Section 291: Corporate Tax Preference Item Reductions

The U.S. tax code provides special deductions and income calculation methods, known as tax preferences, to encourage specific business activities. These provisions can lower a company’s tax liability compared to standard accounting rules. While these incentives serve a public policy purpose, Congress recognized the need to ensure corporations benefiting from them still contribute a fair amount of tax. To achieve this balance, the Internal Revenue Code includes rules that limit or “cut back” the tax benefits derived from certain preference items, moderating their advantages without eliminating them.

Corporations Subject to the Rule

The special rules that reduce tax preference items, detailed in Internal Revenue Code Section 291, apply exclusively to C corporations. A C corporation is a legal structure where the business is taxed separately from its owners. This distinction means that other business structures, like S corporations, partnerships, and sole proprietorships, are not subject to the Section 291 cutback rules. The only exception is for an S corporation that was a C corporation within the three immediately preceding tax years, which may still be subject to these rules.

Targeted Corporate Preference Items

Depreciation on Section 1250 Property

One of the primary targets of Section 291 is the gain from the sale of depreciable real property, known as Section 1250 property. When a business sells such property for a gain, a portion may be “recaptured” and taxed as ordinary income instead of at the more favorable capital gains rate. Section 291 increases the amount of gain treated as ordinary income for C corporations. It recharacterizes 20% of the additional gain that would have been ordinary income if the property were Section 1245 property (personalty) instead of Section 1250 property, which reduces the capital gain benefit.

Percentage Depletion for Coal and Iron Ore

Businesses involved in mining can recover their investment in mineral deposits through depletion deductions. One method, percentage depletion, allows a deduction based on a fixed percentage of the gross income from the property. For coal and iron ore, Section 291 reduces the allowable percentage depletion deduction by 20%. This reduction applies to the amount of the depletion deduction that exceeds the property’s adjusted basis at the end of the tax year, calculated before taking the current year’s depletion.

Intangible Drilling and Development Costs

Companies in the oil, gas, and geothermal industries incur intangible drilling and development costs (IDCs). These costs, which include wages and site preparation, can generally be deducted immediately rather than capitalized. For integrated oil companies, Section 291 reduces the amount of IDCs that can be expensed in the current year by 30%. The disallowed portion is not lost; instead, it must be amortized, or deducted ratably, over a 60-month period beginning with the month the costs are paid or incurred.

Mineral Exploration and Development Costs

Similar to IDCs, costs associated with exploring for and developing domestic mineral deposits (other than oil and gas) can be expensed immediately. Section 291 also applies a 30% reduction to the amount of these costs that a C corporation can deduct in the current year. Just like with IDCs, the 30% portion that is disallowed for immediate expensing must be capitalized and amortized over a 60-month period.

Amortization of Pollution Control Facilities

To encourage businesses to invest in environmentally friendly equipment, the tax code allows for the rapid amortization of certified pollution control facilities over a 60-month period. For C corporations making this election, Section 291 reduces the amortizable basis of the pollution control facility by 20%. This means the corporation can only calculate its 60-month amortization deduction on 80% of the facility’s cost. The remaining 20% of the basis must be depreciated under the regular Modified Accelerated Cost Recovery System (MACRS) rules.

Calculating the Reduction of Tax Benefits

The core mechanism of Section 291 is a reduction of specific tax benefits by a fixed percentage, creating either additional ordinary income or a smaller current-year deduction. The most common application involves the sale of Section 1250 real property. To calculate the adjustment, a corporation determines the gain that would have been recaptured if the asset were Section 1245 property, which recaptures all depreciation as ordinary income. The Section 291 adjustment is 20% of the difference between the Section 1250 and Section 1245 recapture amounts.

For example, assume a C corporation sells a building for a gain of $200,000. It had taken $150,000 in straight-line depreciation. Under normal Section 1250 rules, none of this gain would be ordinary income. However, if the building were Section 1245 property, the full $150,000 of depreciation would be recaptured as ordinary income. Section 291 requires the corporation to treat 20% of this $150,000 amount, or $30,000, as ordinary income. The remaining $170,000 of the gain would be treated as a capital gain.

Relationship to Corporate Alternative Minimum Tax

The relationship between Section 291 and the corporate Alternative Minimum Tax (AMT) has changed due to recent legislation. The prior corporate AMT, which directly interacted with tax preference items, was repealed by the Tax Cuts and Jobs Act of 2017. The Inflation Reduction Act of 2022 established a new corporate AMT (CAMT) for large corporations, effective for tax years beginning after 2022.

This new tax is calculated as 15% of a corporation’s “adjusted financial statement income” (AFSI) and applies to corporations with an average annual AFSI exceeding $1 billion. The CAMT calculation begins with financial statement income, not the regular taxable income that Section 291 modifies. Therefore, the direct mechanical link between Section 291 and the AMT no longer exists.