Legal ruling 1994-3

Computation of the Alternative Minimum Tax Adjusted Current Earnings Amount for Apportioning Taxpayers

Issues

1 For corporations whose income is subject to apportionment and allocation, is the Adjusted Current Earnings (ACE) adjustment in the computation of Alternative Minimum Tax (AMT) calculated prior to or after apportionment and allocation?

2.2. May prior year positive ACE adjustments generated by nonbusiness activities of a member of a unitary group be used to free up a negative ACE adjustment attributable to another member of the unitary group?

3.3. May a prior year positive ACE adjustment attributable to an entity's non California source nonbusiness activities be used to free up negative ACE adjustments of the same entity in subsequent years?

Facts

Situation 1

Corporation A and Corporation B are members of a unitary group required to file a combined report. In year 1, A and B had combined alternative minimum taxable income (AMTI) from unitary business activities of $120x before apportionment and adjustment for ACE. Combined ACE from unitary business activities was $125x before apportionment. Corporation B also had nonbusiness activities in California which generated $35x AMTI and $45x ACE. The A - B group had a combined California apportionment percentage of 60%. A and B's relative California apportionment percentages (under FTB Notice 90-3) were 66 2/3% and 33 1/3% respectively.

In year 2, the apportionment percentages were the same. A & B had combined AMTI and ACE from unitary business activities (before apportionment) of $150x and $135x respectively. Neither taxpayer had nonbusiness income in year 2.

Situation 2

Corporation Y is a single entity apportioning taxpayer. In Year 1, Corporation Y had AMTI attributable to business activities of $100x, and a California apportionment factor of 60%. Corporation Y's ACE attributable to business income was $105x. Y had a nonbusiness activity sourced OLIside of California which generated AMTI and ACE of $20x and $25x respectively.

Law and Analysis

For income years beginning on or after January 1, 1988, California imposes an AMT on corporations, other than S corporations, in partial conformity to the federal AMT.

Revenue and Taxation Code (hereafter Rev. & Tax. Code) Section 23455(b)(1) provides a special California rule calling for the use of the apportionment and allocation provisions of Chapter 17 (Rev. and Tax. Code § § 25101 - 25139) in determining AMTI for taxpayers subject to the AMT. AMTI is thus apportioned and allocated to each taxpayer member under the intrastate apportionment techniques of Legal Ruling 234, October 27, 1959, and FTB Notice 90-3. Each California taxpayer then has its own $40,000 exemption and $150,000 limitation (phasing out the $40,000 exemption) which is applied on a separate company basis.

ACE is computed by making certain adjustments to AMTI (Rev. & Tax. Code § 23400(a)). Internal Revenue Code (IRC) § 56(g), as incorporated with modifications by the California law, requires that for income years beginning after 1989, AMTI must be increased by 75% of the amount by which the corporation's ACE exceeds AMTI (before adjustment for ACE and AMTI net operating loss). If ACE is less than AMTI (before adjustment for ACE and AMTI net operating loss), a negative adjustment to AMTI of 75% of the difference may be allowed, but only to the extent that the taxpayer had incurred net positive ACE adjustments in prior years (negative ACE look-back). There are no provisions which would allow a taxpayer to utilize, for any year, negative adjustments which exceed the prior years positive ACE limitation; they are permanently lost.

For purposes of the regular tax, Rev. & Tax. Code § 251 01 provides that members of a unitary group are required to combine the business income of the members and apportion it among the various states (Edison California Stores v. McColgqn, (1 947) 30 Cal.2d 472, 489-491). For purposes of the regular tax, nonbusiness income is allocated pursuant to Rev. & Tax. Code § 25123. The mechanism to identify, combine and apportion the business income of a unitary group is the combined report (generally described in FTB Publication 1061).

In a combined report, each member first computes its net taxable income, after California adjustments, on a separate entity basis. Then each member's net taxable income is classified as business income or nonbusiness income. The business income of each member is combined and apportioned to California based on the California apportionment percentage of the group. The business income is then further apportioned among the individual taxpayer members L-.--@sed on their relative share of the California apportionment factors which are used to derive the California apportionment percentage (Legal Ruling 234, FTB Notice 90-3). Each member applies its nonbusiness income or loss, and any other adjustments such as the net operating loss, to arrive at California income subject to tax.

In accordance with the general authority of Rev. & Tax. Code § 251 01 and Rev. & Tax. Code § 23455(b)(1), AMTI is required to be apportioned and allocated in the same manner as net income is apportioned and allocated for purposes of the regular tax under Rev. & Tax. Code, Chapter 17, including the use of a combined report.

