Congress Passes Inflation Reduction Act and Sends to President Biden for Enactment

The Inflation Reduction Act of 2022 (Act) was passed by the House of Representatives on August 12, 2022 and is now headed for President Joseph Biden’s signature. The Act includes targeted business tax increases, funding for IRS compliance and enforcement, incentives to promote climate change mitigation and clean energy, and expansion of the small business payroll tax research credit. The measure extends for two years the excess business loss limitation for individuals, estates and trusts.

The filibuster-proof reconciliation legislation resurrects portions of the Build Back Better Act that had been stalled in the Senate since late last year. President Biden is expected to sign the measure in the coming days.

The result of a behind-closed-doors project between Senate Majority Leader Charles Schumer (D-NY) and Senator Joe Manchin (D-WV), the Act faced an initial challenge from Senator Kyrsten Sinema (D-AZ) who negotiated for changes, including the removal of a provision to increase taxes on carried interests targeting wealthy investors, before she would offer her support.

The Act was passed by the Senate on August 7, 2022. The amendment process in the Senate resulted in the extension of the excess business loss limitation for an additional two years, a last minute and unexpected change.

Below are highlights of the major tax provisions in the legislation along with insights to consider with your Andersen advisor.

Excess Business Loss Limitation Extended

An amendment offered by Senator Warner (D-VA) extended the excess business loss limitation for individuals, estates and trusts under Sec. 461(l) for an additional two years, to include 2027 and 2028. The extension was an alternative way to raise $52 billion in additional revenue to offset the amendment to the corporate minimum tax offered by Senator Thune (R-SD) which would have extended the $10,000 SALT cap for an additional year.

The excess business loss provision was not included in the legislative text or in the agreement announced between Senators Manchin and Schumer before the Act was approved by the Senate. The American Rescue Plan, enacted March 11, 2022, previously extended the Sec. 461(l) limitation for an additional year, to include 2026. The Build Back Better Act would have changed the operation of the carryforward to be treated as subject to the limitation on business income and not as a net operating loss (NOL) and would have made the provision permanent. Further extension of the excess business loss provision beyond 2028 is a possibility for future legislation as a way to raise revenue.

Corporate Minimum Tax

In a measure intended to target only the largest of U.S. corporations, the corporate alternative minimum tax (AMT) provision would impose a 15% minimum tax on adjusted financial statement income for corporations with profits in excess of $1 billion in average annual earnings in the previous three years. In the case of U.S. corporations that have foreign parents, it would apply only to income earned in the United States of $100 million or more of average annual earnings in the previous three years (and apply when the international financial reporting group has income of $1 billion or more). It would apply to a new corporation in existence for less than three years based on the earnings in the years of existence.

Expressly excluded from the tax are Subchapter S corporations, regulated investment companies (RICs), and real estate investment trusts (REITs). The tax would apply to large private equity firms organized as partnerships, but excludes portfolio companies owned by these firms.

Firms that file consolidated returns would include income allocable to the firm from related firms including controlled foreign corporations (and any disregarded entities); for other related firms, dividends would be included.

Corporations would generally be eligible to claim NOLs and tax credits against the AMT, and would be eligible to claim a tax credit against the regular corporate tax for AMT paid in prior years, to the extent the regular tax liability in any year exceeds 15% of the corporation’s adjusted financial statement income. At the request of Senator Kyrsten Sinema (D-AZ), the provision was modified to remove the impact of bonus or accelerated depreciation expense from the computation of adjusted financial statement income, which should moderate the impact on manufacturers.

The additional tax would equal the amount of the minimum tax in excess of the regular income tax plus the additional tax from the Base Erosion and Anti-Abuse Tax. Income would be increased by federal and foreign income taxes to place income on a pretax basis.

This provision is intended to impact no more than 200 corporations as a result of the $1 billion profits threshold.  The corporate minimum tax, which would take effect beginning with the 2023 tax year,  is expected to create a variety of compliance challenges, in part due to differences between the computation of financial statement income under accounting principles as compared with taxable income, as determined after applying available deductions and credits as provided for in the Internal Revenue Code.

Excise Tax on Stock Buybacks

A 1% excise tax on the repurchase of stock by publicly traded corporations was added to the Act as part of the negotiation with Senator Sinema. The provision, which would apply to repurchases after December 31, 2022, targets publicly traded U.S. companies that repurchase their own shares in the marketplace and the excise tax would equal 1% of the value of the stock repurchased by the company during the tax year.

The amount subject to tax would be reduced by any new issues to the public or stock issued to employees. The tax would not apply if repurchases are less than $1 million or are contributed to an employee pension or similar plan.

The tax would not apply if the repurchases are treated as a dividend. It also would not apply to repurchases by RICs or REITs. Further, it would not apply to repurchases that are treated as dividends or to purchases by a dealer in securities in the ordinary course of business.

The excise tax would apply to purchases of corporation stock by a subsidiary of the corporation (a corporation or partnership that is more than 50% owned). The tax would also apply to purchases by a U.S. subsidiary of a foreign-parented firm. It would apply to newly inverted (after September 20, 2021) or surrogate firms (firms that merged to create a foreign parent with the former U.S. shareholders owning more than 60% of shares).

IRS Compliance and Enforcement

The Act provides a special allocation of $80 billion to fund IRS compliance and enforcement which is more than six times the current IRS budget of $12.6 billion. The provision provides substantially more funding for enforcement activity ($45.6 billion) than for beleaguered taxpayer services ($3.2 billion). Given the priority of funding, taxpayers can anticipate targeted enforcement and ongoing issues with IRS service functions that will be best addressed with the assistance of a tax advisor well-versed in IRS practice, procedure and controversy. It will also be increasingly important for taxpayers to have documentation to substantiate and defend tax positions going forward.

Clean Energy Incentives

The legislation provides for an investment of approximately $370 billion in strategies designed to combat climate change over the next decade including investments in renewable energy production and tax incentives for consumers. The Act allocates $60 billion for a clean energy manufacturing tax credit and $30 billion for a production tax credit for wind and solar. Tax credits for nuclear power and carbon capture technology are also included in the bill.

Among the consumer incentives built into the legislation is a 10-year consumer tax credit for renewable energy investment in wind and solar. There are also tax breaks for buying electric vehicles including a $7,500 for new electric vehicles and a $4,000 tax credit for the purchase of used ones.

While many of the Act’s provisions are based on similar ones introduced in the Build Back Better Act, the legislation also adds a new provision that would allow taxpayers to transfer certain energy credits to another taxpayer.

The provisions could generate a significant amount of development capital and additional opportunities. For a summary of the provisions, see this chart.

Small Business Payroll Tax Research Credit

The Act also includes an increase in the small business payroll tax research credit under Sec. 41(h). For taxable years beginning after 2022, the credit is increased to $500,000 (currently $250,000).

The opportunity to offset payroll taxes is a significant opportunity for startup companies that are not paying income taxes due to NOLs. The legislation would double the credit potential for qualified small businesses.

The Takeaway

The Act includes targeted business tax increases, funding for IRS compliance and enforcement, incentives to promote climate change mitigation and clean energy, and expansion of the small business payroll tax research credit. The measure extends for two years the excess business loss limitation for individuals, estates and trusts. Contact an Andersen advisor to learn how these changes impact your situation.