax year ending after 12/31/08. A corporate taxpayer generally makes the election not to apply §168(k)(4) to extension property by:
- Attaching a statement to its federal income tax return for the first tax year ending after 12/31/08 stating that it is making the election not to apply §168(k)(4) to extension property.
- Providing written notification to any partnership in which the taxpayer is a partner that it is making the election not to apply §168(k)(4) to extension property, on or before the due date (including extensions) of the taxpayer's federal income tax return for its first taxable year ending after 12/31/08. If the taxpayer makes a late election, the notification must be made no later than the date the taxpayer files its federal income tax return containing the late election.
An automatic extension of six months from the due date of the federal income tax return (excluding extensions) for the taxpayer's first tax year ending after 12/31/08 is granted to make the election not to apply §168(k)(4) , provided the taxpayer timely filed its federal income tax return for the first tax year ending after 12/31/08.
If a taxpayer made the §168(k)(4) election for its first tax year ending after 3/31/08 and does not make the election not to apply §168(k)(4) to extension property, separate bonus depreciation amounts, maximum amounts, and maximum increase amounts are computed and applied to eligible qualified property that is not extension property and to extension property. The bonus depreciation amount for eligible qualified property that is not extension property is computed in the manner described in §5, Rev. Proc. 2008-65, 2008-44 IRB 1082 (as modified).
The bonus depreciation amount is computed only with regard to extension property. The maximum amount equals the maximum increase amount less the sum of the extension property bonus depreciation amounts determined under §168(k)(4)(C) for all preceding years.
A taxpayer allocates its extension property bonus depreciation amount between the business credit limitation under §38(c) and the AMT credit limitation under §53(c) in the same manner as provided in Rev. Proc. 2009-16, 2009-6 IRB 449 , §4.
If a corporate taxpayer did not make the §168(k)(4) election for its first tax year ending after 3/31/08, it may make the §168(k)(4) extension property election. If the election is made, it applies to all eligible extension property placed in service in the taxpayer's first tax year ending after 12/31/08 and in any subsequent tax year.
A corporate taxpayer must make the §168(k)(4) extension property election by the due date (including extensions) of the federal income tax return for its first tax year ending after 12/31/08.
C corporations make the §168(k)(4) extension property election by:
- Claiming the refundable credit on Form 1120, U.S. Corporation Income Tax Return, for the taxpayer's first tax year ending after 12/31/08.
- Filing, with the Form 1120, the Form 3800, General Business Credit, or Form 8827, Credit for Prior Year Minimum Tax—Corporations, or both, as applicable, for the taxpayer's first tax year ending after 12/31/08.
- Filing, with the Form 1120, the Form 4562, Depreciation and Amortization (Including Information on Listed Property), for the taxpayer's first tax year ending after 12/31/08, showing that the taxpayer used the straight-line method and did not claim the stimulus additional first-year depreciation deduction for all extension property.
- Providing written notification to any partnership in which the taxpayer is a partner that the taxpayer is making the election, on or before the due date (including extensions) of the taxpayer's federal income tax return for its first tax year ending after 12/31/08. If the taxpayer makes a late election, notification must be made no later than the date the taxpayer files its federal income tax return containing the late election.
An S corporation makes the election by:
- Making appropriate adjustments on Form 1120S, U.S. Income Tax Return for an S Corporation, for the taxpayer's first tax year ending after 12/31/08 to reflect the results from making the §168(k)(4) extension property election.
- Attaching a statement to the Form 1120S that indicates that the taxpayer is making the election and a statement showing the computation of the increases to the business credit and AMT credit limitations resulting from election.
- Filing, with the Form 1120S, the Form 4562 for the taxpayer's first tax year ending after 12/31/08, showing that the taxpayer used the straight-line method and did not claim the Stimulus additional first-year depreciation deduction for all extension property.
- Providing written notification to any partnership in which the taxpayer is a partner that the taxpayer is making the §168(k)(4) extension property election, on or before the due date (including extensions) of the taxpayer's federal income tax return for its first tax year ending after 12/31/08. If the taxpayer makes a late election, the notification must be made no later than the date the taxpayer files its federal income tax return containing the late election.
No extension property placed in service during first tax year ending after 12/31/08. If a corporate taxpayer did not make the §168(k)(4) election for its first tax year ending after 3/31/08 and does not place in service any extension property during the its first tax year ending after 12/31/08, the taxpayer makes the §168(k)(4) extension property election by attaching a statement to its timely filed original federal income tax return for its first tax year ending after 12/31/08 that states that the taxpayer is making the §168(k)(4) extension property election and by following the steps in Procedure, §6.02(2)(a)(iv).
Once a valid election is made, the Service allows taxpayers considerable flexibility when allocating the bonus depreciation amount between their research credit carryforward amounts (which eventually could expire) and their AMT credits (which can be carried forward indefinitely). See Rev. Proc. 2009-16, §4.01, and the example in Rev. Proc. 2008-65, §6.
Passthrough Entities
Only corporations are allowed to make the §168(k)(4) election, but Rev. Proc. 2009-16 clarifies the application of that § when an electing corporation is a partner in a partnership. In such cases, the electing corporate partner is required to notify the partnership that the partner is making the §168(k)(4) election, and the partnership is then required to provide the partner with sufficient information so that its distributive share of depreciation on eligible qualified property placed in service by the partnership can be computed on a straight-line basis (see §168(k)(4)(G)(ii) and Rev. Proc. 2009-16, §5). However, straight-line depreciation must be used to determine the corporate partner’s distributive share of depreciation attributable to eligible qualified property placed in service by the partnership, even though property placed in service by the partnership itself cannot be taken into account to compute the corporate partner’s maximum §168(k)(4) credit (see Rev. Proc. 2008-65, §5.02(2)).
With respect to pass-through entities, §6 of Rev. Proc. 2009-16 explains the rare situation in which an S corporation can obtain a benefit under §168(k)(4) because it is subject to tax on certain recognized built-in gains and is also allowed a credit for research or AMT credit carryforwards that arose in a prior period when the entity was a C corporation. Rev. Proc. 2009-16, §7, elaborates on the application of a special “rifle-shot” provision (Housing and Economic Recovery Act §3081) enacted by Congress along with §168(k)(4) to provide similar cash benefits to a U.S. partnership that produces automobiles.