The Inflation Reduction Act (the “Act”), a significantly slimmed down version of the Build Back Better Act, was signed into law by President Biden on August 16, 2022. The bill was passed by Congress after a 220-207 vote in the House on August 12, 2022. This followed passage in the Senate on August 7, 2022 by a vote of 51-50, with Vice President Kamala Harris casting the tiebreaking vote.
The Act provides investment in clean energy, promotes reductions in carbon emissions, and extends popular Affordable Care Act premium reductions. It will be paid for through the implementation of a 15 percent corporate minimum tax, budget increases for the Internal Revenue Service to close the tax gap, an excise tax on stock repurchases, and changes to Medicare rules.
The Inflation Reduction Act is significantly smaller than any proposed version of the Build Back Better Act. As such, nearly all of the revenue-generating provisions of prior proposals have been eliminated.
Corporate Alternative Minimum Tax
Effective for tax years beginning after December 31, 2022, the Act introduces an alternative minimum tax (AMT) that would impose a 15 percent minimum tax on “adjusted financial statement income” (AFSI) of applicable corporations. An applicable corporation’s minimum tax would be equal to the amount by which the tentative minimum tax exceeds the corporation’s regular tax for the year, including its base erosion and anti-abuse tax (BEAT) for the tax year.
The Act's alternative minimum tax can be thought of as a "Book Minimum Tax" because the starting point of the calculation is a corporation's average annual adjusted financial statement income which includes financial statements prepared in accordance with generally accepted accounting principles (GAAP). This is a departure from the previous calculation of the corporate alternative minimum tax ("Old AMT") rules, in place prior to the Tax Cuts and Jobs Act (TCJA of 2017), where the starting point was taxable income.
An “applicable corporation” is defined as any corporation (other than an S corporation, regulated investment company or a real estate investment trust) with three-year average annual AFSI that exceeds $1 billion. For these purposes, a corporation must calculate its three-year average AFSI without regard to financial statement net operating losses (NOLs), but with regard to certain specified adjustments to book income, to determine whether the average in any year exceeds $1 billion. The specified adjustments include items related to related entities, foreign income, disregarded entities, federal income taxes, non-reasonable compensation, covered benefit plan amounts, and tax depreciation.
It is important to highlight that tax depreciation deductions, not book, would reduce AFSI, which is intended to help businesses that invest in equipment and facilities (such as manufacturers). Additionally, financial statement NOLS can reduce AFSI.
Carried Interest Rules
Perhaps the most notable difference between the bill proposals in their original form and the bill that was approved by both the Senate and the House is the provisions in connection with carried interest. As originally drafted, the Act would have introduced an extended five-year holding period for partnership interests held in connection with the performance of services (“carried interest”) to qualify for long-term capital gain treatment. The longer holding period would have applied to taxpayers with an adjusted gross income (“AGI”) of $400,000 or more.
To replace the estimated $14 billion that would have been raised through the changes to the carried interest rules, Democrats introduced a new 1 percent excise tax on stock buybacks that is expected to bring in an estimated $73 billion in revenue.
Excise Tax
The Act imposes on each “covered corporation” a 1 percent non-deductible excise tax on the fair market value of any stock repurchased by a domestic corporation with stock traded on an established securities market. A “repurchase” is defined as a redemption under the U.S. Tax Code or other economically similar transaction, as opposed to a dividend payment to shareholders. The tax would apply to repurchases after December 31, 2022. The tax extends to certain affiliates of U.S. corporations, as well as specified affiliates of foreign corporations performing buybacks on behalf of their parent organization.
Some stock repurchases would be exempt from the excise tax, including tax-free reorganizations, repurchased stock contributed to a pension plan or ESOP, or when the total annual amount of repurchases equals $1 million or less.
Extension of Limitation on Excess Business Losses of Noncorporate Taxpayers
The Tax Cuts and Jobs Act (TCJA), enacted in 2017, reformed the income tax treatment of business losses for individual taxpayers and those treated like individuals for income tax purposes (i.e., trusts and estates). Initially effective for tax years beginning after 2017, §461(l) of the Internal Revenue Code limited the ability of noncorporate taxpayers to offset net business losses to $250,000 of nonbusiness income for single filers, including trusts, and $500,000 for joint filers. These amounts are indexed for inflation such that for 2021, the threshold amounts are $262,000 and $524,000 for single and joint filers, respectively. A business loss in excess of this allowance (excess business loss or EBL) is treated as a net operating loss (NOL) in subsequent years, deductible against any type of income (subject to an 80 percent of taxable income limitation).
As a result of the CARES Act, enacted during the pandemic in 2020, the EBL rules were suspended retroactively from 2018 through 2020. Beginning in 2021 they are back in play.
The Act extends the limitation on excess business losses of noncorporate taxpayers until 2028, a two-year extension.
Increased Funding for the IRS
Closing the tax gap – the difference between what should be collected by the IRS and what is actually collected – attracted significant attention in the Act. It allocates roughly $80 billion to the IRS over the next decade, expecting it to increase tax revenue by $200 billion over the same period due to increased enforcement and compliance.
Affordable Care Act
The Act extends Affordable Care Act provisions from the American Rescue Plan Act of 2021. Specifically, the expansion of affordability percentages used in calculating the premium tax credit to make credits available for individuals with incomes above 400 percent of the federal poverty line, as well as credit amounts for those already qualified, applies through 2025. Without the extension, these provisions would expire at the end of 2022.
Research Credit for Small Businesses
In tax years beginning after 2015, certain qualified small businesses are permitted to claim a limited amount of the research credit against payroll taxes. Under the new Act, in tax years beginning after 2022, the amount of this limitation is increased from $250,000 to $500,000.
Clean Energy Tax Credits
The Act also offers many tax incentives related to green energy, including but not limited to:
- Consumer tax credits for home energy efficiency and clean energy projects such as installing heat pumps or rooftop solar panels
- Enhanced electric vehicle tax credits no longer limited by the number of vehicles sold but rather the model’s price and the purchaser’s income
- Production tax credits for the manufacture of solar panels, wind turbines, batteries, and critical minerals processing
- Enhanced investment tax credits for renewable energy activities such as building clean technology manufacturing facilities that make wind turbines and solar panels
- Additional tax credits for clean commercial transportation, industrial manufacturing, and production of biofuels
While the above items highlight the various tax provisions included in the Act, it is important to note those tax law changes that are not included in the bill.
The Tax Cuts and Jobs Act enacted in 2018 contained a provision whereby beginning January 1, 2022, costs incurred for R&D activities will no longer be immediately deductible. Instead, the costs will have to be capitalized and amortized over 5 or 15 years. Costs related to research activities performed in the U.S. will be recovered over a 5-year amortization period, while those related to research activities performed outside the U.S. will be recovered over a 15-year period.
As a result of this treatment, there may be significant timing differences between when a company incurs and pays for these expenses and the ultimate deductibility for tax purposes. These differences will likely result in increased taxable income. The Build Back Better Act included a provision to allow the immediate deduction of research and development costs each year. However, this provision was not included in Inflation Reduction Act.
The extension of the $10,000 limit on a taxpayer’s deduction for state and local income taxes (“SALT cap”) was not included in the Act and will remain in effect pending additional legislative action.