On Tuesday, August 16, 2022, President Biden signed The Inflation Reduction Act of 2022.
The Act is a massive climate, health care and tax bill, and is a “scaled-down” successor to the Build Back Better Act, which, after being passed by the House of Representatives, stalled in late 2021. The bill has been promoted as aid to reduce the country’s crippling inflation in two key ways: by lowering energy and health care costs for families and by helping to reduce the federal budget deficit.
Tax Credits and Other Measures
Some experts don’t see a rapid curb to inflation through this bill, there are a range of measures to help with high costs:
- Tax Credits – The bill offers a number of tax credits to push American consumers and industry away from reliance on fossil fuels and switching to cleaner energy sources including electric vehicles, rooftop solar panels and wind turbines. Those incentives will take effect in 2023 and are expected to result in a significant decrease in greenhouse emissions by the end of the decade. It also includes incentives for companies to manufacture more of that technology in the United States.
- Internal Revenue Service (IRS) Funding – The IRS will get a funding boost to improve its customer service and tax enforcement. This investment should alleviate long response times and accelerate tax refund processing times as well as providing the IRS with resources to conduct more tax audits of large corporations and wealthy individuals and close the “tax gap”.
- Affordable Care Act Extension – Millions of Americans will benefit from a three-year extension of expanded Affordable Care Act subsidies that help with rising health insurance premiums that were originally scheduled to expire this year.
- Medicare and Prescription Drugs – Medicare will be able to negotiate the price of certain prescription drugs bringing down the price beneficiaries will pay for their medications. The bill will put a $2,000 annual cap on out-of-pocket prescription drugs for people insured by Medicare; however, this provision won’t take effect until 2025.
Impact on Corporations and High Net Worth Individuals
To pay for the spending provisions, the following revenue-raising provisions are included in the Act which mostly impact large corporations and wealthy individuals:
- Alternative minimum tax – Based on adjusted financial statement income for C-corporations with average financial profit in excess of $1 billion over the three prior tax years. The provision would impose a minimum tax equal to the excess of 15% of an applicable corporation’s adjusted financial statement income over the corporate alternative minimum foreign tax credit for the tax year.
The new alternative corporate minimum tax resembles the one proposed under the Build Back Better Act, but with a major difference. In a company’s financial statement, the cost of an investment in fixed assets is typically deducted in line with economic depreciation. However, tax depreciation for many assets (including equipment) is accelerated to provide an investment incentive. Businesses can currently fully deduct most of these purchases for tax purposes under 100% bonus depreciation which is set to phase out between 2023 and 2026.
Standard tax depreciation, or the modified accelerated cost recovery systems (MACRS) is also accelerated relative to book depreciation. While the earlier version of the new corporate minimum tax under the Build Back Better Act required book income depreciation, the new version allows corporations to use bonus and accelerated depreciation in their minimum tax calculation.
The Joint Committee on Taxation reported that tax would most likely apply to 150 of the world’s largest companies. Companies that meet the threshold must calculate their taxes under both the 21% regular corporation tax rate and the new 15% corporate alternative minimum tax regime and pay the higher of the two. The provision is effective for tax years beginning after December 31, 2022 and will also apply to foreign companies that earn $100 million of book income in the United States.
Under a last-minute change to the legislation, companies controlled by private equity firms are not subject to the corporate minimum tax if they make less than $1 billion of book income, even if that investment firm’s combined portfolio of companies exceeds the threshold. Some private equity firms may be able to shift assets among companies in their portfolios so that each earns less than the $1 billion threshold to avoid the minimum tax. In addition, an exception was made to exclude corporations engaged in certain manufacturing activities.
- Corporate Stock Buybacks – A new 1% excise tax on publicly traded U.S. corporations for the value of its stock that is repurchased by the corporation or certain affiliates of the corporation more than 50% owned during the tax year beginning in 2023. Corporate stock buybacks can be voluntary or conducted in open market trading.
If voluntary, a company asks shareholders to return a percentage of their shares voluntarily to the company and investors decide how many of their shares they want to sell back and at what price, based on a range determined by the company. Under the open market trading approach, the company buys its own shares on the market, the same as any other investor would which in essence has the effect of the company investing in itself.
Some of the main reasons for a buyback are to boost share price by cutting the supply of shares, reducing cash outflows by requiring the company to pay out fewer dividends or to increase return on equity and return on assets. Stock buybacks are often done by profitable public companies as an alternative to dividends to reward some investors who are ready to sell. With the imposition of the new excise tax on stock buybacks it can be expected that some corporations will respond by reducing buybacks and instead increasing dividends. Proponents of this new excise tax hope that instead of returning cash to wealthy shareholders, large corporations will instead use the money to increase employees’ wages or invest in the business.
- Excess Business Loss – The Act extends the limitation for noncorporate taxpayers with “excess business losses”. An excess business loss (EBL) is the amount by which the total deductions attributable to an individual’s trades or businesses exceed his total gross income and gains attributable to those trades or businesses plus a threshold amount adjusted for cost of living. The EBL limitations for 2022 are $270,000 and $540,000 for single and joint filers, respectively.
The EBL rules were originally scheduled to expire at the end of 2025, but the American Rescue Plan Act extended the application to expire beginning after 2026. The Inflation Reduction Act extends the limit on excess business losses through taxable years
beginning before January 1, 2029. The excess business loss is treated as a net operating loss in subsequent years, deductible against any type of income but subject to an 80% of taxable income limitation.
According to the Congressional Budget Office (CBO), a federal agency that provides budget and economic information to Congress, the bill will have a “negligible effect on inflation” in the near future. Despite that, the CBO also estimates the bill will decrease the federal budget deficit by more than $100 billion over the next decade.
Though the bill may fall short of bringing immediate price relief to consumers, the Inflation Reduction Act will make historic investments to combat climate change, lower healthcare costs, and substantially increase taxes on large corporations and wealthy individuals.
Please contact your Louis Plung advisor with any questions about the Inflation Reduction Act or email [email protected].