The Alternative Minimum Tax applies both to corporations as well as to individuals. While many of the AMT rules are the same, there are some significant differences between the two. One of the more significant of these differences is a provision that totally exempts Small Business Corporations from the AMT. This can present real tax savings opportunities for individuals who are paying the Alternative Minimum Tax because of their business activities.
Small Business Corporation
A Small Business Corporation is an entity formed under state corporate law that has not made an election to be taxed as an “S” corporation. An S corporation does not pay tax itself; rather the income and losses – and AMT items – of the entity “pass through” to the corporation’s shareholders and are reported on the Forms 6251 attached to their individual Forms 1040. A “regular” corporation – including a Small Business Corporation – is separate from its owners, filing its own tax returns and paying its own taxes.
It should be noted that businesses that are formed and operated as sole proprietorships, partnerships or limited liability companies (LLCs) also pass through their income, losses and AMT items to the underlying owners just as S corporations do.
New business vs. existing business
A start-up business has total freedom to choose whatever form it wishes to operate in. Existing businesses currently operating in one of the pass-through forms may want to re-form themselves as Small Business Corporations to take advantage of this AMT benefit. While an S corporation may simply revoke its S election, for the other entities there are certain administrative costs associated with creating a new form of business that will need to be taken into consideration.
Total exemption from the AMT for a Small Business Corporation
In general the AMT applies to all corporations, just as it does to all individuals. However, Congress decided that smaller businesses operating in the corporate form should be totally exempt from the AMT. The test to qualify for this exemption is simple, and it is based on the gross receipts of the business.
If a small corporation has gross receipts of $5 million or less per year it qualifies as a Small Business Corporation, and, thus, it also qualifies for the AMT exemption. The actual test is the average of the entity’s gross receipts over a three-year period. Once a corporation initially qualifies as a Small Business Corporation under the $5 million test, in subsequent years it is allowed to have average gross receipts of up to $7.5 million while still retaining its qualification.
AMT items resulting from operating a business
This exemption from the Alternative Minimum Tax applies only to AMT items that result from operating a business. It does not apply, for example, to nonbusiness AMT items such as the adjustments needed for an individual’s itemized deductions like state and local taxes, home mortgage interest, medical and dental, etc., as well as things like incentive stock options.
The following are the AMT items associated with operating a business:
- depreciation, and corresponding adjustments on disposition of business property
- net operating losses
- depletion, intangible drilling costs and mining costs
- R&D expenses
- long-term contracts
- circulation costs
Other tax issues to be considered
There are a number of non-AMT tax benefits resulting from operating a business in a pass-through entity that also need to be taken into consideration when evaluating the Small Business Corporation benefit. For example, if a pass-through business has start-up losses, these losses may be deductible on the business owner’s personal tax return. For a regular corporation, such losses are accumulated and may be used as a deduction only against future income of the corporation.
If the business is profitable, there is a possibility that the profits from a regular corporation effectively could be taxed twice unless proper planning is done. With the corporation itself paying taxes on its income (after deducting any prior year losses), if it pays a dividend to its shareholders those profits would be taxed twice. This problem can be avoided if the business owners are paid salaries, which are deductible by the corporation, thus avoiding this double tax issue.
Planning to take advantage of this AMT exemption
The key for any taxpayer considering taking advantage of this total exemption from the Alternative Minimum Tax is to start by looking at how much AMT is being paid as a result of the above-listed business AMT items. Only if the total is material enough to offset the costs of changing the form of business, and only if the other tax issues mentioned above do not present negatives, should incorporation be considered.
As has been discussed in previous articles, each AMT item presents its own individual planning opportunities. For the items that result from operating a business, a taxpayer needs to go through each and every one of them to consider the effects of the choices and tax elections he has. As an alternative to this by-the-ones approach, having the business operating in a qualifying Small Business Corporation completely eliminates the need to do this, and might even result in totally avoiding the Alternative Minimum Tax!