The Inflation Reduction Act (IRA) was signed by President Biden on August 12, 2022, purportedly to help reduce the country’s crippling inflation. Using the Tax Foundation’s General Equilibrium Model, they estimate that the Inflation Reduction Act would reduce long-run economic output (GDP) by about 0.2% and eliminate approximately 29,000 full-time jobs in the U.S. It would also reduce average after-tax incomes for taxpayers from every income bracket over time.
The House voted to approve a broad package of tax, energy, and healthcare provisions, which was approved by the evenly divided Senate with the tie-breaking vote of Vice President Kamala Harris.
“By reducing long-run economic growth, this bill may actually worsen inflation by constraining the productive capacity of the economy,” states the Tax Foundation.
Summary of Major Tax Provisions
The updated draft legislation of the Inflation Reduction Act includes the following major changes, effective after December 31, 2022.
Individual Income Taxes
- Extends the limitation on pass-through business losses enacted in the 2017 Tax Cuts and Jobs Act (TCJA) for two years through 2028.
- Extends the expanded health insurance Premium Tax Credits provided in the American Rescue Plan Act (ARPA), including allowing higher-income households to qualify for the credits and boosting the subsidy for lower-income households, through the end of 2025.
Corporate and International Taxes
- Imposes a 15% minimum tax on corporate book income for corporations with profits over $1 billion, effective for tax years beginning after December 31, 2022.
- Creates a 1% excise tax on the value of stock repurchases during the taxable year, net of new issuances of stock, effective for repurchases after December 31, 2022. The tax excludes stock contributed to retirement accounts, pensions, and employee stock ownership plans (ESOPs).
Other Modeled Tax Proposals
- Modifies, extends and creates a variety of tax credits for green energy and other efforts primarily through 2031 or 2033.
- Raises the Superfund tax on crude oil and imported petroleum to 16.4 cents per barrel (indexed to inflation) and increases other taxes and fees on the fossil fuel sector.
Significant Proposals Not Modeled
- Expands IRS enforcement funding by about $80 billion over ten years.
- Imposes a 95% excise tax penalty on drug manufacturers to lower drug prices.
- Increases the research & development tax credit amount that can be claimed against payroll taxes for small businesses by $250,000.
Explanation of Tax Provisions 15% Corporate Minimum Tax (aka 15% Billionaire Corporate Tax)
The largest tax provision is the 15% minimum tax on corporate book income for corporations with an average annual adjusted financial statement income exceeding $1 billion for three consecutive prior tax years, effective beginning in 2023.
A corporate alternative minimum tax (AMT) based on financial statement income (book minimum tax, or BMT) provision would impose a 15% minimum tax on adjusted financial statement income (AFSI) for corporations with average annual AFSI over a three-tax year period over $1 billion. The provision would impose a minimum tax equal to the excess of 15% of an applicable corporation’s AFSI over the corporate alternative minimum tax foreign tax credit (AMT FTC) for the tax year. This provision would be effective for tax years beginning after December 31, 2022.
An “applicable corporation” subject to the BMT is a corporation (other than an S corporation, regulated investment company, or real estate investment trust) that meets an AFSI test in one or more tax years prior to the tax year and ending after December 31, 2021. A corporation meets the AFSI test if its average AFSI (determined without regard to the adjustment for financial statement net operating loss carryovers) over the three tax years ending with the relevant tax year exceeds $1 billion.
The bill authorizes Treasury to issue regulations or other guidance on several issues, including:
- Creation of a simplified method for determining whether a corporation satisfies the $1 billion and $100 million tests.
- Determining when a corporation otherwise subject to the BMT should be exempted.
- Modifications to the determination of AFSI, including treatment of current and deferred taxes.
- How the BMT applies when a corporation changes ownership.
- Whether guidance is needed on the AMT FTC.
The 1986 Reform Act introduced an Alternative Minimum Tax based on “business untaxed reported profits” or a “BURP” tax. This BURP tax was similarly based on book profits, and was repealed after only three years. There was a concern at the time that it would have this potentially detrimental effect on the quality of financial reporting, providing an incentive to underreport earnings to minimize tax. This bill expands the influence of the FASB (the 7-member Financial Accounting Standards Board) as their accounting pronouncements will determine the minimum tax assessable to large corporations.
