Section

[Code of Federal Regulations]
[Title 26, Volume 1]
[Revised as of April 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.58-9]

[Page 543-554]

TITLE 26--INTERNAL REVENUE

CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY

PART 1--INCOME TAXES--Table of Contents

Sec. 1.58-9 Application of the tax benefit rule to the minimum tax for taxable years beginning prior to 1987.

(a) In general. For purposes of computing the minimum tax liability
imposed under section 56 of the Internal Revenue Code of 1954 (Code),
taxpayers are not liable for minimum tax on tax preference items that do
not reduce the taxpayer's tax liability under subtitle A of the Code for
the taxable year. In general, tax preference items that do not reduce
tax liability under subtitle A for the taxable year are those from which
no current tax benefit is derived because available credits would have
reduced or eliminated the taxpayer's regular tax liability if the
preference items had not been allowed in computing taxable income.
However, any credits that, because of such preference items, are not
needed for use against regular tax (``freed-up credits''), are required
to be reduced under the rules of paragraph (c) of this section. For
purposes of this section, a taxpayer's regular tax is the Federal income
tax liability under subchapter A of chapter 1 of the Code, not including
the minimum tax imposed by section 56. Unless otherwise noted, all
references to Internal Revenue Code sections refer to the Internal
Revenue Code of 1954.
(b) Effective date. The rules of this section are effective May 5,
1992, but only as they affect tax preference items that arise in taxable
years beginning after December 31, 1976, and before January 1, 1987.
(c) Adjustment of carryover credits--(1) In general. A taxpayer's
freed-up credits must be reduced by the additional minimum tax that
would have been imposed if a current tax benefit had been derived from
preference items that did not actually produce a current tax benefit.
The amount of this reduction shall be calculated in the following
manner--
(i) Determine the amount of freed-up credits;
(ii) Determine the amount of tax preference items (if any) from
which a current tax benefit was derived for the taxable year
(``beneficial preferences''), and the amount of preferences from which
no current tax benefit was derived for the taxable year (``non-
beneficial preferences''); and
(iii) Determine the portion of the total minimum tax on all tax
preference items for the taxable year that is attributable to the non-
beneficial preferences.
The freed-up credits are then reduced by an amount equal to such
portion of the minimum tax.
(2) Determine freed-up credits. (i) To determine the freed-up
credits for the taxable year, first determine the regular tax that would
have been imposed for the taxable year if preference items had not been
allowed in computing taxable income (``non-preference regular tax''). In
the case of a taxpayer with the capital gain preference described in
section 57(a)(9)(B), non-preference regular tax is computed without
regard to section 1201 and without adding the section 57(a)(9)(B)
preference amount to taxable income. Second, compute the amount of
credits that would have been allowed to reduce the non-preference
regular tax. The credits available to reduce non-preference regular tax
shall include any freed-up credits from other taxable years, as reduced
under paragraph (c)(5) of this section, that are carried to the current
taxable year. Third, subtract the amount of credits that were actually
allowed to reduce the regular tax for such taxable year from the amount
of credits that would have been allowed to reduce non-preference regular
tax. The result is the amount of the freed-up credits.
(ii) The following examples illustrate the determination of freed-up
credits. The first two examples assume that the foreign tax credits
being used do not exceed the limitation under section 904.

Example 1. In 1982 Corporation B has $17.6 million dollars in
foreign tax credits available for the taxable year. If preference items
were not allowed in determining regular tax, the regular tax would have
been $10.2 million and foreign tax credits used to reduce regular tax
would have been $10.2 million. Because of tax preference items, however,
B's regular tax is $6.3 million and the amount of foreign tax credits
actually used to reduce the regular tax is $6.3 million. The amount of

[[Page 544]]

freed-up foreign tax credits is $3.9 million ($10.2 million minus $6.3
million).
Example 2. Assume the same facts as in Example 1 of paragraph
(c)(2)(ii) of this section except that Corporation B has $7.2 million
dollars in foreign tax credits. If preference items were not allowed,
the non-preference regular tax would have been $10.2 million and the
foreign tax credits used to reduce the regular tax would have been $7.2
million. Because of tax preference items, however, B's regular tax is
$6.3 million, and the amount of foreign tax credits actually used to
reduce the regular tax is $6.3 million. The amount of freed-up foreign
tax credits is $.9 million ($7.2 million minus $6.3 million).
Example 3. In 1983 Corporation C has $500,000 of investment tax
credits available. If preference items were not allowed, non-preference
regular tax would have been $690,000 and all $500,000 of investment tax
credits would have been allowed to reduce non-preference regular tax
liability. Because of tax preferences, however, C's actual regular tax
is $439,750. As a result of the limitation under section 38(c), only
$377,537 of the investment tax credits are allowed to reduce the actual
regular tax. Freed-up credits are $122,463 ($500,000 minus $377,537).
Example 4. In 1984 Corporation B has ordinary income of $20,000 and
net section 1201 gain of $300,000, none of which is attributable to
foreign sources. B has no other items of tax preference in 1984. B's
non-preference regular tax for 1984 is $126,950, the amount of tax that
would be imposed without regard to section 1201.

