A-14 Tax Projections Under Present Law. Tax liability is estimated in each year using the same set of rules that are applied in the base year. Table A-3 presents the total tax liability for each year under both current law and proposed law. This table is a parallel to Table 5 in Section III. Income is divided into ordinary and preferred income, and capital gains are taxed using either the statutory corporate tax rate or the alternative tax on capital gains, whichever results in the lesser amount of tax liability. The add-on minimum tax is computed using the "preference items" generated by the depletion and depreciation calculators. One important point to note is that the tax calculator only carries net operating losses (NOL's) forward during the projection period, not backward, because there is no way to know whether sufficient tax liability is available from prior years to allow a carryback. The amount of net operating losses is the sum of the NOL's carried forward from the survey into the base year plus the net amount of NOL's generated during the projection period. Tax Projections Under Proposed Law. Tax liability under proposed law is estimated by using the rules as they appear in the Administration proposals, occasionally clarified through more recent interpretations or through discussions with Treasury staff. For a more detailed comparison of present to proposed law, see Appendix C. The same general methodology is used to estimate proposed tax liabilities and to estimate current tax liabilities, with the obvious difference being the inclusion and exclusion of several income items as well as the rate changes. Under proposed law, the first depreciation and depletion allowances. changes are those in Once these allowances have been calculated per the change in tax laws, they are treated in the same manner as under current law. NOTES: Details may not add to totals due to rounding. The amounts listed are chosen for illustrative A-16 In addition to those items which affect the amount of taxable income, the Administration proposals present four additional items that affect the taxable income base in the projection period. The first, and largest, of these is the recapture of the excess of ACRS depreciation allowances over straight-line depreciation allowances for the period from January 1, 1980 and July 1, 1986. A portion of this excess depreciation is to be added to taxable income over three years, 1986 to 1988. For the hypothetical company in Table A-2, this amount is $2,050,000 in 1986 and 1987, and $2,733,000 in 1988. Second, the Administration proposals call for a 10 percent dividends paid deduction to be allowed beginning in 1987. Third, capital gains on depreciable assets that are placed in service after January 1, 1986 will be taxed at the statutory corporate tax rate rather than the preferred rate of 28 percent. Capital gains on depreciable assets placed in service prior to the proposal date will still be taxed at the preferred rate. During the projection period, the sum of capital gains on preand post-1986 depreciable assets is equal to other capital gains in each year. Fourth, the capital-gains treatment of royalty income is gradually phased out. By 1989, royalty income from unrelated companies will have changed from capital gains to ordinary income, broadening the base of ordinary income. Thus, in 1989 the sample company will have $2,406,000 of royalty income that will be treated as ordinary income. The corporate tax rate on ordinary income is reduced to 33 percent, effective July 1, 1985. As a result, in the first year of the projection period a blended tax rate of 39.5 percent is used for ordinary income. A-17 Since the Administration proposals would repeal the investment tax credit, the only ITC's that could be used are those carried over from the base year. Companies that have remaining available investment tax credits are allowed to use them up in the same manner as under current law. However, investment tax credits cannot be used to offset the alternative minimum tax under proposed law, and are simply carried forward until they can be used in the model. For example, the hypothetical company is only able to use $1,207,000 of the allowable $1,317,000 of investment tax credits in 1985, so the remainder is carried over into 1986. However, under proposed law, the alternative minimum tax must be paid in 1986, so the ITC's are carried over again to a future year where the alternative minimum tax does not apply in this case, 1989. - The section of the calculator that deals with minimum taxes estimates the amount of additional tax liability arising from the alternative minimum tax. In addition to the "preference items" which are present under current law, there is an additional "preference item" under the Administration proposals. This item is the excess of exploration and development costs that are deducted as an expense over the amount that would have been allowed had the expense been amortized over a ten-year period. It is assumed that if this proposal is enacted, companies will be allowed to go back ten years and amortize their past exploration and development expenditures for tax purposes, so that they will not incur an overly large "preference item" in the first year. The hypothetical company, which reported gross development expense of $2,000,000 in 1980, will have $2,767,000 added into alternative taxable income in 1986. For the alternative minimum tax, only those preference items above $10,000 are included, after a threshold exemption of $15,000. Large companies, then, have an effective threshold exemption of $25,000. A-18 The alternative minimum tax is calculated by adding the total of the "preference items" to taxable income. Adjustments are made to taxable income for those net operating losses created by preference items used to offset income. Given the size of the "preference items" for companies in the coal industries, it is assumed for simplicity's sake that all of the net operating 3 losses of the coal companies were due to preference items. result, the preference items are added to taxable income before net operating losses in the tax calculator. As a This sum of "preference items" added to taxable income is then multiplied by 20 percent and compared to regular tax liability after credits. If the alternative minimum tax is greater than the regular tax, then the alternative minimum tax is paid and the investment tax credits and net operating losses (which could otherwise have been used) are carried forward to future years. The line labeled Additional Corporate Minimum Tax Liability is, in this case, the difference between total tax liability and the amount of alternative minimum tax that must be paid. In 1986, the hypothetical company's alternative minimum tax is calculated by taking 20 percent of the sum of the total "preference items" ($8,268,000) and taxable income before NOL deduction ($9,563,000), yielding an alternative minimum tax of $3,566,000. The difference between this amount and net tax liability is $127,000 and is entered on the line for additional corporate minimum tax liability. According to the "tax benefit rule", net operating loss carryovers are to be reduced to the extent that a company receives a current benefit from them. In the case of the 3 While this assumption is useful for a short-run analysis, it would be necessary to modify the assumption for a longer-term analysis because many of the large preference items will be eliminated by the Administration proposal. |