The tax is calculated as 15 percent of adjusted financial statement income, which is different than taxable income. A taxpayer is only liable for the book minimum tax if their regular tax liability is lower than the minimum tax. For example, if a company has adjusted financial statement income of $10 billion, and they pay $1.2 billion in regular taxes, the taxpayer will have to pay $300 million in additional taxes (.15 x $10 billion - $1.2 billion).

The minimum tax applies to companies with an “average annual adjusted financial statement income” above $1 billion for three consecutive years.

What Are Differences between Financial Statement and Tax Accounting?

Companies follow different sets of rules when reporting to investors and for tax purposes. This helps explain why some large profitable companies pay very little in federal corporate income taxes. Tax accounting is based on the Internal Revenue Code, which defines income and expenses for tax purposes. US book accounting is typically based on generally accepted accounting principles of the United States (GAAP).

Some differences between book and tax income are temporary while others are permanent. In 2020, for example, businesses could fully deduct for tax purposes the cost of many types of capital investments in the year they acquired those assets because of the 2017 Tax Cuts and Jobs Act. But when reporting to shareholders, they had to depreciate those assets over several years.

There also are permanent differences in the way the tax code and GAAP treat income and expenditures, which can make financial statement income either larger or smaller than taxable income. For example, tax-exempt bond interest is recorded as income on financial statements but not for tax purposes, which makes financial income larger than taxable income. (Municipal bonds make up most of that category.)

Limits exist, however, to how much a company can deduct interest expenses in computing taxable income, but not for computing financial statement income, which makes taxable income larger than financial income.

Another major difference is the treatment of some forms of executive compensation, like stock options or unvested stocks. Corporations can deduct different amounts for equity-based compensation, such as employee stock options, under financial accounting than under tax accounting. Under financial accounting, companies deduct the value of equity compensation at fair market value when it is offered. Under tax accounting, companies deduct equity compensation when employees are vested, or when an option is exercised, which can be much later. When the stock price goes up, that can create a significant increase in the deduction under the tax law, compared with financial accounting. However, when the stock price is flat or goes down, the tax deduction under the income tax can be lower. Companies with substantial equity-based compensation and rising stock prices will therefore more likely be subject to the book minimum tax.

The book minimum tax applies to global earnings, allowing credits for most foreign taxes paid. The global intangible low-tax income (GILTI) regime enacted in 2017 already imposes a 10.5 percent minimum tax on a share of US multinationals’ foreign earnings. However, the higher rate and broader base of the 2022 book minimum tax means that some corporations paying low taxes abroad may face additional liability under the new book minimum tax.

Although book income can be either larger or smaller than taxable income, firms have an incentive to minimize reported taxable income and maximize reported income on financial statements, which means book income is often higher than taxable income.

What Is Adjusted Financial Statement Income?

To determine the tax base for the book minimum tax, businesses start with the income reported on their financial statements and then make several adjustments that generally lower the book minimum tax base compared with financial statement income. The most important one allowable under the IRA is cost recovery: firms compute their adjusted book income using bonus and accelerated depreciation, as they do for their regular taxable income.

Another important adjustment is the treatment of defined benefit pension plans, which are tax-favored. Companies can deduct defined benefits pension expenses as they do for their taxable income. They can also generate income for the purpose of the defined benefit plans, which is not taxable. The book minimum tax thereby removes from its base deductions and income under defined benefit pension plans.

What Other Tax Preferences Are Still Allowed under the IRA?

The law does not reduce the measure of taxes paid on adjusted financial income by general business credits or by credits for research, green energy, and low-income housing. Therefore, it allows firms to continue to receive the full value of these credits.

What Is the Treatment of Losses and Prior Years Minimum Taxes Paid?

Companies with operating losses in previous years can reduce their adjusted financial income by a maximum of 80 percent for the purposes of paying the minimum tax.

Any minimum tax can be used to offset future regular tax liability. This means that for many companies, the minimum tax acts as an advance on future tax payments. Effectively, a company can claim previous book minimum taxes as credits to lower their regular tax liability, down to the book minimum tax liability for that year.

Which Firms Would Pay the New Tax and How Much Tax Would They Pay?

Only corporations with a three-year average adjusted book income above $1 billion are subject to the minimum tax. The Joint Committee on Taxation estimated in 2022 that approximately 150 taxpayers would be subject to the tax and it would raise about $222 billion over 10 years. Hoopes and Kindt (2022) estimate that 78 taxpayers would have been subject to the minimum tax if the law had been in place in 2021.

Updated January 2024