(3) Determination of beneficial and non-beneficial preferences--(i)
In general. The amount of tax preferences from which a current tax
benefit is derived (``beneficial preferences'') and the amount from
which no current tax benefit is derived (``non-beneficial preferences'')
for the taxable year are determined as set forth below.
(ii) Regular tax liability is the same regardless of preference
items. (A) If the taxpayer's tax liability (after credits) would be the
same regardless of whether preference items were allowed to reduce
taxable income, then all of the taxpayer's preference items are non-
beneficial preference items.
(B) The following example illustrates the rule set forth in
paragraph (c)(3)(ii)(A) of this section. This example assumes that
foreign tax credits being used do not exceed the limitation under
section 904.

(iii) Regular tax liability differs because of preference items. If
tax liability (after credits) is less because preference items are
allowed to reduce taxable income, then some of these preference items
have provided a current tax benefit. In such cases, the amount of
beneficial and non-beneficial preferences are determined as follows:
(A) Non-beneficial preferences. (1) The non-beneficial preferences
are determined by converting the freed-up credits for such taxable year
into an amount of taxable income. To make this conversion, freed-up
credits are ``grossed up'' (i.e., divided by the regular tax marginal
rate at which such credits would have offset non-preference regular tax)
to determine the amount of tax preferences that freed up such credits.
For purposes of this calculation, the 5-percent addition to tax provided
by section 11(b) shall be included in determining the marginal rate. The
aggregate of these grossed-up amounts is the total amount of non-
beneficial preferences for the taxable year.
(2) The freed-up credits shall be grossed up beginning at the lowest
marginal tax rate that would have applied to the additional taxable
income arising if tax preferences were not allowed. Thus, the marginal
tax rates at which the actual regular tax was imposed shall not be taken
into account in grossing up freed-up credits, even if

[[Page 545]]

all or a portion of such tax is not offset by credits because of
limitations on the allowance of such credits (such as the section 904
limit on foreign tax credits or the section 38(c) limit on investment
tax credits). For example, if the first dollar of additional non-
preference taxable income would have been taxed at a rate of 46 percent,
then freed-up credits shall be grossed up at 46 percent, even if regular
tax imposed on taxable income at a 40-percent rate was not offset by
credits because of the limitations on investment tax credits under
section 38(c). See Examples 1 and 2 in paragraph (d) of this section for
illustrations of the gross up of freed-up credits in cases where
limitations apply to the amount of credit allowed to offset actual
regular tax.
(3) The following example illustrates the gross up of freed-up
credits to determine non-beneficial preferences. This example assumes
that foreign tax credits being used do not exceed the limitation under
section 904.

Example. (i) Corporation L has the following items for the 1985
taxable year:

Actual taxable income............................... ........ $90,000
Regular tax......................................... ........ 21,750
Available credits:
Foreign tax credits for 1985...................... $15,000
Foreign tax credits carried forward from 1984..... 25,000
Investment tax credits carried forward from 1984.. 20,000
----------
........ 60,000
Credit allowed to offset actual regular tax:
Foreign tax credits for 1985...................... 15,000
Foreign tax credits carried forward from 1984..... 6,750
----------
21,750
Actual regular tax liability........................ ........ 0
Preferences......................................... ........ 110,000
Taxable income for 1985 determined as though ........ 200,000
preferences were not allowed.......................
Non-preference regular tax.......................... ........ 71,750
Credits allowed to offset non-preference regular
tax:
Foreign tax credits for 1985...................... 15,000
Foreign tax credits carried forward from 1984..... 25,000
Investment tax credits carried forward from 1984.. 20,000
----------
60,000
Non-preference regular tax liability................ ........ 11,750

(ii) The freed-up credits for 1985 are $38,250 ($60,000 minus
$21,750). The non-preference regular tax of $71,750 is determined by
applying the regular tax rates set forth in section 11(b) to the
$200,000 of taxable income as follows:

------------------------------------------------------------------------
Taxable income Rate Tax
------------------------------------------------------------------------
$25,000 X .15 = $3,750
25,000 X .18 = 4,500
25,000 X .30 = 7,500
25,000 X .40 = 10,000
100,000 X .46 = 46,000
------------------ -----------------
$200,000 $71,750
------------------------------------------------------------------------

(iii) Thus, for purposes of determining the non-beneficial
preferences, freed-up credits are grossed up as follows: The credits
allowed against the regular tax and the freed-up credits are treated as
offsetting non-preference regular tax in the same order as such credits
would have been allowed to offset such tax, beginning at the lowest
marginal tax rate. The freed-up credits are grossed up beginning at the
lowest marginal tax rate at which additional taxable income would have
been taxed if preferences were not allowed. Thus, in this example freed-
up credits are grossed up beginning at 40 percent, and the amount of L's
non-beneficial preferences for the 1985 taxable year is $84,456.

