Inflation Reduction Act of 2022
By Dalton Bradshaw, CPA
On July 27, 2022, Senate Majority Leader Charles Schumer and Senator Joe Manchin struck a deal to revive a Democratic reconciliation bill. The deal, coined “The Inflation Reduction Act of 2022” (the Act), seeks to combat inflation and promote green energy initiatives by increasing minimum corporate taxation, closing tax “loopholes,” and expanding IRS enforcement. The Act sent shockwaves through Washington, as most of the deal was negotiated privately and representatives on both sides of the aisle were not aware of its existence until it was announced. While the announcement was surprising, Democrats have celebrated the introduction of the Act as it includes numerous climate agenda provisions that were seemingly dead after being struck from the Build Back Better Act. On the other hand, Republicans have largely decried the Act with claims that it takes a flawed approach to combat inflation and will stifle global competition.
On Sunday, August 7, 2022, the Senate passed the Act with votes split evenly along party lines. Vice President Kamala Harris provided the tie breaker, bringing the Democratic votes to 51 versus 50 Republican votes, to pass the Act through a process called reconciliation. The reconciliation process allows the Act to pass with 50 votes in the Senate, rather than the 60-vote majority required for most legislation, and avoids a filibuster from Republican counterparts. The Bill will now head to the House of Representatives, which also holds a Democratic majority, for a vote on Friday, August 12, 2022, and is expected to pass. The Act is not yet a done deal, but its passage would seem to be likely unless some members of the Democratic party push for amendments that might delay or ultimately prevent its passage in the House or as an amended bill in the Senate.
Minimum Corporate Tax Rate
The largest revenue generator included in the Act is the revival of the corporate alternative minimum tax (AMT), which was terminated with the passage of the Tax Cuts and Jobs Act (TCJA) in 2017. If passed, the Act would impose a 15% minimum tax on a corporation’s “adjusted financial statement income” (book income), which can be offset by a corporate AMT foreign tax credit. The AMT would only apply to corporations whose average book income for the three preceding tax years exceeds $1 billion, or $100 million for certain foreign-parented corporations. If passed, this tax would be effective for tax years beginning after 2022. In the initial version of the Act released in late July, the adjusted financial statement income calculation did not allow for accelerated depreciation. However, due to opposition from Arizona Democratic Senator Kyrsten Sinema, accelerated depreciation will now be exempted from the 15% corporate AMT. As a compromising measure, the Act now includes a 1% excise tax on stock buybacks for corporations. Congress’ Joint Committee on Taxation (JCT) estimates that the corporate AMT could generate an additional $313 billion in tax revenue over the next decade.
The reintroduction of the corporate AMT has drawn criticism on the grounds that it could stifle global competition for U.S. corporations and hamper investment in and expansion of U.S. corporations. In recent months, the Organization for Economic Cooperation and Development (OECD) and its member countries have worked to enact a similar global minimum corporate tax of 15%. However, the OECD plan calculates financial statement income on a country-by-country basis, whereas the Act assesses the tax on global revenue. If the governments of European countries do not treat the U.S. corporate AMT as an equivalent law, then U.S. corporations could be subject to double taxation under U.S. law and the OECD plan.
An analysis by the JCT found that the 15% corporate AMT would heavily impact U.S. manufacturers, who would be responsible for roughly 49.7% of the tax revenue. Ultimately, these corporations will likely pass the tax cost off to employees, shareholders, and consumers, which will effectively raise the cost of manufactured goods for individuals at all income levels. The National Association of Manufacturers estimates that the tax in 2023 alone will reduce wages and real GDP by $17.1 billion and $68.5 billion, respectively.
IRS Tax Enforcement
In addition to the corporate AMT rate, the Act seeks to increase revenue by bolstering tax compliance enforcement by the IRS. The Act provides $80 billion for the IRS over the next nine years in addition to its current annual budget of $12.6 billion. The Act specifically allocates $45.6 billion of the funding for litigation, criminal investigations, technology, and a new fleet of vehicles for their agents. By significantly increasing the IRS’ funding, taxpayers can expect a sharp increase in audits, criminal referrals, and civil suits. Increased IRS enforcement is expected to generate an additional $200 billion in tax revenue.
Some tax professionals and commentators on the Act have expressed concern that much of the increased tax revenue from under-reported income will likely originate from middle-class taxpayers since the ultra-wealthy are more capable of employing attorneys and accountants who can successfully defend their clients before the IRS. IRS Commissioner Rettig, however, told Congress last Thursday that the IRS’ investment in its increased enforcement resources is designed around Treasury’s directive that audit rates will not rise relative to recent years for households making under $400,000.
Tax breaks for low-income taxpayers, specifically the Earned Income Credit (EIC), will not likely be subject to increased enforcement. Despite estimates that $18 billion in improper EIC payments are made annually, the IRS would face significant pushback for pursuing EIC enforcement, meant to benefit low-income taxpayers, especially amid an economic recession.
The initial version of the Act also sought funding by limiting a so-called tax “loophole” in the form of long-term capital gain treatment for carried interest. Carried interest refers to profit shares in equity funds held by hedge fund managers and other private equity funds. Historically, these interests could be sold as capital assets and, thus, only subject to favorable capital gains tax rates if they were held for more than one year. Since these shares are awarded as compensation for labor, many have argued that they should be subject to ordinary income rates rather than capital gain rates.
