Making the Corporate Alternative Minimum Tax Less Silly

The House reconciliation bill includes numerous changes to the taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. code: good, bad, and ugly. However, the new corporate alternative minimum tax, or CAMT, goes largely untouched.

The CAMT is an exceedingly complex policy that was introduced in the InflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. Reduction Act of 2022 (IRA). Given how much the House reconciliation bill costs already, it’s understandable that the bill does not repeal CAMT. However, a small fix to how CAMT treats certain investments in oil and gas would have minimal costs.

The original motivation for CAMT was to address discrepancies between book incomeBook income is the amount of income corporations publicly report on their financial statements to shareholders. This measure is useful for assessing the financial health of a business but often does not reflect economic reality and can result in a firm appearing profitable while paying little or no income tax. (calculated for financial statements) and taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. (calculated for tax returns) by levying a minimum tax on book income. Fundamentally, this is a solution in search of a problem: book income and taxable income are intended to measure different things, and have different rules for good reasons. Taxable income may be lower than book income in a given year because a company has made a lot of investments, which are often deducted faster than they are under book income rules. Placing a tax based on book income would put a disproportionate tax burden on investment.

Fortunately, some lawmakers recognized the problems with taxing book income during the IRA debate. Then-Sen. Kyrsten Sinema (D/I-AZ) insisted businesses should be able to take the same accelerated depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. deductions under the new CAMT just as they can under the regular corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. . That moved the new CAMT further away from being based on book income, but given that there is no good reason to base a tax on book income, that was a welcome change.

However, the CAMT still has problems. Most notably, it’s extremely complex: so complex, in fact, that the IRS waived penalties associated with the failure to pay CAMT liability in 2023. Additionally, the ability to add back accelerated depreciation deductions did not prevent CAMT from placing a direct penalty on deductions for all investment. CAMT does not allow full immediate deductions for intangible drilling costs, or IDCs.

Intangible drilling costs are the operating costs associated with oil and gas extraction operations. They include costs such as worker wages, supplies, and maintenance. They are called “intangible” to distinguish them from equipment purchases, and, for most businesses, they would be considered operating costs, immediately deducted even under a tax based on book income. But in the tax code, IDCs are considered investments, as they are associated with future, rather than present, profits.

Ordinarily, independent producers can fully expense IDCs, while integrated producers (firms involved in both upstream and downstream oil and gas operations, the firms one might colloquially call “Big Oil”) can expense 70 percent of their IDCs while spreading deductions for the remaining costs out over five years. But under CAMT, IDCs need to be depleted over several years.

By preventing full deductions for IDCs, the CAMT creates a tax penalty for investment in American oil and gas drilling. While this penalty is insignificant for aggregate investment, it is significant for oil and gas investment, particularly given that IDCs make up between 60 and 80 percent of an oil well’s costs. As Congress and the Trump administration discuss ways to drive American “energy dominance,” fixing a tax penalty in the tax code is a natural place to start.

A fix to IDC treatment in the tax code would not change the fiscal profile of the reconciliation package. According to a Joint Committee on Taxation (JCT) analysis of the Promoting Domestic Energy Production Act, a bill that would add full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. for intangible drilling costs to the calculation for CAMT, the fix would only cost $1.1 billion over a decade—a rounding error in the context of a $4 trillion bill.

While it would be more expensive than just a fix, and, on the margin, Congress should be looking for pay-fors rather than more tax cuts, full CAMT repeal may be much less expensive than previously thought. As a new piece in Tax Notes observes, the CAMT has dramatically underperformed revenue expectations. In the original analysis of the tax, it was expected to raise almost $35 billion in 2024. Meanwhile, based on public company financial disclosures, it only collected $572 million last year.

Full-scale repeal of the corporate alternative minimum tax (CAMT might be a significant win for simplification at a surprisingly low cost. And a fix for its disproportionate penalties for oil and gas extraction would be a drop in the bucket in terms of revenue.

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