----------------------------------------------------------------------------------------------------------------
Credit
allowed Freed-up Divided by Non-
Type against credit tax rate beneficial
regular tax preferences
----------------------------------------------------------------------------------------------------------------
FTC (85)................................................ $3,750 ........... .15
Do.................................................. 4,500 ........... .18
Do.................................................. 6,750 ........... .30
FTC (84)................................................ 750 ........... .30
Do.................................................. 6,000 ........... .40
Do.................................................. ........... $4,000 .40 = $10,000
Do.................................................. ........... 14,250 .46 = 30,978
ITC (84)................................................ ........... 20,000 .46 = 43,478
-------------------------------------------------------
$21,750 $38,250 ........... .. $84,456
----------------------------------------------------------------------------------------------------------------

[[Page 546]]

Foreign tax credit = FTC (year)
Investment tax credit = ITC (year)

(B) Beneficial preferences. The amount of beneficial preferences for
the taxable year is computed by subtracting the non-beneficial
preferences for the taxable year from the total amount of tax
preferences for such year. This rule may be illustrated by the following
example:

Example. Assume the same facts as in the Example in paragraph
(c)(3)(iii)(A)(3) of this section. The amount of L's beneficial
preferences for 1985 is $25,544 (total preferences of $110,000, minus
non-beneficial preferences of $84,456).

(4) Determine the minimum tax attributable to non-beneficial
preferences. (i) The portion of the minimum tax that is attributable to
the non-beneficial preferences is computed as follows--
(A) Compute the minimum tax that would be imposed on all tax
preference items for the taxable year if all of the preferences had
produced a tax benefit.
(B) Compute the minimum tax that would be imposed on the beneficial
preferences if these were the taxpayer's only preferences. (This is the
amount of minimum tax actually imposed for the taxable year.)
(C) Subtract the amount computed in paragraph (c)(4)(i)(B) of this
section from the amount computed in paragraph (c)(4)(i)(A) of this
section. The result is the minimum tax attributable to the non-
beneficial preferences for the taxable year. This amount is sometimes
referred to hereinafter as the ``credit reduction amount''.
(ii) The following examples illustrate determination of the credit
reduction amount. These examples assume that foreign tax credits being
used do not exceed the limitation under section 904.

Example 1. (i) In 1982 Corporation B has $17.6 million dollars in
foreign tax credits available for the taxable year. If preference items
were not allowed in determining regular tax, the regular tax would have
been $10.2 million and foreign tax credits used to reduce regular tax
would have been $10.2 million. Because of tax preference items, however,
B's regular tax is $6.3 million and the amount of foreign tax credits
actually used to reduce the regular tax is $6.3 million. The amount of
freed-up foreign tax credits is $3.9 million ($10.2 million minus $6.3
million).
(ii) The total amount of B's tax preference items is $8.4 million.
B's non-preference regular tax is $10.2 million and, reduced by foreign
tax credits, is zero. B's actual regular tax is $6.3 million and,
reduced by foreign tax credits, is zero. Since the amount of credits
that would have been allowed to offset the non-preference regular tax
would have reduced such tax to an amount ($0) equal to the actual
regular tax liability ($0), B received a tax benefit from none of the
$8.4 million of tax preferences and therefore all of these preferences
are non-beneficial preferences.
(iii) Since B has $8.4 million in total preference items and no
regular tax liability, the minimum tax on that amount would be
$1,258,500 (($8.4 million minus $10,000) multiplied by .15). None of the
preference items is a beneficial preference. Thus, the minimum tax
attributable to non-beneficial preferences (and therefore, the credit
reduction amount) is $1,258,500.
Example 2. (i) Corporation L has the following items for the 1985
taxable year:

Actual taxable income............................... ........ $90,000
Regular tax......................................... ........ 21,750
Available credits:
Foreign tax credits for 1985...................... $15,000 ........
Foreign tax credits carried forward from 1984..... 25,000 ........
Investment tax credits carried forward from 1984.. 20,000
----------
$60,000
Credit allowed to offset actual regular tax:
Foreign tax credits for 1985...................... $15,000 ........
Foreign tax credits carried forward from 1984..... 6,750
----------
$21,750
Actual regular tax liability........................ ........ 0
Preferences......................................... ........ 110,000
Taxable income for 1985 determined as though ........ 200,000
preferences were not allowed.......................
Non-preference regular tax.......................... ........ 71,750
Credits allowed to offset non-preference regular
tax:
Foreign tax credits for 1985...................... $15,000 ........
Foreign tax credits carried forward from 1984..... 25,000 ........
Investment tax credits carried forward from 1984.. 20,000
----------
$60,000
Non-preference regular tax liability................ ........ 11,750

(ii) The freed-up credits for 1985 are $38,250 ($60,000 minus
$21,750). The non-preference regular tax is $71,750. The amount of L's
non-beneficial preferences for the 1985 taxable year is $84,456.
(iii) The minimum tax on L's total preference items of $110,000
would be $15,000 (($110,000 minus $10,000) multiplied by .15).

[[Page 547]]

Since the amount of non-beneficial preferences is $84,456, the amount of
L's beneficial preferences for 1985 is $25,544 ($110,000 minus $84,456).
The minimum tax on L's beneficial preferences of $25,544 is $2,332
(($25,544 minus $10,000) multiplied by .15). (This is the amount of
minimum tax imposed for 1985.) The minimum tax attributable to non-
beneficial preference items (and therefore, the credit reduction amount)
is $12,668 ($15,000 minus $2,332).

