Your Tax Advisor’s Guide To The Inflation Reduction Act

Your Tax Advisor’s Guide To The Inflation Reduction Act

Implications For Christopher Columbus, Oysters, And Walruses

The dramatic history of the Inflation Reduction Act is known – now we have to understand and live with the practical results.

The Senate passed the bill with a vote of 51-50, with Vice President Kamala Harris breaking the tie. As of today, the House has not made changes, and President Biden is expected to sign the bill.

Electric Vehicles – Not the Spark We Were Looking For

Unfortunately for electric vehicle fans, there will be little or no active assistance for purchasers in the near future, and only individual buyers with annual incomes of less than $150,000 will qualify for assistance.

In an effort to bring electric vehicle(“EV”) production to the U.S., a deal between Senator Joe Manchin (D – W.Va.) and Senate Majority Leader Chuck Schumer (D. – N.Y.) is included in the bill that would extend an already existing $7,500 consumer tax credit for EVs until 2032. The ultimate goal of the proposal is to raise battery component manufacturing and assembly for EVs in North America from 50% to 100% by 2028.

However, this extension does not come without stipulations. The bill would tighten up the requirements that would allow electric vehicles to qualify for this tax credit. Only EVs that were built in the U.S. would be eligible. Restrictions would be placed on battery production, requiring a minimum percentage of the battery components be manufactured or assembled in North America. A certain amount of lithium and nickel, both minerals necessary to manufacturing the batteries, must be sourced in the U.S. or from its free-trade partners. Around 40% of the battery minerals must be mined and processed in the U.S. or partner countries, increasing to 80% after 2026.

Many car manufacturers have expressed their concerns about these strict requirements. Ford, GM, and others are seeking more time to be able to meet these requirements as well as an expansion of options that they will be able to source the minerals from. Currently, only about 15% of minerals used in battery production are extracted or processed in the U.S. or by its trade partners, with the majority being from China. These restrictions aim to decrease reliance on China for production and create jobs in the U.S.

As it stands right now, very few electric vehicles qualify for this tax break. It appears that manufacturers are not confident in their ability to meet the bill’s short timeline.

The 15% Minimum Corporate Tax – Billionaire Companies Will Pony-Up Seven Hundred Million Dollars Over Ten YearsCongress Isn’t Horsing Around

The two primary revenue-raising provisions of the bill are a 15% corporate minimum tax and IRS tax enforcement funding, together estimated to raise over $400 billion. In total, the bill will raise over $700 billion in revenue over 10 years, including the aforementioned tax changes, as well as taxes and savings from a prescription drug-pricing proposal.

The summary of the Inflation Reduction Act with respect to taxes provides the following:

The proposal’s two main components would re-build the IRS and impose a 15% Corporate Minimum Tax to ensure the wealthiest Americans and corporations cannot avoid paying their fair share of taxes… Additionally, the proposal would impose a 15% domestic tax on the approximately 200 largest corporations that currently pay less than that corporate tax rate.

The current statutory corporate tax rate is 21%. However, some 200 or more large corporations use tax loopholes to avoid paying that rate and actually pay below 15%.

The corporate alternative minimum tax (AMT) proposal would impose a 15% minimum tax on adjusted financial statement income for corporations with profits in excess of $1 billion. Corporations would generally be eligible to claim net operating losses and tax credits against the AMT, and would be eligible to claim a tax credit against the regular corporate tax for AMT paid in prior years, to the extent the regular tax liability in any year exceeds 15 percent of the corporation’s adjusted financial statement income.

This provision would be effective for taxable years beginning after December 31, 2022.

In a separate summary, the bill states, “there are no new taxes on families making $400,000 or less and no new taxes on small businesses – we are closing tax loopholes and enforcing the tax code.”

The bill seeks to implement taxes on corporations by applying an “Average Annual Adjusted Financial Statement Income Test.” A corporation meets this test for a taxable year if “the average annual adjusted financial statement income for the 3-taxable-year period ending with such taxable year exceeds $1 billion.”