There is also sound rationale for apportioning and allocating ACE in the same manner as net income is apportioned and allocated for purposes of the regular tax. This method of calculating ACE: (1) takes into account combined reporting procedures and unitary theory; (2) avoids interaction of nonbusiness items earned by different members with business income of the group in the process of both setting the 75% limitation, and determining the negative ACE look-back; (3) allows income earned in a unitary business setting to be offset by loss in that same business setting, which is consistent with the contribution or dependency principle of unitary tax law; (4) is a straightforward computation involving calculations and formats familiar to taxpayers and necessitates only the individual taxpayer members to track prior year positive ACE amounts; (5) lacks the complexities that plague 'group basis" methods of applying negative ACE limitations when the composition of the combined group changes from year to year; and (6) is consistent with the computation of the California net operating loss by unitary apportioning taxpayers.

Therefore, in order to achieve proper treatment and sourcing of business and nonbusiness items, ACE is apportioned and allocated in the same manner as net income is apportioned and allocated for purposes of the regular tax.

Consistent with the computation of the regular tax of a unitary group, each taxpayer member of the combined group must then compare its share of the California apportioned and allocated AMTI (before adjustment for ACE) with its share of the California apportioned and allocated ACE, and apply the 75% adjustment. Negative ACE adjustments may only be allowed to reduce AMTI to the extent that the particular taxpayer member had net positive California apportioned and allocated ACE adjustments in prior years. Appcation of these principles to the situations described above follo-Situation 1:

Situation 1:

The ACE adjustment for Corporations A & B is computed as follows for years 1 & 2:

Only the positive ACE adjustment attributable to business activities in year 1 is apportioned to Corporation A. Therefore under Rev. & Tax. Code § § 23455(b)(1) and 25101, A's negative ACE amount in year 2 is limited to that amount. The portion of the positive ACE adjustment that was attributable to nonbusiness activities in year 1 was allocated entirely to Corporation B, and may only be used to allow the deduction of B's negative ACE amounts in subsequent years.

Situation 2:

Corporation Y's ACE adjustment must be computed in the same post-apportioned manner as shown in Situation 1, except that a single entity is involved. For year 1, business AMTI and ACE apportioned to California are $60x and $63x respectively. 75% of the difference results in a positive ACE adjustment of $2.25x. Since no part of the nonbusiness AMTI or ACE is allocated to California, no portion of the California ACE adjustment is attributable to nonbusiness activities. Positive ACE amounts that are apportioned or allocated outside of California may not be used to free up negative ACE adjustments in subsequent years. The maximum negative ACE adjustment that may be deducted in year 2 is $2.25x.

The current FTB Form 1 00, Schedule P, instructs the taxpayer to compute the accumulated ACE adjustments in a manner that technically conflicts with the approach set forth in this Legal Ruling. The Department is planning to revise the current FTB Form 1 00, Schedule P to reflect a post-apportionment computation for single entity apportioning taxpayers. Apportioning taxpayers should modify the current FTB Form 100, Schedule P as follows:

Schedule P, line 4

For taxpayers required to apportion their income, pre-ACE adjusted AMTI is apportioned and allocated to California in the same manner as net income for purposes of the regular tax. For taxpayers required to compute income using a combined report, each corporation's pre-ACE adjusted AMTI is the sum of (1) that corporation's share of business pre-ACE adjusted AMTI determined by using the factor method prescribed in Legal Ruling 234 and FTB Notice 90-3, and (2) any of that corporation's California source nonbusiness pre-ACE adjusted AMTI.

Schedule P, line 5a

For taxpayers required to apportion their income, ACE is apportioned and allocated to California in the same manner as net income for purposes of the regular tax. For taxpayers required to compute income using a combined report, each corporation's ACE is the sum of (1) that corporation's share of business ACE determined by using the factor method prescribed in Legal Ruling 234 and FTB Notice 90-3, and (2) any of that corporation's California source nonbusiness ACE.

Schedule P. line 5d

For combined reports, each taxpayer corporation enters the excess of its prior year positive California ACE adjustments over its prior year negative California ACE adjustments, both of which are computed using the method prescribed in this Legal Ruling.

Taxpayers that have followed the computation reflected in the current Schedule P may need to recompute their ACE adjustments using the computation set forth in this Legal Ruling.

Holdings

1. Under the principles of allocation and apportionment for computing the regular tax, the ACE amount in the computation of AMT in the context of a combined report is calculated after allocation and apportionment. Consistent with unitary theory, each separate California taxpayer's business and nonbusiness California ACE amounts are aggregated for determining its ACE adjustment to California AMTI.
2. Prior year positive ACE adjustments generated b' nonbusiness activities of member of a unitary group may not be used to free up negative ACE adjustments attributable to another member of the unitary group.
3. Prior year positive ACE adjustments attributable to an entity's non-California source nonbusiness activities may not be used to free up negative ACE adjustments of the same entity in subsequent years.

Drafting Information

The principal author of this notice is Cody C. Cinnamon of the Franchise Tax Board Legal Division. For further information regarding this notice, contact Ms. Cinnamon at the Franchise Tax Board Legal Division, P.O. Box 1468, Sacramento, CA 95812-1468.

NOTE: ((---)) = Indicates obsolete information.