With the new tax law in effect on January 1, 2018, and many corporations having fiscal year-ends that differ from a calendar (December 31) year-end, the Internal Revenue Service (IRS) recently issued guidance on how to calculate income taxes under the different tax rate schedules for corporate taxpayers with a tax year that includes both December 31, 2017 and January 1, 2018. Notice 2018-38 provides this guidance when calculating the income tax under both the regular and alternative minimum tax (AMT) systems.
The taxation of corporation income is governed by IRC Section 11(a). Prior to the recent tax reform legislation, Section 11(b) provided graduated corporate tax rates, starting at 15% and increasing to 35% (with higher effective rates eliminating the benefit of lower brackets). “C” corporations were also subject to their own AMT regime.
With tax reform came permanent changes to corporate income tax rates. The Tax Cuts and Jobs Act (the Act) established a flat corporate tax rate of 21% effective for taxable years beginning after December 31, 2017. The Act also limited the application of AMT to taxpayers other than corporations (thus eliminating corporate AMT).
For calendar year-end corporations, the transition was easy, since their 2017 year ended under the previous tax rate schedule and their 2018 year started with the new one. But how should fiscal year-end corporations handle their tax calculations? The IRS Notice provides the answer.
The notice explains that the existing Internal Revenue Code provides “that if any rate of tax imposed by Chapter 1 of the Code changes, and if the taxable year includes the effective date of the change (unless that date is the first day of the taxable year), then –
(1) tentative taxes shall be computed by applying the rate for the period before the effective date of the change, and the rate for the period on and after such date, to the taxable income for the entire taxable year; and
(2) the tax for such taxable year shall be 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 taxable year.
The notice provides a detailed example for a corporation with a June 30 year-end: the corporation would have 184 days taxed under the old tax rates from July 1, 2017 through December 31, 2017; and then 181 days from January 1, 2018 to the corporation’s June 30, 2018 year-end taxed under the new rates. The example uses a corporation with a 34% effective tax rate under the old rules and the 21% rate under the new rules and determined it would pay a total tax of $275,534 for the fiscal year (for an overall effective rate of 27.6%). The example indicated that the corporation was not in an AMT position for the period through December 31, 2017.