(5) Reduction of freed-up credits--(i) In general. The freed-up
credits are reduced by an amount equal to the minimum tax attributable
to the non-beneficial preferences (``credit reduction amount''). If the
taxpayer has only one type of freed-up credit (i.e., only investment tax
credit or only foreign tax credit) and that credit was earned in only
one year (the current year or a carryover year), then the credit is
reduced by the credit reduction amount. This rule may be illustrated by
the following example. This example assumes that foreign tax credits
being used do not exceed the limitation under section 904.

Example. (i) In 1982 Corporation B has $17.6 million dollars in
foreign tax credits available for the taxable year. If preference items
were not allowed in determining regular tax, the regular tax would have
been $10.2 million and foreign tax credits used to reduce regular tax
would have been $10.2 million. Because of tax preference items, however,
B's regular tax is $6.3 million and the amount of foreign tax credits
actually used to reduce the regular tax is $6.3 million. The amount of
freed-up foreign tax credits is $3.9 million ($10.2 million minus $6.3
million).
(ii) The total amount of B's tax preference items is $8.4 million.
B's non-preference regular tax is $10.2 million and, reduced by foreign
tax credits, is zero. B's actual regular tax is $6.3 million and,
reduced by foreign tax credits, is zero. Since the amount of credits
that would have been allowed to offset the non-preference regular tax
would have reduced such tax to an amount ($0) equal to the actual
regular tax liability ($0), B received a tax benefit from none of the
$8.4 million of tax preferences and therefore all of these preferences
are non-beneficial preferences.
(iii) Since B has $8.4 million in total preference items and no
regular tax liability, the minimum tax on that amount would be
$1,258,500 (($8.4 million minus $10,000) multiplied by .15). None of the
preference items is a beneficial preference. Thus, the minimum tax
attributable to nonbeneficial preferences (and therefore, the credit
reduction amount is $1,258,500.
(iv) All of the $3.9 million of freed-up credits are foreign tax
credits that arise in the same year and that otherwise would be carried
forward. Since the entire amount of B's tax preferences are non-
beneficial preferences, the minimum tax of $1,258,500 that would be
imposed on the total tax preferences is the credit reduction amount.
Thus, B's $3.9 million of freed-up foreign tax credits is reduced by
$1,258,500. The foreign tax credit carryforward from 1982 is
$10,041,500. This amount is the sum of $2,641,500 (the freed-up foreign
tax credit of $3,900,000, reduced by the credit reduction amount of
$1,258,500), plus $7.4 million (the foreign tax credit that would have
been carried over even if tax preference items had not been allowed).

However, if the taxpayer has more than one type of freed-up credit, or
the taxpayer's freed-up credits are from more than one taxable year,
then the credit reduction amount must be allocated under the exact
method described in paragraph (c)(5)(ii) of this section, unless an
election is made under paragraph (c)(5)(iii) of this section to use the
simplified method.
(ii) Exact method. For each type of freed-up credits and for each
taxable year within such type from which any such credits are earned,
the amount of credit reduction shall be equal to the amount of minimum
tax attributable to the non-beneficial preferences that freed up the
credits for that type and taxable year. The amount of the credit
reduction is computed by multiplying the amount of non-beneficial
preferences which freed up credits for each type and taxable year by the
minimum tax rate. For purposes of this computation, if the amount of the
taxpayer's minimum tax exemption for the taxable year (as determined
under section 56(a)) exceeds the amount of the taxpayer's beneficial
preferences, such excess exemption shall reduce the amount of non-
beneficial preferences to be multiplied by the minimum tax rate. The
non-beneficial preferences shall be reduced by any such excess exemption
in the same order in which the credits that were freed up by such
preferences would have been allowed to offset tax. Thus, for example,
any excess exemption shall first reduce non-beneficial preferences that
freed up foreign tax credits. Any such excess exemption

[[Page 548]]

remaining after reducing non-beneficial preferences that freed up
foreign tax credits to zero would then be used to reduce the non-
beneficial preferences that freed up investment tax credits.
(iii) Simplified method--(A) Description of method. In lieu of the
exact credit reduction method described in paragraph (c)(5)(ii) of this
section, taxpayers may elect to use the simplified credit reduction
method. Under the simplified credit reduction method, the amount of
freed-up credits for each type of credit and for each taxable year in
which such credit is earned is multiplied by a fraction. The numerator
of the fraction is the total credit reduction amount as determined in
paragraph (c)(4)(i)(C) of this section. The denominator is the total
amount of freed-up credits as determined in paragraph (c)(2)(i) of this
section. The product of this multiplication is the amount of credit
reduction for each type and taxable year of freed-up credit.
(B) Election to use simplified method. A taxpayer may elect to use
the simplified credit reduction method for all taxable years to which
this section applies by attaching a statement indicating such an
election on the amended Federal income tax return or returns applying
the adjustments of this section. If an election is made for any taxable
year, it must be made for all taxable years. Once an election has been
made, it can be revoked only with the permission of the Commissioner.
Similarly, once returns have been filed applying the exact credit
reduction method, an election to apply the simplified method can be made
only with the consent of the Commissioner.
(iv) Effect of credit reduction on credit carryovers. Under both the
exact method and the simplified method, the determination of credit
carryovers to other taxable years is made on the basis of freed-up
credits remaining after such reduction, plus any other unused credits.
Thus, an amount of freed-up credits that is equal to the credit
reduction amount shall not be allowed to reduce tax liability in any
taxable year. Such disallowance is without regard to whether such
credits would otherwise be allowed as a carryover. The freed-up credits,
as reduced under this paragraph (c)(5), shall be carried over or carried
back in applying this section in a carryover or carryback year. No
minimum tax liability shall be due with respect to the non-beneficial
preferences for any taxable year.
(v) Examples. The following examples illustrate reduction of freed-
up credits.