$80 Billion for IRS Budget
The Inflation Reduction Act increases the IRS budget by roughly $80 billion over ten years. The money is broken into four primary categories—enforcement, operations support, business system modernization, and taxpayer services—as well as a few other minor items.
Source: Inflation Reduction Act of 2022 Link Here May not sum due to rounding
Table I: IRS Funding Increases by Category
The goal of enforcement funding is “to collect owed taxes, to provide legal and litigation support, to conduct criminal investigations, to provide digital asset monitoring and compliance activities, to enforce criminal statutes related to violations of internal revenue laws and other financial crimes, to purchase and hire passenger motor vehicles.”
IRS funding for operations support will support taxpayer services and enforcement programs, including “rent payments; facilities services; printing; postage; physical security; headquarters and other IRS-wide administration activities; research and statistics of income; telecommunications; information technology development, enhancement, operations, maintenance, and security; the hire of passenger motor vehicles.”
IRS funding for taxpayer services will go towards programs such as “pre-filing assistance and education, filing and account services, and other services.”
The bill states that these appropriated funds will remain available until September 30, 2031, and no use of the funds is intended to increase taxes on taxpayers with taxable income below $400,000. The provision also provides $15 million for the IRS to prepare and deliver a report to Congress on the cost of developing and operating a free direct efile tax return system. The provision permits Treasury to exercise greater flexibility with respect to personnel, including certain “direct hire” authority.
Excise Tax on Corporate Stock Repurchases
The bill imposes a non-deductible 1% excise tax on publicly traded US corporations for the value of any stock that a corporation repurchases during the tax year.
A “repurchase” is defined as a redemption of the stock of the corporation and any other economically similar transaction as determined by the Treasury. A “specified affiliate” of a publicly traded US corporation that performs the buyback of the publicly traded US corporation’s stock is also subject to the excise tax.
A specified affiliate of a corporation is defined as (1) another corporation more than 50% of the stock of which is owned, directly or indirectly, by the corporation and (2) any partnership more than 50% of the capital interests or profits interests of which is held by the corporation.
The amount of repurchases subject to the tax is reduced by the value of any stock issued by the corporation during the tax year, including stock issued or provided to the employees of the corporation or a specified affiliate of the corporation during the tax year, whether or not such stock is issued or provided in response to the exercise of an option to purchase such stock.
The provision includes special rules for foreign-parented domestic corporations, which would treat a repurchase of stock by certain affiliates of a publicly traded foreign corporation (including domestic corporations, domestic partnerships, and foreign partnerships with domestic partners) as if it were a repurchase by a publicly traded US corporation. Additional rules apply if the foreign corporation is treated as a surrogate foreign corporation under Section 7874 due to a transaction completed after September 20, 2021.
The provision would not apply:
- to the extent the repurchase is part of a reorganization under Section 368(a) and no gain or loss is recognized on the repurchase by the shareholder;
- if the repurchased stock or its value is contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan;
- if the total value of stock repurchased during the tax year does not exceed $1 million;
- if the repurchase is by a dealer in securities in the ordinary course of business;
- to repurchases by a regulated investment company or real estate investment trust; or
- to the extent the repurchase is treated as a dividend.
The provision authorizes Treasury to issue guidance necessary or appropriate to carry out and to prevent the avoidance of the provision. The provision would apply to repurchases of stock after December 31, 2022.
Climate and Clean Energy Provisions
The Inflation Reduction Act includes numerous incentives for clean energy. The bill would reinstate and significantly expand current incentives by providing an estimated $370 billion of new energy-related tax credits over the next ten years. The bill also would significantly impact companies relying on financing arrangements for energy-related projects, permitting more flexibility with direct-pay and transferable credit options.
Collectively, the energy tax provisions in the bill would represent the largest US effort to date to spur reductions in greenhouse gas emissions. They are intended to catalyze material investments by the corporate sector, with several major themes:
- Clean energy generation: The bill extends the current system of tax credits for renewable energy through 2024 and then transitions those incentives into a “technology-neutral” clean electricity credit beginning in 2025. New credits would support nuclear energy and other lower-carbon technologies.
