On Aug. 16, 2022, President Biden signed into law the Inflation Reduction Act of 2022, sweeping legislation addressing healthcare, climate change and renewable energy incentives, and inflation, among other priorities. A much slimmer version of the President’s Build Back Better proposals, the Act is the result of significant and lengthy negotiations within the Democratic caucus aimed primarily at gaining the support of Senators Manchin and Sinema.
In addition to its numerous tax provisions targeting renewable energy and renewable energy investment – explored in this overview by our Renewable Energy team – the Act contains several other significant tax provisions that businesses should note, including:
- The corporate alternative minimum tax (CAMT), a 15% minimum tax on certain corporations with average financial statement income exceeding $1 billion. The CAMT is based in part on financial statement income, or “book income,” and targets corporations reporting substantial financial statement income but paying little or no U.S. income tax because of available deductions and credits.
- Among the tax incentives and credits for investment into renewable energy, a new provision allowing certain transfers of energy credits.
- The extension to 2028 (two-year extension) of the excess business loss limitation, which limits the ability of noncorporate taxpayers to deduct business losses exceeding an indexed-for-inflation amount. The extension of the excess business loss limitation was inserted into the Act in lieu of any extension to the $10,000 limitation on state and local tax deductions (the “SALT Cap”).
- A 1% excise tax on certain stock repurchases and economically similar transactions.
- An amendment to the research and development (R&D) tax credit rules for Qualified Small Businesses (QSBs).
Read on for more detail on several of these provisions.
The Act also provides $80 billion in additional IRS funding, over half of which ($45 billion) is aimed at enforcement efforts, nearly doubling the IRS’s current enforcement budget. Increased expected IRS enforcement, and “closing the tax gap,” is a key revenue raiser in the Act.
The Act does not, however, include amendments to the “carried interest” three-year holding period provisions. When initially proposed in July, the legislation included amendments to the carried interest provisions that would have, among other changes, captured real estate gains. Real estate gains continue to be generally excluded from the carried interest three-year holding period provision.
Prior to repeal in 2017’s Tax Cuts and Jobs Act (TCJA), corporations were subject to an alternative minimum tax based on the excess of taxable income computed with reduced deductions and tax benefits over generally calculated taxable income. The pre-TCJA corporate alternative minimum tax did not, however, incorporate financial statement income. Recent press reports identified numerous large corporations reporting substantial financial statement income but little or no corporate taxable income. In response, the CAMT, unlike the prior alternative minimum tax, is based on corporate financial statement income.
Effective for tax years beginning on or after Jan. 1, 2023, the Act’s CAMT imposes a minimum tax for certain corporations based on their “adjusted financial statement income” (“AFSI”). The CAMT applies to the extent an “applicable corporation’s” “tentative minimum tax” exceeds the sum of its regular tax liability and its base erosion anti-abuse (BEAT) tax liability. Tentative Minimum Tax equals the excess of 15% of corporate AFSI over an available CAMT foreign tax credit.
Applicable Corporations are those that earn average AFSI (measured over a three-year period) over $1 billion. Special rules apply to corporations in existence for less than 3 years and corporations with short taxable years, and in determining whether a corporation is an applicable corporation, controlled group and common control aggregation apply. S corporations, regulated investment companies, and real estate investment trusts (REITs) are excluded from the definition of an “applicable corporation” and therefore are not subject to the CAMT.
The key to the CAMT is in the definition of AFSI. ASFI begins with the corporate taxpayer’s “applicable financial statement” (“AFS”) net income or loss and is subject to various adjustments, including, for example, adjustments for affiliated groups, taxpayers included (or not) on a consolidated tax return, and income earned through partnerships or disregarded entities. Special provisions also apply to U.S. shareholders of foreign corporations, as well as to foreign corporations with effectively connected income.
Significantly, AFSI is computed by substituting certain amounts determined under federal tax law for the financial statement counterparts, including:
- The use of tax depreciation deductions (and very limited intangible amortization) in lieu of the depreciation amounts in the AFS.
- Disregarding amounts in the AFS relating to certain covered benefit plans, increasing AFSI for income related to a covered benefit plan included in tax gross income, and decreasing AFSI for allowable covered benefit plan tax deductions.
AFSI may also be reduced by allowable financial statement net operating losses (“FSNOL”). The FSNOL reduces the AFSI by the lesser of the aggregate amount of financial statement NOL carryovers to the taxpayer year, or 80% of AFSI computed without regard to such NOL carryovers, and is carried forward indefinitely.
As with any new tax legislation, Treasury is expected to fill in the gaps and details with Regulations.
Renewable energy incentives
The Act contains numerous renewable energy credit provisions, many new and some re-proposals of former credits, designed to incentivize renewable energy projects and enhance the financing of those projects, as well as to promote electric vehicle technology and improve the energy efficiency of real property. Promoted technologies include solar, wind, clean hydrogen, and carbon recapture and sequestration. The new credits also incentivize investment in the production of certain renewable energy components. The projected tax cost of these credit provisions – estimated at nearly $350 billion – reflects an unprecedented investment in renewable energy technologies.
While our Renewable Energy team has already provided a more extensive overview of these provisions, we’d particularly like to note here one provision that will likely impact the manner in which renewable energy projects are financed. Prior to the Act, credits could be transferred – or monetized – only in limited circumstances. The Act, however, allows for certain one-time sales of credit to unrelated buyers for cash, providing additional monetization options for developers and perhaps expanding the base of investors in renewable energy.
Excise tax on repurchase of corporate stock
For tax years beginning on or after Jan. 1, 2023, the Act imposes a nondeductible 1% excise tax on the fair market value of stock repurchased by publicly traded corporations. A “repurchase” includes stock redemptions and transactions characterized as redemptions for federal income tax purposes. Additionally, Treasury is authorized to include transactions “economically similar” to redemptions as “repurchases.”
Certain exclusions apply, including repurchases part of certain tax-free reorganizations and repurchases of stock contributed to employee pension plans.
Any new issues to the public, or stock issued to employees, would be deducted from the taxable amount, and repurchases below $1 million or contributed to employee pension plans (or similar plans) would not be subject to tax. The Act includes special rules for acquisitions of stock of certain foreign corporations.
Research & Development (R&D) tax credits
For tax years beginning after Dec. 31, 2022, an additional $250,000 of R&D tax credits can be used to offset the employer-paid Medicare portion of a company’s payroll taxes for Qualified Small Businesses (QSBs). A QSB is defined as a company that meets the following two criteria:
- Has less than $5 million dollars in annual gross receipts for the taxable year; and
- Does not have gross receipts for more than 5 prior years.
This doubles the maximum amount of R&D credits that may be applied against payroll taxes from $250,000 – as enacted by the PATH Act in 2015 – to a total of $500,000. The credit cannot exceed the tax imposed for each calendar quarter, although any unused amounts are carried forward to subsequent quarters. This increase in the maximum will benefit start-ups and small businesses that may not have income tax liability to effectively take advantage of the R&D tax credit.
Between this change and the passage earlier this month of the CHIPS and Science Act, now is a good time for all businesses to assess the full range of their R&D credit opportunities.
The many tax provisions of the Inflation Reduction Act are complex, and worth discussing with a trusted advisor to learn how they may impact your business or project. We will be monitoring the continued development of these new elements; be sure you’re subscribed to receive our updates.
Subject matter expertise
CPA, JD, Managing Partner - Tax
CPA, Partner, Practice Leader, Federal Tax Services
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