What is the Alternative Minimum Tax and How Does it Affect the R&D Tax Credit?

What is the Alternative Minimum Tax (AMT)?

The Alternative Minimum Tax (AMT) is a federal income tax imposed on individuals, corporations, estates and trusts that prevents higher income taxpayers from using certain credits and deductions to significantly lower their tax liability.

“Under the tax law, certain benefits can significantly reduce a taxpayer’s regular tax amount. The AMT sets a limit on those benefits. If the tax benefits would reduce total tax below the AMT limit, the taxpayer must pay the higher Alternative Minimum Tax amount,” as stated by the IRS.

When and Why was the AMT created?

The AMT was created in 1969 when Congress became aware that nearly 200 people with high incomes were legally using so many deductions and tax breaks that their federal income tax due was zero. The AMT was originally created as an attempt to make the tax system fairer.

What are the fundamentals of the AMT?

A person’s taxes are recalculated under a set of AMT rules that differ from regular tax rules. AMT rules disallow certain deductions that make it almost impossible for anyone to avoid being taxed.

Once the deductions are eliminated, the tax is recalculated. If the AMT tax is greater than the regular tax, the taxpayer owes the total of the AMT tax.

The IRS explains that, “the AMT is the excess of the tentative minimum tax (TMT) over the regular tax. Thus, the AMT is owed only if the tentative minimum tax is greater than the regular tax. The TMT is figured separately from the regular tax.”

The AMT is imposed on the adjusted amount of taxable income above a certain threshold.

What are the 2014 Alternative Minimum Taxable Income Thresholds and Exclusions?

  • Single or head of household taxpayers:
    • Threshold: $117,300
    • Exclusion: $52,800
  • Married taxpayers filing jointly:
    • Threshold: $156,500
    • Exclusion: $82,100
  • Married filing separately:
    • Threshold: $78,250
    • Exclusion:  $41,050

How does the AMT Affect the R&D Tax Credit?

AMT can determine whether a taxpayer is put in a refund due or taxes owed status with the IRS when they file for an R&D credit.

The R&D Tax Credit leads to a reduction in expenses which leads to an increase in income which results in an increase in tax liability. The R&D tax credit can only offset  the regular income tax, not the Tentative Minimum Tax. If the taxpayer is already required to pay the AMT, then claiming a R&D tax credit will not yield a tax reduction.

If the taxpayer paying AMT decides to claim the R&D Tax Credit in a previous year through an amended return, then the additional income received from the credit will more than likely result in a higher AMT and regular tax and not a credit or reduction.

 

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The Benefits of IC-DISC and Producer’s Loans

IC-DISC, which stands for Interest-Charge Domestic International Sales Corporation is an export tax benefit for small and medium U.S. manufacturers. Due to the amount of money the incentive can save a company, it is alarming how few businesses are taking advantage of the IC-DISC laws.

According to U.S. tax laws, a company can utilize an IC-DISC to have its export income tax liability reduced by more than 50%. Instead of being taxed the standard income tax rates (highest being 35%), IC-DISCs’ profits are being taxed at the dividend rate of 15%.

Bottom line, the IC-DISC is allowing companies to double their post-tax income. Sounds pretty good, right?

That being said, here is a generalized description of three different types of businesses that can qualify for IC-DISC:

  1. A manufacturing company that directly exports its own goods overseas.
  2. A company that provides engineering or architectural services that are administered in the U.S. for a structure built outside the U.S.
  3. A company produces a component part that is included in a product that is exported overseas.

A domestic corporation must file an election with the IRS to be treated as an IC-DISC for tax purposes. The corporation must maintain a minimum capitalization of $2,500 of authorized and issued shares and meet the qualifying export receipts test and export assets test, which state that at least 95% of the IC-DISC’s gross receipts and assets must be related to the export of U.S . manufactured property whose value is at least 50% attributable to the U.S. produced content.

Here is a quick 3- Step Guide to the IC-DISC:

  1. Why an IC-DISC? Since the IS-DISC is a tax-exempt corporation, it earns income that would otherwise be taxable to the exporter. The IC-DISC itself will not be taxed on the income, but once the income is distributed to the shareholders it will be taxed at dividend income tax rates, which are significantly less than ordinary income tax rates. The difference between dividend tax rates and ordinary tax rates is extreme enough to create tax savings.
  2. Who Qualifies? If you are able to answer “yes” to all of the following questions, you may qualify for an IC-DISC.
    • Does your company export (directly or indirectly) more than $3 million annually?
    • Is your manufacturing done within the United States?
    • Are you a privately-held company?
  3. Is It Worth It? To find out whether it is financially compelling for your business, estimate your savings using the table below.
Export Sales Est. Minimum Tax Savings Est. Maximum Tax Savings
$3 Million $14,000 $69,000
$5 Million $23,000 $115,000
$10 Million $46,000 $230,000
$25 Million $115,000 $575,000
$100 Million $460,000 $2,300,000

 

Another aspect of the IRC  worth mentioning when talking about IC-DISC’s is a Producer’s Loan, a loan paid to a U.S. manufacturing company, usually the operating entity paying sales commissions to the DISC.

According to IRC Section 993 (d), for a loan to qualify as a Producer’s Loan, it must meet the following requirements:

  1. the loan, when added to all other producer’s loans made by the DISC, does not exceed the DISC income at the start of the month in which the loan is made;
  2. the loan is documented by a written note with a maturity date of no more than five years;
  3. Must be made to a person engaged in U.S. manufacturing, production, growing, or extraction or export property;
  4. the loan must be designated as a producer’s loan at the time it is written.

If it is in the company’s best interest to use a Producer’s Loan, it would accelerate the deduction for the operating entity and put off payment of any taxes on dividends appropriated to a later time. It would not affect the 95% Asset Test of the DISC since it is considered an export asset under the IRC, but the proper documentation and evidence of the loan must be readily available.

 

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