The Inflation Reduction Act and What It Means for You
The Inflation Reduction Act (the Act) was recently signed into law on Aug. 16 and contains a number of provisions to increase IRS funding, raise taxes on large corporations, incentivize renewable energy usage, and reduce the cost of prescription drugs.
IRS Funding and Resulting Changes
The increase in IRS funding has garnered attention due to the potential impacts of the change. With the primary intent to strengthen tax enforcement (over half of the spending budget), the Act raised the IRS budget by approximately $80 billion over 10 years. The money will be allocated into four categories—enforcement, operations support, taxpayer services, and business system modernization. The additional enforcement is estimated to raise a net $124 billion over the 10-year Congressional budget window.
While the average individual taxpayer and small business are not exempt from these increases in tax enforcement, high-net-worth individuals, large corporations, and complex pass-through entities should see an uptick in audit activity in the coming years. In these situations, tax enforcement efforts will be dedicated to better targeting audits at noncompliant taxpayers for certain infractions. It is now more important than ever for taxpayers to work closely with their tax advisors to ensure that they have the support and documentation they need to successfully manage any IRS examination of their returns.
It’s important to be aware of some common IRS triggers that may attract attention of an audit. For example, cryptocurrency and other digital currencies are increasing and popularity, and as a result, are under a microscope to be properly reported. Other areas that may signal a red flag are cash-based businesses, international reporting, large noncash donations, complex real estate transactions, and substantial losses reported on Schedule C.
With the growth of enforcement, taxpayers should ensure that returns are accurate and completed with substantiating documents for all expenses and deductions.
Key Tax Changes
The Inflation Reduction Act included four major tax provisions:
- 15% minimum tax on corporations with over $1 billion in revenue
- 1% excise tax on corporate share buybacks
- Two-year extension of limitation on excess business losses
- Research and development credit increase
Effective for tax years ending after Dec. 31, 2022, the corporate alternative minimum tax (AMT) applies to C corporations that have an average annual adjusted financial statement income (AFSI) greater than $1 billion over a three-year period. The corporate AMT also pertains to corporations with AFSI of $100 million or more if they are part of a foreign-parented multinational group with an average AFSI over $1 billion. The U.S. Congress Joint Committee on Taxation has estimated that only 150 companies will be impacted by this change. Since mixing in financial statement income into the taxable income calculations will create a host of problems for authorities and businesses, the AICPA is working diligently to influence the upcoming regulations to mitigate the effects.
Additionally, the Act includes an excise tax that enacts a 1% surcharge on publicly traded corporate stock buybacks. Meaning, the value of any stock that is repurchased by a corporation during a taxable year would be subject to a 1% excise tax, effective after Dec. 31, 2022. Stock contributed to retirement accounts, pensions, and employee-stock ownership plans (ESOPs) are excluded from the excise tax.
Noncorporate taxpayers also receive a two-year extension of the excess business loss (EBL) limitation set to expire in 2027. The EBL limits the amount that a noncorporate taxpayer can deduct from a pass-through entity or sole proprietorship.
Among its tax provisions, the Act expands the research and development tax credit after Dec. 31, 2022 for small business startups less than five years old with less than $5 million in gross receipts. It increases the amount of the credit from $250,000 to $500,000 and can be used against both the social security as well as the Medicare portion of payroll tax liability.
Climate Change Tax Credits
The new Act contains several provisions aimed at fighting climate change by reducing carbon footprints.
Electric vehicle tax credits are a significant part of the new law’s focus on clean energy, which includes:
- Tax credits up to $7,500 for buying a new or used electric vehicle, extended until December 2032.
- Tax credits up to either $4,000 or 30% of the price of a used vehicle.
- Tax credits on qualified commercial clean vehicles up to over a certain size.
Starting in 2024, EV buyers will have the option to apply the tax credit at the time of purchase to lower the price of the vehicle, essentially transferring the credit amount to the dealer and not having to wait until tax time. The credit applies to vehicles with an MSRP less than $80,000 for SUVs, vans, and pickup trucks, and $55,000 for other vehicles. Individual taxpayers with modified adjusted income over $150,000 ($300,000 married filing jointly) will not qualify for the EV tax credit.
In addition to EV credits, the Act also includes a number of clean energy tax credits and incentives for both individuals and businesses. Some provisions are extensions and adjustments of existing incentives, while others are new.
The main renewable energy tax incentives that were extended and expanded include:
- home energy efficiency tax credits for individuals and businesses that construct or upgrade to energy-efficient systems through 2032
- renewable energy production tax credit and investment tax credit
- carbon capture and storage credit
- funds for agricultural conservation programs
Some of the new tax credits include:
- clean energy manufacturing tax credits
- alternative fuel refueling property credit
- zero-emissions nuclear power production credit
- technology-neutral clean electricity production and investment credits
- tax credits for new rate structure for new wage and apprenticeship requirements
The Act also introduces new ways to monetize these credits with a direct pay option or the brand-new transferability feature. The direct pay option is treated like a tax refund and makes it easier for taxpayers of renewable energy projects to monetize the value of the tax credits. The transferability feature, on the other hand, allows a taxpayer to transfer the tax credits to an unrelated party for cash, similar to the EV purchase option above.
Despite the name of the Act, the nonpartisan Congressional Budget Office Director Phillip Swagel wrote in a statement that enacting the bill would have a “negligible” effect on inflation in 2022. Further, the effect in 2023 would be plus or minus 0.1 of a percentage point.
The Act also made steps to lower the cost of prescription drugs. These changes include:
- an Affordable Care Act subsidy extension through 2025
- permission for Medicare to negotiate drug prices
- a cap on Medicare recipients’ drug expenditures at $2,000 per year
We Can Help
More guidance on each section will follow in the coming weeks. Meanwhile, if you have any questions about how these changes will affect you or your business, please contact me at email@example.com or call (805) 963-7811 to speak with an advisor.