On September 13, 2024, the U.S. Department of Treasury and the Internal Revenue Service released long-awaited proposed regulations regarding the corporate alternative minimum tax (CAMT), which was introduced as part of the Inflation Reduction Act of 2022. While CAMT was advertised to affect only a handful of the wealthiest corporations, the Proposed Regulations will have far reaching implications for private equity funds.

Overview

The CAMT imposes a minimum tax on an “applicable corporation” equal to the excess of 15% of its adjusted financial statement income (AFSI) (minus a foreign tax credit) over its regular corporate tax for the year. An “applicable corporation” is any regular corporation with average annual AFSI greater than $1 billion for any three-year period ending during 2022 or later. The CAMT also applies to a U.S. corporate subsidiary of a foreign-parented multinational group (FPMG) if the FPMG has more than $1 billion and the U.S. subsidiary (together with certain affiliates) has at least $100 million, in each case, in average AFSI over a three-year period. However, neither the $1 billion nor the $100 million threshold is inflation indexed, potentially expanding the scope of applicable corporations over time.

An applicable corporation’s AFSI is determined from the financial statement income (FSI) as reflected in its applicable financial statement, with various adjustments as allowed by Congress. The Proposed Regulations allow a corporation to use a simplified method to determine whether it is an applicable corporation. Under the simplified method, the thresholds are reduced by half and FSI is generally not adjusted.

The Proposed Regulations codify and build upon earlier CAMT guidance issued by Treasury and the IRS, as well as provide additional rules regarding partnerships, M&A transactions, financially distressed corporations, foreign corporations and other topics. The applicability of these rules is exceedingly broad, as many of the provisions apply by their terms not just to the relatively small group of large corporations that will be CAMT taxpayers, but to the much larger group of so-called “CAMT entities,” which includes any entity that is regarded for tax purposes, even if not a CAMT taxpayer itself.

Determining AFSI from Interests in a Partnership

Large public sponsors and certain investors in private equity funds may be subject to CAMT, and therefore will need to determine their AFSI from investments in partnerships. 
Basic Principles

The CAMT rules provide that the AFSI of a partner in a partnership is adjusted so that it only takes into account the partner’s distributive share of the partnership’s AFSI. In implementing this rule, the Proposed Regulations take a “bottom-up” approach, which starts with an AFSI determination at the partnership level. In Treasury’s view, this approach allows for a consistent methodology for calculating the adjustments to AFSI in different structures. For example, a CAMT entity partner that reports its partnership interest on a mark-to-market basis would avoid having AFSI from market fluctuations in the value of its partnership interest under the bottom-up approach because the Proposed Regulations generally make adjustments to FSI to remove market fluctuations.

The “bottom-up” approach generally involves five steps, in this order:

1. The CAMT entity partner removes any FSI attributable to its interest in the partnership from the CAMT entity partner’s applicable financial statement. Gain or loss on the sale or other disposition of a partnership interest reflected in the FSI of the CAMT entity partner, however, is still included, although FSI gain or loss is determined based on CAMT basis that reflects prior years’ AFSI adjustments rather than cost.
2. The CAMT entity partner computes its “distributive share percentage”, which generally is (x) the CAMT entity partner’s FSI attributable to the partnership divided by (y) the partnership’s total FSI. If the CAMT entity partner uses fair value accounting for its partnership interest, the denominator is based on the aggregate change in the fair value of the partnership.
3. The partnership computes its modified FSI, which is generally the partnership’s AFSI after taking into account certain items required to be separately stated to the CAMT entity partner by the Proposed Regulations.
4. The CAMT entity partner determines the amount of its distributive share by multiplying (x) its distributive share percentage by (y) the partnership’s modified FSI.
5. The CAMT entity partner includes the amount of its distributive share in its AFSI, subject to certain adjustments.

In the case of a tiered partnership structure, the Proposed Regulations require each partnership, starting with the lowest-tier partnership and continuing in order up the chain of ownership to the CAMT entity, to determine the distributive share of each CAMT entity partner in the tiered-partnership chain.

