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Guidance provided on blended tax applicable to many corporations under TCJA

April 17, 2018

In a Notice and accompanying Information Release, IRS has provided guidance on how a corporation with a fiscal year that includes Jan. 1, 2018 will pay federal income tax (including the alternative minimum tax) using a blended tax rate due to the changes made by the Tax Cuts and Jobs Act (TCJA, P.L. 115-97, 12/22/2017).

Background. Code Sec. 11(a) imposes a tax on the taxable income of every corporation (corporate tax). Under pre-TCJA law, corporations were subject to graduated tax rates of 15% (for taxable income of $0-$50,000), 25% (for taxable income of $50,001-$75,000), 34% (for taxable income of $75,001-$10,000,000), and 35% (for taxable income over $10,000,000). Personal service corporations paid tax on their entire taxable income at the rate of 35%. (Former Section 11(b))

Under pre-TCJA law, the corporate alternative minimum tax (AMT) was 20%, with an exemption amount of up to $40,000. The AMT equaled the excess, if any, of the tentative minimum tax (TMT) for the tax year, over the corporate tax for the tax year. Former Section 55(b)(1)(B) provided that in the case of a corporation, the TMT for the tax year was 20% of so much of the alternative minimum taxable income (AMTI) for the tax year as exceeded the exemption amount, reduced by the alternative minimum tax foreign tax credit for the tax year. (Former Section 55)

Under changes made by the TCJA, for tax years beginning after Dec. 31, 2017, the corporate tax rate is a flat 21% rate. (Code Sec. 11(b)) For tax years beginning after Dec. 31, 2017, the corporate AMT is repealed. (Code Sec. 55)

Code Sec. 15(a) provides that, when tax rates change during a taxpayer’s tax year (a “straddle year”), the taxpayer’s tax for the straddle year is computed using a blended tax rate. That is, the taxpayer (i) calculates two tentative taxes for the straddle year by applying each tax rate to the taxpayer’s income for the year, (ii) multiplies each tentative tax by the proportion of the straddle year to which each tax rate applies, and (iii) adds the results of the two calculations.

Code Sec. 15(b) provides that for purposes of Code Sec. 15(a), if a tax is repealed, the repeal is considered a change of rate, and the rate for the period after the repeal is zero.

Code Sec. 15(c) provides, in part, that for purposes of Code Sec. 15(a) and Code Sec. 15(b), if the rate changes for tax years “beginning after” or “ending after” a certain date, the following day is considered the effective date of the change.

Guidance.  In a Notice and accompanying Information Release, IRS has provided guidance on how Code Sec. 15 applies in determining the federal income tax (including AMT) of a corporation for a tax year that begins before Jan. 1, 2018, and ends after Dec. 31, 2017 (i.e., a fiscal year rather than a calendar year) because of changes made by the TCJA to the tax rates for corporations under Code Sec. 11(b) and to the AMT for corporations under Code Sec. 55.

Notice 2018-38 provides that a corporation with a tax year that includes Jan. 1, 2018, but does not start on that day, must apply Code Sec. 15(a) to determine the amount of federal income tax imposed under Code Sec. 11 for that tax year. Thus, under Code Sec. 15(a), a tentative tax of a corporation for the tax year that includes Jan. 1, 2018, is computed by applying the rates of tax imposed under Code Sec. 11(b) before the change of the tax rate under TCJA, and a tentative tax for a corporation is computed by applying the 21% rate of tax imposed under Code Sec. 11(b), as amended by TCJA. The tax imposed under Code Sec. 11 for the tax year that includes Jan. 1, 2018, is the sum of that proportion of each tentative tax which the number of days in each period bears to the number of days in the entire tax year.

Notice 2018-38 notes that certain taxpayers, such as life insurance companies and regulated investment companies, are not subject to the tax imposed under Code Sec. 11(a), but are nonetheless taxed under other Code provisions that use the rates of tax set out in Code Sec. 11(b). The application of Code Sec. 15 applies in determining the chapter 1 tax for these taxpayers in the same manner as for corporations subject to the tax imposed by Code Sec. 11(a).

AMT. In addition, Notice 2018-38 provides that the repeal of the AMT for corporations is a change in the TMT rate from 20% to zero under Code Sec. 15(b) and Code Sec. 15(a). Further, under Code Sec. 15(c), the effective date of this change of rate is Jan. 1, 2018.

The computation of tax provided under Code Sec. 15(a) applies to a change in any rate of tax imposed by chapter 1 of the Code if the tax year includes the effective date of the change, unless that date is the first day of the tax year. The tax under Code Sec. 55 is a tax imposed by chapter 1 of the Code. Consequently, a corporation with a tax year that includes Jan. 1, 2018, but does not start on that day, must apply Code Sec. 15(a) to determine the amount of its TMT for that tax year.

Under Code Sec. 15(a), a tentative TMT for the corporation is computed by applying the 20% TMT rate provided under Former Section 55(b)(1)(B) prior to the change under TCJA, and a tentative TMT is computed by applying the 0% TMT rate resulting from the repeal under TCJA of the AMT for corporations. The corporation’s TMT for the tax year that includes Jan. 1, 2018, is the sum of that proportion of each tentative TMT which the number of days in each period bears to the number of days in the entire tax year.

Notice 2018-38 provides an example illustrating this blended tax computation.

References: For the corporate income tax rate, see FTC 2d/FIN ¶ D-1003United States Tax Reporter ¶114.01.

IR 2018-99, 4/16/2018; Notice 2018-38, 2018-18 IRB

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