Example 1. (i) Corporation L has the following items for the 1985
taxable year:

Actual taxable income............................... ........ $90,000
Regular tax......................................... ........ 21,750
Available credits:
Foreign tax credits for 1985...................... $15,000 ........
Foreign tax credits carried forward from 1984..... 25,000 ........
Investment tax credits carried forward from 1984.. 20,000 ........
----------
60,000
Credit allowed to offset actual regular tax:
Foreign tax credits for 1985...................... $15,000 ........
Foreign tax credits carried forward from 1984..... 6,750 ........
----------
21,750
Actual regular tax liability........................ 21,750
Preferences......................................... 110,000
Taxable income for 1985 determined as though 200,000
preferences were not allowed.......................
Non-preference regular tax.......................... 71,750
Credits allowed to offset non-preference regular ........
tax:
Foreign tax credits for 1985...................... $15,000 ........
Foreign tax credits carried forward from 1984..... $25,000 ........
Investment tax credits carried forward from 1984.. 20,000 ........
----------
60,000
Non-preference regular tax liability................ 11,750

(ii) The freed-up credits for 1985 are $38,250 ($60,000 minus
$21,750). The non-preference regular tax is $71,750. The amount of L's
non-beneficial preferences for the 1985 taxable year is $84.456.
(iii) The credit reduction amount for 1985 is $12,668, the amount of
minimum tax attributable to L's non-beneficial preferences. This amount
is allocated to reduce each category of freed-up credit and to each year
from which such credit is carried over. L's $38,250 of freed-up credits
consists of $18,250 of foreign tax credits carried forward from 1984,
which were freed up by $40,978 of non-beneficial preferences, and
$20,000 of investment tax credits carried forward from 1984, which were
freed up by $43,478 of non-beneficial preferences.
(iv) The apportionment of this credit reduction amount to each
category of freed-up

[[Page 549]]

credit and each taxable year from which such credits are carried over is
determined as follows under the exact credit reduction method:
(A) Foreign tax credits carried forward from 1984:

Non-beneficial preferences that freed up 1984 FTCx.15=Credit reduction
of 1984 FTC

$40,978x.15=$6,146

(B) Investment tax credits carried forward from 1984:

Non-beneficial preferences that freed up 1984 ITCx.15=Credit reduction
of 1984 ITC

$43,478x.15=$6,522

Thus, the foreign tax credits from 1984 that are carried forward to 1986
are $12,104 ($18,250 minus $6,146). The investment tax credits from 1984
that are carried forward to 1986 are $13,478 ($20,000 minus $6,522).
(v) The reduction of the freed-up credit under the simplified credit
reduction method is as follows:
(A) Foreign tax credit carried forward from 1984:
[GRAPHIC] [TIFF OMITTED] TC14NO91.150

[GRAPHIC] [TIFF OMITTED] TC14NO91.151

(B) Investment tax credits carried forward from 1984:
[GRAPHIC] [TIFF OMITTED] TC14NO91.152

[GRAPHIC] [TIFF OMITTED] TC14NO91.153

Thus, under the simplified credit reduction method, L has $12,206 of
foreign tax credits for 1984 ($18,250 minus $6,044) that are carried
forward to 1986, and $13,376 of investment tax credits for 1984 ($20,000
minus $6,624) that are carried forward to 1986.
Example 2. Assume the same facts as in Example 1 of this paragraph
(c)(5)(v), except that the foreign tax credits available for use in 1985
include $10,750 in credits carried forward from 1980 and $14,250 in
credits carried forward from 1984, rather than $25,000 carried forward
from 1984. Thus, $4,000 of the freed-up foreign tax credit is carried
over from 1980. The other $14,250 of freed-up foreign tax credit is
carried over from 1984. The non-beneficial preferences that freed up the
1980 foreign tax credit are $10,000. The non-beneficial preferences that
freed up the 1984 foreign tax credit are $30,978. Under the exact credit
reduction method, the credit reduction amounts for each of these credits
are determined as follows:
(i) Foreign tax credit carried forward from 1980:
$10,000x.15=$1,500
(ii) Foreign tax credit carried forward from 1984:

$30,978x.15=$4,646

Thus, the foreign tax credit from 1984 that is carried forward to 1986
is $9,604 ($14,250 minus $4,646). Since the foreign tax credit from 1980
expires after 1985, none of that credit is carried forward to 1986.