Reporting and Filing Requirements

The Proposed Regulations would impose far-reaching reporting and filing requirements on both the CAMT entity partner and the partnership, and would represent a significant expansion of existing annual compliance obligations. Further, a partnership that fails to comply with such obligations would be subject to penalties.
Under the reporting requirements, each CAMT entity partner generally is required, within 30 days of the end of the year, to request from the partnership any information needed by the CAMT entity partner to determine its distributive share of the partnership’s AFSI. Both the request for information and the information received must be maintained by the CAMT entity partner in its books and records.

A partnership is required to furnish information requested by a CAMT entity partner and to file that information with the IRS. An upper-tier partnership subject to these reporting and filing requirements must request information from a lower-tier partnership, which must provide it to the upper-tier partnership and file it with the IRS.

Overall, these reporting and filing requirements, if finalized as proposed, could impose significant compliance burdens on private equity funds. For example, the Proposed Regulations would impose this burden on a fund and each of its flow-through subsidiaries if a single fund investor is subject to CAMT. Additionally, whether the fund or the investor requesting CAMT information should be responsible for the incremental compliance expenses would likely become a point of negotiation.

We expect taxpayer comments to the Proposed Regulations will seek to limit these operational burdens.

Partnership Contributions and Distributions

Under basic tax principles, partners can contribute property with a built-in gain (or loss) (BIG Property) to a partnership without triggering gain (or loss), and partnerships can distribute property to its partners without triggering gain (or loss). For financial accounting purposes, transfers to and from a partnership are realization events and result in FSI. In a departure from interim IRS guidance that would have excluded such FSI from AFSI, the Proposed Regulations would create a new “deferred sale” regime that applies to such contributions and distributions to and from partnerships, turning these formerly tax-deferred transactions into taxable transactions for CAMT entities.

Mechanically, the Proposed Regulations would require a CAMT entity partner contributing BIG Property to a partnership to take into account when determining its AFSI any FSI from the contribution (which must be redetermined using the property’s CAMT basis). This gain (or loss) is taken into account ratably over the applicable recovery period for the contributed property. The recovery period generally matches the tax depreciation schedule, and there are corresponding CAMT basis adjustments to the CAMT entity’s partnership interest. Note, however, that the maximum recovery period is 15 years, which seems to apply even for an asset that does not depreciate. If the partnership sells or otherwise disposes of the contributed property, the CAMT entity partner’s remaining deferred financial gain (or loss) accelerates. A disposition would seem to include a further contribution by an upper-tier partnership to a lower-tier partnership.

Similarly, the Proposed Regulations would apply a “deferred sale” construct to partnership distributions, requiring a CAMT entity partner to take into account when determining its AFSI its allocable share of any FSI from the distribution (which must be redetermined using the property’s CAMT basis). As with contributions, this gain (or loss) is taken into account ratably over the applicable recovery period for the distributed property.

These deferred sale rules are intended to align the CAMT consequences of the contribution with the income tax rules by recognizing FSI over the applicable recovery period. As drafted, however, they would apply to many run-of-the-mill transactions and reorganizations utilized by private equity sponsors in forming common partnership-based investment structures. For example, these rules would apply to contributions of stock to a holding partnership in anticipation of a joint-venture or internal reorganization.

Open Scoping Question

The Proposed Regulations also present a technical question around scoping in the rules relating to FPMGs. As noted above, CAMT also applies to a U.S. corporate subsidiary of an FPMG if the group has over $1 billion, and the U.S. subsidiary (together with certain affiliates) has at least $100 million, in each case, in average AFSI over a three-year period. A foreign-parent group may be indifferent as to whether the holding company is a corporation for U.S. federal income tax purposes. Therefore, the Proposed Regulations deem certain non-corporate entities (which would include U.S. and non-U.S. partnerships) to be a corporation for these purposes.

For such a non-corporate entity and its subsidiaries to be within the scope of CAMT, they must have 50% or greater ownership of a foreign corporation and be required under the applicable financial accounting standard to consolidate with such foreign corporation. If that is the case, then the non-corporate entity is treated as the parent of an FPMG, potentially bringing all of its other U.S. subsidiaries into scope of CAMT. While on its face this rule may cover private equity funds that have at least one non-U.S. investment and could therefore bring all of their U.S. corporate investments into scope, in many cases, private equity funds do not consolidate their portfolio companies on their financial statements, preventing the aggregation of income of brother-sister portfolio companies under a single fund.

The Private Equity Report Fall 2024, Vol 24, No 3