After the surprise announcement at the end of July, the Inflation Reduction Act (the Act) has passed the Senate. Estimated to raise $740 billion with $306 billion earmarked toward deficit reduction, the Act includes provisions to control price increases on prescription drugs, promote climate change remediation along with clean energy provisions and reduce the deficit through targeted tax increases.
The most notable change since it advanced from the Senate Finance Committee to the floor is that the carried interest provision was dropped following negotiations to ensure the support of Sen. Kyrsten Sinema (D-Ariz.). Other changes include modifications to the computation of the corporate minimum tax, the addition of an excise tax on stock buyouts, and an extension of the excess business loss limitation rule for noncorporate taxpayers.
The Act now heads to the House, where potential opposition from the SALT caucus appears to have gone away. The Act does not address the $10,000 state and location tax deduction limitation, but on Sunday, two key Democratic representatives from New Jersey, Mikie Sherrill and Josh Gottheimer, who previously said “no SALT, no deal,” indicated they would support the Act. While not assured, we anticipate the need for a political victory in an election year will result in any opposing House members conceding to the Senate version. If and when the Act passes both chambers of Congress, it is expected to be signed into law by President Joe Biden.
15% corporate minimum tax
Estimated to be the largest revenue raiser in the Act, the 15% corporate minimum tax generally is computed on applicable corporations averaging over $1 billion in adjusted financial statement (AFS) income for three consecutive years. Certain foreign-owned corporations with book income over $100 million are also subject to the minimum tax. While aggregation rules could pull more entities into these thresholds, S corporations, regulated investment companies (RICs) and real estate investment trusts (REITs) are not considered applicable corporations.
Essentially, the tax is calculated at 15% of adjusted financial statement income (AFSI) less any corporate alternative minimum foreign tax credit and net operating losses for the tax year. AFSI is defined to be net income or loss as reported on the AFS with certain modifications, including items related to controlled foreign corporations, disregarded entities, federal income taxes, non-reasonable compensation, covered benefit plan amounts and tax depreciation. Affected taxpayers pay the higher of regular tax or the computed corporate minimum tax.
This tax will impact a wide range of industries, including pharmaceutical, technology, clothing, manufacturing (such as chemical and transportation equipment) as well as wholesale and retail trade, information and holding companies.
While the Act authorizes the Department of Treasury to prescribe regulations or other guidance, this new corporate minimum tax will be complex. Areas needing direction include determining which corporations meet or are exempt from the different thresholds, defining modifications to AFSI, analyzing the impact of ownership changes, among others. Taxpayers should prepare for increased record-keeping requirements and compliance costs.
This tax is effective for tax years beginning after Dec. 31, 2022.
The Act’s original draft called for an extended holding period for partnership interests held in connection with the performance of services before qualifying for long-term capital gain treatment. Essentially, investors would be required to own an applicable partnership interest for five years (instead of the three-year period under current law) before they could take advantage of the 20% long-term capital gain tax rate. This provision would have primarily impacted the private equity and hedge fund industries and was expected to raise approximately $14 billion.
Sen. Joe Manchin (D-W.Va.) was adamant about closing this perceived loophole when negotiating with Senate Majority Leader Chuck Schumer (D-N.Y.). However, Sinema required its removal before agreeing to vote for the Act.
The Act replaced the carried interest changes with a 1% nondeductible excise tax on the fair market value of any stock repurchased by a domestic corporation with stock traded on an established securities market. The excise tax applies to repurchases after Dec. 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. This provision is expected to raise $73 billion.
There are several exceptions to the tax, including: (1) tax-free reorganizations, (2) repurchased stock that is contributed to a pension plan or ESOP, (3) total annual repurchases of $1 million or less, (4) the purchase is completed by a dealer in securities in ordinary course of business, (5) the repurchase is treated as a dividend and (6) the repurchase is by a RIC or REIT. Additionally, repurchases subject to tax are netted with new public and employee stock issuances during the taxable year.
As with the new corporate minimum tax, the rules around this stock repurchase excise tax will be complicated and require additional recordkeeping and compliance.
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.
The Act aims to incentivize cleaner energy production and consumption using a variety of tax credits and targeted qualified loan programs. The Act expands the number of credits designed to lower the cost of residential energy-efficient improvements, such as HVAC systems, solar and water heaters. There is also a $4,000 credit to make it more affordable for certain lower- and middle-income individuals to purchase used clean energy vehicles, and a $7,500 credit for the purchase of a new clean energy vehicle.
We will provide greater details on the energy credits enacted once the Act passes the House.
The Act allocates an additional $80 billion in funding toward IRS enforcement and operations support. Furthermore, the premium tax credit program under the Affordable Care Act was extended through 2025. This effectively lowers healthcare premiums for taxpayers purchasing health insurance through the federal marketplace.
Please reach out to your Baker Tilly advisor if you have questions regarding your tax position. We continue to monitor legislative developments and will issue additional alerts as warranted.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.