For U.S. companies that report over US$1 billion in profits to shareholders, the Inflation Reduction Act implements a 15% corporate alternative minimum tax (CAMT) based on book income.

A 15% corporate alternative minimum tax for a corporation whose financial statement income exceeds $1 billion was included in the Inflation Reduction Act in 2022.  Since the passage of the law, there has been uncertainty about whether corporations would owe taxes on paper profits, or unrealized capital gains, on stocks starting in 2022.

The new tax will require companies to compute two separate calculations for federal income tax purposes and pay the greater of the new minimum tax or their regular tax liability. To determine whether the new tax applies, companies must first ascertain whether their “average annual adjusted financial statement income” (AFSI) exceeds $1 billion for any three consecutive years preceding the tax year.

The historic tax treatment has long been that paper profits (or unrealized capital gains) created a deferred tax liability that is only paid when the stocks or assets are sold, and the profits realized.

Recent guidance from the Internal Revenue Service, while not definitive, suggests that paper profits on stocks could be subject to a 15% tax this year, according to New York tax expert Robert Willens. The issue involves the tax treatment of applicable financial statement income (AFSI), a measure of earnings.

“The IRS left open the question of whether ‘mark to market’ gains and losses should be disregarded when computing AFSI,” Willens wrote to Barron’s. “As of now, they are included in AFSI. The IRS solicited the comments of investors as to whether these gains and losses should be backed out of AFSI or whether they should remain in the tax base.”

The beauty of the previous tax rules is that a company could defer the taxes indefinitely on unrealized gains in long-held stocks, especially when the preferred holding period is “forever.”

Individuals can defer capital-gains taxes until the sale of assets and can often avoid taxes entirely if the assets are left in their estates, assuming the estates are below the current threshold for inheritance taxes.

There have been proposals floated in Congress from some lawmakers to tax unrealized gains held by individuals, but they haven’t gained traction.

References:

1. https://www.barrons.com/articles/warren-buffett-berkshire-hathaway-tax-51673028329
2. https://www.ey.com/en_gl/tax-alerts/us-inflation-reduction-act-includes-15-corporate-minimum-tax-on-income