j. Affiliation rules for Alaska Native Corporations Present Law Under present law, Native Corporations established under the Alaska Native Claims Settlement Act (43 U.S.C. 1601 et seq.) (and 100-percent subsidiaries of such corporations) are entitled to file consolidated returns if they qualify under the more liberal affiliation rules formerly in effect for all corporations before the Deficit Reduction Act of 1984. These affiliation rules are in effect for such corporations for taxable years beginning before 1992. During the transitional period, eligibility of such corporations for affiliation may be determined solely on the basis of a literal application of the statutory requirements. No provision of the Code or principle of law may be applied to deny the benefit of any losses or credits of such corporations to the affiliated group of which the corporation is a member. Accordingly, the benefit of such losses and credits may not be denied, for example, by application of the assignment of income doctrine, section 269 (relating to disallowance of deductions or credits following a tax-avoidance motivated acquisition), or section 482 (relating to the Commissioner's authority to reallocate income, deductions, or credits among commonly controlled businesses). Possible Proposals 1. Limit utilization of losses of Alaska Native Corporations to loss carryforwards existing on the date of enactment of the 1986 Act, plus certain post-enactment losses (e.g., those incurred in taxable years beginning before January 1, 1988). 2. Deny carrybacks of Native Corporation losses to 1986 or 1987 to the extent such losses would offset income generated by a corporation that would not be eligible for affiliation in the absence of the special affiliation rules. 3. Prohibit losses from being used against income that is assigned to a Native Corporation subsidiary, as opposed to income that is attributable to assets of or services performed by the subsidiary. Pros and Cons Arguments for the proposals 1. Present law permits the unrestricted sale of future losses, as well as losses existing at the effective date of the 1986 Act, by Alaska Native Corporations. This provides an undue benefit from the continued creation of losses. 2. Absent a prohibition against carrybacks of future Native Corporation losses to 1986 and 1987, taxpaying corporations can assign income to the Native Corporation group in those years, when losses are worth between 40 and 46 cents on the dollar, rather than in the year the losses are incurred when they will be worth only 34 cents on the dollar. Arguments against the proposals 1. The special affiliation rules, including the rules allowing assignment of income, assure the ability of the Native Corporations to derive the full benefit of their losses at the earliest possible date, generating funds to help the Corporations become self-sufficient. k. Denial of graduated rates for personal service corporations Present Law Under present law, beginning July 1, 1987, corporations are generally subject to a tax at the rate of 34 percent. However, for corporations with a taxable income below $335,000, graduated rates are provided. These rates are 15 percent on taxable income not over $50,000, and 25 percent on taxable income over $50,000 and not over $75,000, with the benefits of these lower rates phased out as taxable income increases from $100,000 to $335,000. Possible Proposal The benefits of the graduated corporate rates could be denied to personal service corporations. Argument for the proposal Pros and Cons 1. Income from personal services should not receive the benefit of the lower graduated corporate tax rates. Since personal service income may generally be paid as deductible salary to the owneremployees and thereby be taxed once at the owner-employees' tax rate, it is inappropriate to tax it at a lower corporate rate. Other Code provisions treat personal service corporations the same as their owners-e.g., the passive loss rules and the cash accounting provisions. Argument against the proposal 1. All corporate income should be taxed at the regular corporate rates. The graduated rates were enacted to benefit corporations with lower incomes and should not be limited. 1. Conversion of C corporation to S status Present Law In general, gain realized when a C corporation liquidates is subject to corporate level tax. If a C corporation elects to convert to S corporation status and holds assets with a net unrealized "built-in gain" (that is, with a value in excess of basis) at the time of its conversion, the built-in gain is subject to a separate corporate-level tax to the extent it is realized within ten years after the conversion. Although built-in corporate level gain is thus generally taxed as realized over the 10-year period, such gain is not taxed at the corporate level to the extent it is offset by post-conversion losses. The Internal Revenue Service has stated that the inventory method used by a taxpayer for tax purposes shall be used in determining whether goods disposed of following a conversion to S corporation status were held by the corporation at the time of conversion. Thus, a C corporation using the last-in, first-out (LIFO) method of accounting for its inventory which converts to S corporation status will not be taxed on the built-in gain attributable to LIFO inventory to the extent it does not invade LIFO layers during the ten-year period following the conversion. Possible Proposals A C corporation using the LIFO method which elects S corporation status could be required to include in income the LIFO recapture amount (that is, the excess of the inventory's value using a first-in, first-out (FIFO) flow assumption over its LIFO value on the date of the conversion) upon conversion. Full recapture could be required in the year of conversion or applying a FIFO inventory flow assumption, or the income could be spread over some period of time (e.g., five years, ten years). The built-in gain provisions could generally be revised to operate more effectively to measure and tax over a deferred period the corporate level gain existing at the time of conversion. Pros and Cons Arguments for the proposals 1. The provision that imposes a separate corporate-level tax on built-in gains may be ineffective in the case of LIFO inventory, since a taxpayer experiencing constant growth may never be required to invade LIFO inventory layers. The LIFO method C corporation thus may, by converting to S status, escape the recapture tax that would have been imposed had there been a liquidation. 2. Under present law, LIFO taxpayers electing S corporation status pay less corporate level tax than FIFO taxpayers, since LIFO recapture tax that is not paid within the 10 year period is never recovered. 3. The provision dealing with conversion from C to S status should conform more closely to the results that would have occurred in a liquidation. Arguments against the proposal 1. Built-in gain attributable to LIFO inventory is no different than built-in gain attributable to other types of assets, and should not be subject to harsher rules. Accordingly, if such inventory is not deemed to have been disposed of during the statutory recognition period, no separate corporate-level tax should be imposed. 2. The proposal would dilute the benefit of the LIFO method, the use of which Congress has expressly authorized. If Congress believes that the LIFO method provides unwarranted tax benefits, it should address this problem directly, not by triggering recapture upon a conversion to S status which is not treated as a liquidation for other purposes. 3. It is inappropriate to more closely conform the results of a conversion from C to S status to the results that would have occurred if the corporation had liquidated; this imposes too heavy a burden on a conversion from C to S status. |