(d) Examples. The following examples are comprehensive illustrations
of the adjustments described in paragraph (c) of this section:

Example 1. (i) This example illustrates the operation of the credit
reduction adjustment when the amount of foreign tax credit allowed is
subject to the overall limitation under section 904. For purposes of
this example, assume that Corporation x has the following items for the
1984 taxable year:

Taxable income (determined as though preferences were not allowed)
$140,000
From foreign sources..............................................70,000
Foreign tax credits from 1984......................................5,000
Foreign tax credits from 1983......................................7,000
Actual taxable income.............................................50,000

[[Page 550]]

From foreign sources..............................................25,000

(ii) The credit reduction adjustment and minimum tax liability for
the taxable year are determined as follows:

1. Taxable income (determined as ........... ........... $140,000
though preferences were not
allowed)........................
2. Tax preferences for 1984...... ........... ........... 90,000
3. Taxable income (line 1 minus ........... ........... 50,000
line 2).........................
4. Regular tax on line 3 amount
(actual regular tax) before
credits:
$25,000x.15=$3,750
25,000x.18=4,500............ ........... ........... 8,250
5. Foreign tax credits allowed ........... ........... 4,125
against regular tax (limited to
50% of actual regular tax under
sec. 904)--1984 foreign tax
credits.........................
6. Regular tax after credits ........... ........... 4,125
(line 4 minus line 5)...........
7. Regular tax on line 1 amount
(non-preference regular tax)
before credits
25,000x.15=$3,750............
25,000x.18=4,500.............
25,000x.3=7,500..............
25,000x.4=10,000.............
40,000x.46=18,400............ ........... ........... 44,150
8. Foreign tax credits allowed
against non-preference regular
tax:
$5,000 (1984 foreign tax
credits)
7,000 (1983 foreign tax ........... ........... 12,000
credits)....................
(the allowed credits do not
exceed the section 904
limitation of $22,075)
9. Non-preference regular tax ........... ........... 32,150
after credits (line 7 minus line
8)..............................
10. Freed-up credits (line 8
minus line 5):
1984 foreign tax credits..... $5,000
(4,125)
-------------
$875
1983 foreign tax credits..... $7,000
0
-------------
7,000
Total...................... ........... $7,875

------------------------------------------------------------------------
Non-
Type Freed-up Divided by beneficial
credit tax rate preferences
------------------------------------------------------------------------
FTC (84)........................... $875 .30 $2,917
FTC (83)........................... 6,625 .30 22,083
Do............................. 375 .40 938
------------ ------------
7,875 25,938
============ ============
Total non-beneficial preferences..................... 25,938
------------------------------------------------------------------------

12. Beneficial preferences (line 2 minus line 11)......... 64,062
13. Minimum tax on total tax preferences ((line 2 minus 12,000
the greater of line 6 or $10,000)x.15)...................
14. Minimum tax on beneficial preferences ((line 12 minus 8,109
the greater of line 6 or $10,000)x.15)...................
15. Credit reduction amount (line 13 minus line 14)....... 3,891
16. Reduction of freed-up credits under the exact method
(subtotals of line 11 multiplied by .15):
(a) 1984 foreign tax credits:
$2,917x.15=$438
(b) 1983 foreign tax credits:
($22,083+$938) x.15=$3,453
(c) Total credit reduction.............................. 3,891

Note:If X had elected to use the simplified credit reduction method,
the amount of credit reduction would be determined by multiplying the
amount of freed-up credit in each category and taxable year by the
following ratio:
[GRAPHIC] [TIFF OMITTED] TC14NO91.154

[[Page 551]]

(d) Under this method, the 1984 freed-up foreign tax
credits would be reduced by $433 ($875x.494)and the
1983 freed-up foreign tax credits would be reduced by
$3,458 ($7,000x.494).
17. Freed-up credits after reduction under the exact
method (line 10 subtotal minus line 16 subtotals):
(a) 1984 foreign tax credits ($874 minus $438)........ 437
(b) 1983 foreign tax credits ($7,000 minus $3,453).... 3,547
Thus, assuming that Corporation X did not elect to use the simplified
method, Corporation X will carryover $437 of 1984 foreign tax credits to
1985 and $3,547 of 1983 foreign tax credits to 1985. Had Corporation X
elected to use the simplified method, freed-up credits after reduction
would be as follows:
(a) 1984 foreign tax credits ($875 minus $433)........ 442
(b) 1983 foreign tax credits ($7,000 minus $3,458).... 3,542

Example 2. (i) Corporation X has the following items for its 1985
taxable year:

Taxable income (determined as though preferences were $1,500,000
not allowed)...........................................
1984 investment tax credits............................. 400,000
1985 investment tax credits............................. 100,000
Actual taxable income................................... 1,000,000
(ii) The credit reduction and minimum tax of X for 1985
are determined as follows:
1. Taxable income determined as though.................. $1,500,000
2. Tax preferences for 1985............................. 500,000
3. Taxable income (line 1 minus line 2)................. 1,000,000
4. Regular tax on line 3 amount (actual regular tax)
before credits:........................................
$25,000x.15=$3,750
25,000x.18=4,500
25,000x.30=7,500
25,000x.40=10,000
900,000x.46=414,000................................... 439,750
5. Investment tax credits allowed (limited under section 377,537
38 (c) to $25,000 of net tax liability, plus 85 percent
of net tax liability in excess of $25,000..............
6. Regular tax after credits (line 4 minus line 5)...... 62,212
7. Regular tax on line 1 amount (non-preference regular
tax) before credits:
25,000x.15=$3,750
25,000x.18=4,500
25,000x.30=7,500
25,000x.40=10,000
900,000x.46=414,000
405,000x.51=206,550
95,000x.46=43,700 690,000
8. Investment tax credits allowed against non-preference 500,000
regular tax............................................
9. Non-preference regular tax after credits (line 7 190,000
minus line 8)..........................................
10. Freed-up credits (line 8 minus line 5):
1984 investment tax credit............................ $400,000
(377,537)
---------------
22,463
1985 investment tax credit............................ $100,000
--0--
---------------
100,000
---------------
Total............................................. $122,463
===============