Exceptions are created by the bill where the “applicable corporation” shall not include any corporation which (a) has a change in ownership, or (b) has a specified number (to be determined) of consecutive taxable years, including the most recent taxable year, in which the corporation does not meet the average annual adjusted financial statement income test, and the Secretary determines that it would not be appropriate to continue to treat such corporation as an applicable corporation.

For corporations that would otherwise be an “applicable corporation” but have not been in existence for three taxable years, the Average Annual Adjusted Financial Statement Income Test will be applied on the basis of the period during which such corporation was in existence.

To summarize the corporate tax provisions, companies with at least $1 billion in income will be required to calculate their annual tax liability two ways: (1) with longstanding tax accounting methods, which are generally 21% of profits less deductions and credits, and (2) applying the 15% rate to reported earnings, known as book income. Whichever of these two methods is greater is what the corporation will owe.

“We have multi-billion dollar corporations paying less in their tax rate than nurses and firefighters.” – Senate Finance Committee Chair, Ron Wyden (D-OR). It is evident that nothing included in the Inflation Reduction Act is intended to raise taxes on the middle-class.

The Carried Interest Tax Loophole Fails AgainWhat You Didn’t Know About Christopher Columbus

Currently, the carried interest loophole allows investment managers to pay the lower 20% long-term capital gains tax rate on income received as compensation, rather than the ordinary income tax rates of up to 37% that they would pay for the same amount of wage income.

The common structure for capitalizing on the carried interest loophole is the “two-and-twenty.” Under a two-and-twenty fee structure, investors pay the fund manager 2% of the assets they have invested in the fund each year, plus 20% of the fund’s returns. If you thought this was a 20th century devise created by Wall Street bankers, you’re wrong. The two-and-twenty is derived from Fourteenth-century Italian ship captains that were compensated in part with an interest in whatever profits were realized on the cargo they carried. It is therefore possible that Christopher Columbus would have never financed three boats with Queen Isabela of Portugal if he would have had to pay a 37% ordinary income tax rate and a 3.8% Medicare tax. His boats would have been the Nina, the Pinta, and the Santa Mahedgefundera. He would have possibly discovered Sanhedgefrundcisco instead. This was before Rice-A-Roni became popular in Europe.

Under current tax law, the carried interest paid to fund managers is taxed as if it were a profit from a long-term investment rather than what it is: compensation for managing other people’s money. This distinction allows the general partners to nearly halve their tax bill by paying the 20% long-term capital gains rate instead of the ordinary income tax rate of 37% that would likely apply to these top earners.

Both President Obama and Trump promised to close this loophole during their presidencies but each have failed. See Katy Osborn’s TIME Article: “This Is The Tax Loophole Obama, Bush, and Trump All Want To Close.” Yet again, an effort to close the loophole has failed, now under the Biden administration. Senator Manchin was firm on his desire to close this loophole with the Inflation Reduction Act: “Our tax code should not favor red state or blue state elites with loopholes like SALT and should focus more on closing unfair loopholes like carried interest.” However, the fate of the bill was quickly turned over to Kyrsten Sinema (D-AZ) who opposed the closure of this loophole. Sinema discussed blocking the overall legislation if the bill remained in its original form, so the carried interest language was removed to ensure the bill’s survival.

Closing the carried interest loophole would have taxed certain wealthy Americans, thereby fulfilling President Biden’s promise, at least in part, to make the wealthy pay their fair share, despite not coming in the same form as early proposals like a “wealth tax” supported by Senators Warren (D-MA) and Sanders (I-VT
VT
). The proposition of a wealth tax was taken off the table for the Biden administration due to heavy scrutiny and the likelihood of an uphill battle within the legislature and in the courts.

Stock Buyback Tax – The Next Buyback Will Cost More For Jack

Although the carried interest language was removed from the bill, in its place is a 1% excise tax on corporations when they repurchase stock from their shareholders. This measure will likely generate as much or even more revenue as the carried interest proposal and is estimated to raise $74 billion.

Republican and Democratic lawmakers alike have criticized U.S. corporations for greatly favoring buybacks over growth-producing investments. For example, in 2018, Senator Rubio (R-FL) proposed legislation to tax corporate stock buybacks as dividends, intending to increase business investment and create jobs.

