On August 7, 2022, the Senate passed the Inflation Reduction Act of 2022 (H.R. 5376) (the “Act”). The announced goal of the Act is to create an economic initiative to address various climate protection initiatives. In addition to the climate focused initiatives, the Act is also designed to have a significant impact on tax and health care policy in the United States.
The House of Representatives is expected to pass the Act on August 12, 2022 and the President is expected to sign the bill into law shortly thereafter. At this time, it is unclear what further revisions, if any, will be made to the Act as part of this legislative process. Below is a summary of the significant tax related provisions as set forth in the version of the Act as passed by the Senate.
Imposition of a New Corporate Alternative Minimum Tax
Under current tax law, income tax is imposed on the taxable income of the taxpayer. The profit and loss of the taxpayer, as reported on the taxpayer’s financial statements, is not determinative of the amount of income tax liability. As passed by the Senate, the Act would impose a new corporate alternative minimum tax that will based on “adjusted financial statement income.” That would apply to some, but not all, taxpayers operating as C corporations that meet certain financial thresholds.
Under the Act, a new corporate alternative minimum tax would be imposed at a rate of 15 percent of the adjusted financial statement income of “applicable corporations.” Adjusted financial statement income is defined generally as the net income or loss of the taxpayer as set forth on the taxpayer’s applicable financial statement, with certain adjustments. These adjustments include disregarding the financial statement impact of income taxes and, in the case of certain tax-exempt entities, to only take into account adjusted financial statement income of an unrelated trade or business and income derived from debt-financed property. Further, tax depreciation is allowed in lieu of financial statement depreciation and net operating loss carryforwards are allowed but limited to the lesser of financial statement net operating loss carryovers or eighty percent of adjusted financial statement income.
In general terms, a corporation will be treated as an “applicable corporation” if the corporation has average adjusted financial statement income for a 3-year period ending in excess of one billion dollars for one or more taxable years ending after December 31, 2021. This determination is made by including adjusted financial statement income of controlled group members.
Certain exceptions are provided for corporations which undergo changes in ownership or have a specified number of consecutive taxable years (to be determined by Treasury) in which the corporation does not meet the average annual adjusted financial statement income test. Special rules are also provided which govern the application of these rules to foreign parented multinationals and foreign entities engaged in a U.S. trade or business.
Creation of an Excise Tax on Stock Repurchases
The Act levies an excise tax of 1% of the fair market value of any stock which is repurchased by a covered corporation. A covered corporation includes any domestic publicly traded corporation or partnership and certain of their affiliates, disadvantaging U.S.-parented public corporations vis-a-vis their foreign competitors. Repurchases include stock redemptions, transactions considered by IRS to be economically similar to stock redemptions and the acquisition of stock of a covered corporation by a specified affiliate of the corporation. However, the value of the stock treated as repurchased by the corporation is reduced by the fair market value of any stock issued by such corporation during the same taxable year, including shares issued to employees. Finally, the Act makes this excise tax non-deductible.
Creation of Additional Tax Credits Related to Climate Related Matters
Among the changes made by the Act are the extension of the tax credit for electricity produced from certain renewable sources and the modification of this credit to expand its scope. Specifically, these changes would apply to the production tax credit set forth in Section 45 of the Internal Revenue Code. The Act also extends and modifies the investment tax credit set forth in Section 48 of the Internal Revenue Code. The carbon oxide sequestration credit set forth in Section 45Q is also extended. The Act also creates or modifies various credits against fuel excise taxes for biodiesel, renewable diesel and certain alternative fuels.
The Act includes a number of tax credits related to energy efficiency for residences and modifies the energy efficient commercial building deduction which will increase the incentive for building owners to make energy-efficient commercial building (or retrofit existing commercial buildings with energy-efficient improvements).
A summary of all of the tax credits and incentive related to clean energy are beyond the scope of this alert. However, the following is a list of what is currently included in the Act:
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Extension and Modification of Energy Credit
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Energy Credit for Solar and Wind Facilities in Low-Income Communities
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Credit for Carbon Oxide Sequestration
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Zero-Emission Nuclear Power Production Credit
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Biodiesel and Renewable Diesel Credit
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Sustainable Aviation Fuel Credit
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Credit for Production of Clean Hydrogen
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Energy Efficient Home Improvement Credit
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Residential Clean Energy Credit
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Energy Efficient Commercial Budlings Deduction
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New Energy Efficient Home Credit
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Clean Vehicle Credit
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Credit for Qualified Commercial Clean Vehicles
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Alternative Fuel Refueling Property Credit
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Advanced Energy Project Credit
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Advanced Manufacturing Production Credit
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Clean Electricity Production Credit
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Clean Electricity Investment Credit
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Clean Fuel Production Credit
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Increase in research credit against payroll tax for small businesses
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Rural Development and Agricultural Credit
Significant Increase to IRS Funding
Under the Act, an additional $80 billion in funding will be appropriated to the Internal Revenue Service. These additional funds will be available for increased enforcement, operational improvements, customer service, and systems modernization. The additional $80 billion is more than six times the current annual IRS budget of $12.6 billion.
The additional budget would be allocated as follows:
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$45+ billion for tax enforcement including determining and collecting taxes owed by tax debtors, providing legal and litigation support, conducting criminal investigations (including investigative techniques), providing digital asset monitoring and compliance activities, and enforcing criminal statutes related to violations of the tax laws and other financial crimes.
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$25+ billion for operations support.
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Nearly $5 billion for business systems modernization including development of callback technology and other technology to provide a more personalized customer service.
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$3+ billion for taxpayer services including pre-filing assistance and education, filing and account services, and taxpayer advocacy services.
The bill states that these appropriated funds are to remain available until September 30, 2031, and no use of the funds is intended to increase taxes on any taxpayer with taxable income below $400,000.
Certain Limitations on Deductions Imposed under the 2017 Tax Cuts and Jobs Act
1. Limitation of Deductions for State and Local Taxes
The $10,000 cap on the State and Local Tax (“SALT”) deduction was restated but not extended. Sen. John Thune of South Dakota offered an amendment that passed to extend the cap on SALT deductions by another year. In response, Sen. Mark Warner of Virgina replaced Thune’s amendment with a different tax provision striking the one year extension and restating the SALT cap which will remain in place until 2025 and not 2026 as Thune proposed.
2. Limitation on Non-Corporate Losses
The Act extends the limitation for noncorporate taxpayers with “excess business losses.” For this purpose, excess business losses are the amount by which business deductions exceed gross business income. This provision would limit such losses to $500,000 per year (for married filing jointly filers and $250,000 for others) with both amounts indexed for inflation. This provision was scheduled to sunset but has been extended through taxable years beginning before Jan. 1, 2029.
Additional Matters to Note.
Changes to the Carried Interests Rules. At one point, the Senate considered a provision in a prior version of the Act that would have changed the holding period to obtain long-term capital gain treatment on carried interests. As proposed, long-term capital gain treatment on carried interests would have been available for non-real estate related matters if the interest was held for at least five years. This change was removed from the version passed by the Senate.