11. Non-beneficial preferences are computed as set forth in the
table below. Under this computation, non-beneficial preferences are
considered to free up credits that would have offset non-preference
regular tax beginning at the lowest tax rates at which income that was
offset by tax preferences otherwise would have been subject to regular
tax. In this case, income that was offset by tax preferences would have
been taxed beginning at the 51 percent marginal tax rate. Although some
of the income offset by preferences would be taxed at the 46 percent
marginal rate (because taxable income in excess of $1,405,000 is not
subject to the 5 percent addition to tax on taxable income in excess of
$1 million), the 51 percent marginal rate is taken into account first.

Total non-beneficial 240,123
preferences.................
------------------------------------------------------------------------

12. Beneficial preferences (line 2 minus line 11).......... 259,877
13. Minimum tax on total tax preferences ((line 2 minus the 65,668
greater of line 6 or $10,000) X .15)......................

[[Page 552]]

14. Minimum tax on beneficial preferences ((line 12 minus 29,650
the greater of line 6 or $10,000) X .15...................
15. Credit reduction amount (line 13 minus line 14)........ 36,018
16. Reduction of freed-up credits under the exact method
(subtotals of line 11 multiplied by .15):
(a) 1984 investment tax credits:
$44,045 x .15=$6,607
(b) 1985 investment tax credits:
$196,078 x .15=$29,411
(c) Total credit reduction............................... 36,018
17. Fixed-up credits after reduction (assuming that
Corporation X does not elect the simplified method):
(a) 1984 investment credit ($22,463 minus $6,607)........ 15,856
(b) 1985 investment credit ($100,000 minus $29,411)...... 70,589

(e) Miscellaneous rules--(1) Investment Credit Recapture. If during
any taxable year property to which section 47 applies is disposed of,
then for purposes of determining any increase in tax under section 47
for such year, the amount of any reduction under this section of freed-
up section 38 credit which was earned in the year the property was
placed in service shall be treated as a credit that was allowed in a
prior taxable year.

Example. Corporation D places property in service in 1983 that
generates investment tax credits of $10,000. D earns no other investment
tax credits in 1983. None of the investment tax credits are used to
reduce tax liability in 1983 or any prior years. In 1984, D uses $1,000
of this credit to reduce regular tax liability. In addition, D has items
of tax preferences in 1984. However, under section 58(h), D is not
liable for minimum tax on any of these preference items because none of
these preference items produces a tax benefit in 1984. As a result, an
adjustment is made under the provisions of Sec. 1.58-9 and the
investment tax credit carryforward from 1983 is reduced by $4,000. Thus,
D has an investment tax credit carryforward of $5,000 that is
attributable to the property placed in service in 1983. In 1986, the
property is disposed of and the investment tax credits earned in 1983
are recomputed as required under section 47. This recomputation results
in a reduction of $6,000 of the investment tax credits earned in 1983. D
must now adjust its 1983 investment tax credit carryforward under
section 47(a)(6) by reducing this carryforward to zero. In addition, D
has an additional tax liability of $1,000 for 1986.

(2) Period of limitations; adjustments to tax liability. The
adjustments described in this section shall, in general, apply for
purposes of assessing deficiencies or claiming refunds of tax for any
taxable year for which the tax liability is affected by the adjustments
of this section, provided that the period of limitations under section
6501 has not expired for such taxable year. Therefore, these adjustments
generally apply for purposes of assessing deficiencies and refunding any
overpayment of tax for all years for which the period of limitations has
not expired regardless of whether the period of limitations has expired
for the taxable year in which the non-beneficial preferences arose.
However, the adjustments of this section do not apply to reduce
otherwise allowable credits that were freed up by such non-beneficial
preferences where:
(i) The taxpayer paid minimum tax on all tax preference items
arising in the taxable year in which the non-beneficial preferences
arose;
(ii) The taxpayer has not made a claim for a credit or refund for
such minimum tax; and
(iii) The period of limitations for claiming a credit or refund
under section 6511 has expired for such taxable year.
(A) Further, if--
(1) the taxpayer never paid minimum tax attributable to non-
beneficial preferences;
(2) credits that were freed up by such preferences were used to
reduce tax liability for a taxable year for which the period of
limitations has expired; and
(3) credits so used exceed the amount of credits that would have
been available if the credit reduction required under this section with
respect to such preferences had been made,
(B) Then, the taxpayer shall be liable for the minimum tax equal to
the amount of credits so used, provided the period of limitations has
not expired for the taxable year in which preferences arose.
(3) Claims for credit or refund. A taxpayer may claim a credit or
refund of minimum tax that was made on non-beneficial preferences.
However, such a claim for a credit or refund shall be disallowed to the
extent that the taxpayer has reduced tax liability in a