Stock Buybacks in Action: a company buys back stock, thereby reducing the number of its outstanding shares on the market, which increases the value per share for remaining shareholders. Buybacks are one of the mechanisms corporations use to shift their profits to shareholders, the other being a dividend, which is a cash payment to shareholders that is taxed as income tax. Buybacks are taxed as capital gains because they increase the stock value, but they may not be taxed for years, and in some cases are never taxed at all because the taxable event is when the stock is sold. Some investors will hold on to their stocks for life, and upon death, the investor’s heirs will benefit from the step-in basis.

The proposal in the Inflation Reduction Act would subject corporations to a tax equal to 1% of their stock repurchases, thereby ensuring the shifted profits are taxed in some form.

Some argue against stock buybacks and say that companies should be spending a far larger portion of their profits to reinvest in the core business, rather than returning cash to equity investors. The argument is that by reinvesting in the company itself, companies can hire more workers and build more manufacturing facilities and products. Others argue that stock buybacks are good because it returns money to investors, thereby providing more opportunities for investments in small businesses or budding industries to promote innovation and growth.

Funding the IRS – Law Abiding Taxpayers To Be Blessed But For Some It Will Cause a Mess

The Inflation Reduction Act claims that by investing $80 billion over the next ten years for tax enforcement and compliance, the IRS will collect $203 billion (a net gain of approximately $125 billion in tax revenue). The provision of the bill allocates the 10-year funding for the IRS as follows:

  1. $3,181,500,000 for taxpayer services,
  2. $45,637,400,000 for enforcement,
  3. $25,326,400,000 for operations support,
  4. $4,750,700,000 for business systems modernization.

These appropriated funds are to remain available until September 30, 2031, and the bill summary states, “no use of the funds is intended to increase taxes on any taxpayer with taxable income below $400,000.”

Some concerns have been raised that the IRS’s increased budget will give the Service more firepower to audit the middle-class while the wealthy will be able to continue dodging taxation (as they are more likely to be able to afford sophisticated tax counsel). Such commentators worry that when the IRS audits people, those making under $200,000 will have to pay their fair share of taxes. We have never considered that people paying taxes when they are audited constitutes a tax. While the concerns are at least valid from the standpoint of protecting middle-class Americans, several friends of mine that make less than $200,000 and pay their taxes prefer to see others pay their fair share of taxes.

The present underfunding of the IRS has invited and encouraged tax fraud en masse, which will hopefully now be significantly reduced.

My father was a lifelong United States government employee and was very proud to be serving the United States of America and its citizens. Anti-IRS rhetoric seems unpatriotic to me, especially when it comes from elected officials. The vast majority of our clients accurately account for, calculate, and pay their federal income and other taxes. To insinuate that anyone would have a “patriotic duty” or license to try to pay less than what they actually owe in taxes because they can play the audit lottery is to encourage criminal conduct, which can cause many people to be misled and manipulated.

Green Home Renovations – More Home Depot Sensations

The bill also includes tax credits on “green” home improvements. The tax credit is raised from the previous $500 lifetime cap to $1,200 annual tax credit for green remodels. Homeowners will be able to budget out different energy efficient home upgrades over a 10 year period.

Sorry, but there are no incentives for growing your own medical marijuana. Just continue to encourage your mother-in-law to do so.

Coastal Restoration A.K.A. the Walrus and the Oysters

Those who live in coastal areas may benefit significantly from the 2.6 billion dollars in grants to conserve and restore coastal habitats and protect the community’s reliance on such habitats. This will likely benefit a good many wealthy home and resort owners but has not been highly publicized. The oysters in this tale have a happy ending this time around.

I give my thanks to Stetson University College of Law students, Samuel Craig and Gabrielle Lias Geiger, for their significant research and assistance with respect to the preparation of this article.

https://www.forbes.com/sites/alangassman/2022/08/12/your-tax-advisors-guide-to-the-inflation-reduction-act-implications-for-christopher-columbus-oysters-and-walruses/