Guidance explains calculations based on rate change enacted in 2017
The 21 percent federal corporate tax rate now in effect applies to tax years beginning after Dec. 31, 2017. Previously, the maximum federal corporate tax rate was 35 percent. For a corporation’s fiscal year or companies with tax years that begin before Dec. 31, 2017, but end after that date (an Affected Fiscal Year) – for example, a year beginning Oct. 1, 2017 and ending Sept. 30, 2018, – a blended rate applies.
The IRS has released Notice 2018-38, explaining how to apply the blended rate under section 15 of the Tax Code, as well as news release IR-2018-99, conveying the basic message that for Affected Fiscal Years, the blended rate applies in lieu of either the new 21 percent rate or the tax rate applicable under old law.
Blended rate tax calculation
The blended rate calculation first requires computation of taxable income based on the law governing income and deduction items in effect for the corporation’s entire Affected Fiscal Year. The blended tax rate applicable to this taxable income amount is based on the ratio of (1) the number of days in the tax year before Jan. 1, 2018 to and (2) the number of days in the tax year after Dec. 31, 2017.
For example, consider a corporation with a taxable year beginning on July 1, 2017 and ending on June 30, 2018. It is a U.S. corporation, with its entire taxable income subject to the federal corporate income tax. Its taxable income for the year is $1,000,000. The blended rate rule has no effect on the corporation’s computation of taxable income.
Taxable income is computed under the rules in effect for the corporation’s year; these may include some rules enacted in 2017 but not others. For example, the new rule permitting 100 percent bonus depreciation (also known as full expensing) may apply to tangible depreciable property acquired after Sept. 27, 2017 during the Affected Fiscal Year. (For more on this bonus depreciation rule, see our prior alerts available here and here.) On the other hand, the new rule disallowing deductions for net business interest expense exceeding 30 percent of adjusted taxable income does not apply in this example, because it applies only to tax years beginning after Dec. 31, 2017. (For more on this interest deduction limitation, see our prior alerts available here and here.)
Federal income tax on the corporation’s $1,000,000 taxable income would be $340,000 at the old rate (34 percent) and $210,000 at the new rate (21 percent). Applying to these tax amounts, the ratio of 184 to 181, representing the number of days in the tax year before Jan. 1, 2018 and after Dec. 31, 2017 respectively, and dividing by the 365 days in the tax year results in a blended rate tax amount of $275,534.
Notice 2018-38 provides a step by step example of the blended rate calculation. It also explains the blended rate calculation for the corporate alternative minimum tax (AMT). Because the corporate AMT is repealed for tax years beginning after Dec.31, 2017, the corporate AMT blended rate calculation for an Affected Fiscal Year applies a zero AMT rate, weighted by the number of post-Dec. 31, 2017 days in the tax year.
The Notice also states that blended rate computations apply to fiscal year corporations, such as life insurance companies and regulated investment companies (also known as RICs), that are not subject to the regular corporate income tax, but are subject to another federal income tax that refers to the regular corporate income tax rates.
The Notice 2018-38 and news release IR-2018-99 provide taxpayers with notification and explanation regarding the infrequently encountered blended rate tax computation. The IRS in April 2018 also issued Instructions for tax forms that may require applying of the blended rate computation: Form 1120 Instructions, Form 1120-L Instructions and Form 1120-RIC Instructions. Each addresses the section 15 blended rate calculation. The IRS’ release of the Notice, the news release and these Instructions is commendable, and helpful to taxpayers and tax advisors navigating the complex federal corporate income tax rules.