[[Page 553]]

taxable year for which the period of limitations has expired by using
freed-up credits in excess of the amount that would have been available
if the credit reduction required under this section had been made. Such
claim must be made by filing an amended return for the taxable year for
which such minimum tax was paid. Further, if a claim for credit or
refund is filed, amended returns must also be filed for any taxable year
for which tax liability would be affected as a result of the reduction,
under this section, of credits freed up by such non-beneficial
preferences. See section 6511 and the regulations thereunder regarding
the period of limitations for claiming a credit or refund.
(4) Carryovers of foreign tax credit to taxable years after 1986. In
the case of foreign tax credit carryforwards to taxable years beginning
after December 31, 1986, reductions in such credits required under this
section shall apply for purposes of computing the alternative minimum
tax foreign tax credit under section 59(a) of the Internal Revenue Code
of 1986 as well as for purposes of computing the foreign tax credit for
regular tax purposes.
(5) Credit Carrybacks. If credit carrybacks increase the amount of
credits for a taxable year, the adjustments described in this section
shall be recomputed taking into account the additional credits. This
rule may be illustrated by the following examples:

Example 1. (i) In 1981 corporation D has actual taxable income of
$72,500 and regular tax before credits of $15,000. In computing actual
regular taxable income, D made use of $36,739 of tax preference items,
so that D's taxable income determined as though preference were not
allowed would be $109,239. D's non-preference regular tax before credits
is $30,000. D earns $25,000 of foreign tax credits in 1981, none of
which exceed the limitation under section 904 determined using either
actual regular taxable income or the non-preference taxable income.
These credits reduce actual regular tax to zero ($0) and would have
reduced non-preference regular tax to $5,000 ($30,000 minus $25,000).
Thus, D has freed-up foreign tax credits from 1981 of $10,000 ($25,000
minus $15,000). Pursuant to the adjustments required under this section,
D determines that its credit reduction amount is $3,843 and reduces its
freed-up credit (and its credit carryover) from 1981 to $6,157 ($10,000
minus $3,843). D also pays minimum tax of $167 on $11,114 of beneficial
preferences (($11,114 minus $10,000) multiplied by .15).
(ii) In 1982 D earns additional foreign tax credits. After
application of the foreign tax credit carryback rules, D would have
$5,000 of 1982 foreign tax credits available for use in 1981. D must
recalculate the adjustments required under this section by treating
$5,000 of foreign tax credit from 1982 as carried back and (assuming
that these credits do not exceed the limitation under section 904) used
to reduce non-preference regular tax liability in 1981 to zero ($0).
That is, $5,000 of the foreign tax credits earned in 1982 are treated as
credits freed up because of D's tax preference items in 1981. Pursuant
to the rules set forth herein, D must take into account the foreign tax
credits from both 1981 and 1982 in determining to what extent a tax
benefit was derived from the preference items used to determine actual
regular tax liability in 1981 and in computing the credit reduction
amount. When the $5,000 of foreign tax credits from 1982 are considered,
all preferences become non-beneficial preferences, and the credit
reduction amount is $4,010. Assuming that D elects the simplified
method, the 1981 freed-up credits and the 1982 freed-up credits will
each be reduced by the following percentage:
[GRAPHIC] [TIFF OMITTED] TC14NO91.155

The 1981 freed-up foreign tax credits of $10,000 are thus reduced by
$2,673 ($10,000 multiplied by .2673), to $7,327 and the 1982 freed-up
foreign tax credits of $5,000 are reduced by $1,334 ($5,000 multiplied
by .2673) to $3,666. D also files a claim for credit or refund of the
$167 of minimum tax paid in 1981.
Example 2. In 1985 corporation E's non-preference regular taxable
income was $25,000. E had no available credits. It paid zero in regular
tax, however, because of $25,000 in preference items. E paid $2,250 of
minimum tax on these preferences (($25,000 minus $10,000) multiplied by
.15). In 1986, E has additional investment tax credits. After
application of the investment tax credit carryback rules, E would have
$1,000 investment tax credit from 1986 available for use in 1985. E must
recompute the adjustments required under this section by treating $1,000
of these 1986 investment tax credits as carried back and used to reduce
non-preference regular tax liability for 1985. Pursuant to the rules of
this section, all of these $1,000 of credits are freed-up credits. Non-
beneficial preferences are $6,667 ($1,000 grossed up at a 15 percent
regular tax rate). Beneficial preferences are $18,333 ($25,000 minus
$6,667). Minimum tax on all preferences would be $2,250 (($25,000 minus
$10,000) multiplied by .15); minimum tax on beneficial preferences would
be $1,250 (($18,333 minus $10,000) multiplied by .15).

[[Page 554]]

Minimum tax attributable to the non-beneficial preferences is thus
$1,000 ($2,250 minus $1,250), which is the credit reduction amount. E
thus reduces the $1,000 of credits carried back to 1985 to zero. Under
the rules of this section, the amount of minimum tax due for 1985 is
redetermined. It is equal to the minimum tax on beneficial preferences,
which, as described above, is $1,250. Because E paid minimum tax of
$2,250 in 1985, E files a claim for credit or refund for $1,000 of the
minimum tax paid in 1985.

(f) Treatment of net operating losses. [Reserved]

[T.D. 8416, 57 FR 19255, May 5, 1992; 57 FR 24848, June 11, 1992]