- Clean energy transportation: The bill includes significant extensions, expansions, and enhancements of credits intended to support the widespread adoption of electric vehicles for both passenger and commercial use.
- Building energy efficiency: The bill contains extended and expanded provisions to support investments in building energy efficiency by both commercial real estate owners and homeowners.
- Carbon capture: The bill enhances the existing tax credits for carbon capture and utilization or storage, including a new provision intended to incentivize the commercialization of direct air capture technologies.
- Lower carbon manufacturing and green jobs: Most of the credits in the bill are available at significantly higher levels if prevailing wage and apprenticeship requirements are met. In addition, the bill revives the tax credit program for building advanced energy manufacturing facilities in the United States.
- Credit monetization: The bill allows eligible taxpayers to elect to be treated as having made a tax payment equal to the value of the credit for which they otherwise would be eligible under numerous credits. Taxpayers ineligible for the direct-pay election instead could opt to transfer any applicable credit to another taxpayer.
- Continuity of alternative fuel incentives: The bill retroactively and prospectively extends the biodiesel and biodiesel mixture credits (which also are available for renewable diesel), the alternative fuel credit, and the alternative fuel mixture credits while transitioning to a technology-neutral clean fuels credit beginning in 2025.
- Creation of a sustainable aviation fuels credit: The bill creates a new income and excise tax credit for the sale or use of a qualifying sustainable aviation fuel mixture. The credit would be $1.25 per gallon of sustainable aviation fuel plus an applicable supplementary amount.
Tax Accounting Implications
While credits and incentives often arise in the tax laws and may be claimed on a tax return, they ultimately may not be accounted for within the income tax accounting standard. A number of features can make them more similar to a government grant or subsidy as opposed to a credit related to a net income tax. Therefore, each credit and incentive must be analyzed carefully to determine whether it should be accounted for under ASC 740 or whether it constitutes a government grant and is therefore subject to other guidance.
The application of income tax accounting is warranted if a particular credit or incentive can be claimed only on the income tax return and can be realized only through the existence of taxable income. When there is no connection to income taxes payable or taxable income and when the credits are refundable regardless of whether an entity has an income tax liability, the benefit should be accounted for outside of the income tax model and presented within pre-tax income.
Two-Year Extension of IRC Section 461(l) Business Loss Rules
The Act extends the IRC Section 461(l) excess business loss limitation for non-corporate taxpayers for two years. This limitation was set to expire on January 1, 2027 and will now expire on January 1, 2029.
Prescription Drug Pricing Provisions
The bill makes significant changes to federal prescription drug pricing policies affecting individuals receiving care through Medicare. The bill’s prescription drug pricing provisions would:
- Enable Medicare to negotiate the price of some high-cost, single-source prescription drugs.
- Institute new inflationary rebates under Medicare.
- Cap Medicare Part D prescription drug out-of-pocket costs at $2,000 per year.
- Redesign the Medicare prescription drug program.
The bill incorporates changes made in response to a review by the Senate parliamentarian. The parliamentarian ruled that a requirement for pharmaceutical companies to pay a rebate if the prices of certain prescription drugs exceeded a specified rate of inflation was permitted under Senate rules to apply to Medicare plans but could not be applied to private sector health plans.
The bill retains the $35 per-month cap on insulin copay charges for Medicare participants.
Prescription Drug Pricing Negotiation Noncompliance Excise Tax
The bill seeks to lower prescription drug costs for Medicare patients by imposing a non-deductible excise tax on manufacturers, producers, or importers that fail to enter into negotiated drug pricing agreements. The tax would apply to each sale made during specified non-compliance periods.
The IRS has been authorized to provide clarifying language to many of the aforementioned provisions and was requested by Secretary Yellen to provide a utilization plan of their $80 billion allocation within six months of the passing of this bill.
While not all-inclusive, this article is intended to provide insight into the general provisions of the Act, most of which will take effect next year.