In response to this opposition, the holding period to apply capital gain rates to carried interest was increased to three years with the passage of the TCJA in 2017. Originally, the Act sought to take this a step further by extending the holding period to five years. However, opposition from Senator Sinema, a key vote in an evenly divided Senate, caused the carried interest provision to be removed from the Act entirely.
How will the money be used?
Green Energy Initiatives
The bulk of the anticipated investments in the Act comes in the form of green energy investments. Most of the credits included in the Act were originally part of the Build Back Better Act but were ultimately excluded before its passage. Most of the green energy initiatives included in the Act are materially the same as before with slight modifications or adjusted termination dates.
In summary, the Act calls for the following green energy initiatives:
- Extends Electricity Produced from Renewable Resources Credit through 2024
- Extends Energy Investment Credit through 2024
- Entities can elect to claim a direct payment for certain energy projects in lieu of multiple energy credits
- Residential Energy Credits
- Revives the credit through 2032 (expired in 2021)
- Replaces lifetime credit maximum with $1,200 annual limit
- Clean Vehicle Credit
- Extends the credit through 2032
- Eliminates the limitation on the number of vehicles produced by a manufacturer
- Expands the credit to include a $4,000 credit for the purchase of used clean vehicles
- New Green Energy Credits
- Sale or Use of Sustainable Aviation Fuel (after 2022)
- Production of Clean Hydrogen (after 2022)
- Energy produced from zero-emission nuclear power facility (between 2024 and 2033)
Healthcare Reform and Expansion
The Act calls for an extension of Affordable Care Act provisions that were introduced within the American Rescue Plan Act through 2025. This will allow taxpayers with income over 400% above the federal poverty line to obtain premium tax credits and more affordable health insurance. Currently, this is set to expire at the end of 2022.
The Act also includes provisions that will allow Medicare to negotiate prices for specific prescription drugs and place a ceiling on out-of-pocket prescription drug costs for its users at $2,000 annually. While this could certainly reduce spending if passed, it may have an unintended negative impact on innovation within the pharmaceutical industry.
Notable Exclusions from Bill
While the Act addresses many areas of the Democratic party’s agenda, there are a number of proposals that were excluded from the bill. Some notable exclusions from the Act are as follows:
- 8% Net Investment Income Tax on materially participating closely -held business owners
- Increased tax rates for businesses, individuals, trusts, and estates
- Increased Capital Gain tax rates
- Surtax on income over $10 million
- Increase of the $10,000 State and Local Tax (SALT) Deduction Cap
- Enhanced Child Tax Credit
Excluding proposals that increase taxes on the wealthy is likely the Democratic party’s best shot at acquiring the votes necessary to pass the Act. However, changing the $10,000 SALT cap has been a sticking point for many Democratic representatives from high-income and property tax states, such as New York and California. Additionally, the Democrats have faced resistance to tax increases from within their own party in light of an impending recession. Given the current composition of Congress, the inclusion of these proposals likely would have rendered the Act dead on arrival. The composition of provisions within this Act appears to have been carefully curated to garner as much support as possible in Washington.
In summary, the Act seeks to combat inflation, reduce the federal spending deficit, and invest in green energy initiatives through increased tax revenues and collections. In a summarized version of the Act released by the Democratic members of the Senate, it is estimated that these provisions will reduce the federal deficit by roughly $306 billion in fiscal year 2022. Top line estimates of revenue-raising measures, expenditure outlays, and deficit reductions are as follows:
|Total Revenue Raised||$744 Billion|
|15% Corporate Minimum Tax||$258 Billion|
|Prescription Drug Pricing Reform||$288 Billion|
|IRS Tax Enforcement||$124 Billion|
|Excise Tax on Stock Buybacks||$74 Billion|
|Total Investments||$433 Billion|
|Energy Security and Climate Change||$369 Billion|
|Affordable Care Act Extension||$64 Billion|
|Total Deficit Reduction||~$311 Billion|
Although the Act takes aim at combatting inflation, preliminary estimates of its impact paint a grimmer outlook. On July 29, 2022, the University of Pennsylvania released its preliminary estimates of budgetary and macroeconomic effects of the Act based on the Wharton Budget Model. The Model, which is widely used within Washington, found that “the impact on inflation is statistically indistinguishable from zero” by 2031. Supporters of the Act claim that a reduction in the federal deficit will, in turn, stifle inflation. However, the Penn Wharton model also found that a net deficit reduction would not be realized until 2027 at the earliest. Therefore, the key intent of the Act would not be even partially realized for another five years, and taxpayers would foot the bill for new taxes as the economy slides into recession. Additionally, the increased taxes and prescription drug price controlling could potentially stifle investment and innovation across multiple industries.
We will continue to monitor developments surrounding the Inflation Reduction Act of 2022 and communicate any relevant updates in a timely manner. If you have any questions or concerns on how the passage of this Act may affect your tax situation, please contact your BMSS advisor at (833) CPA-BMSS.