- Significant provisions in the Inflation Reduction Act take aim at lowering the cost of health insurance and prescription drugs and offer billions in clean energy tax incentives.
- The most significant tax increases are primarily aimed at the largest corporations and publicly traded companies.
- The bill includes the appropriation of additional funding for the IRS to enhance enforcement activities, operations support, and business system modernization.
- The vast majority of proposed tax increases on individuals were not included in the final bill, with no changes to individual income tax rates or estate and gift tax rates.
How will the new Inflation Reduction Act affect you or your business?
The budget reconciliation bill, commonly referred to as the Inflation Reduction Act, was signed into law on August 16, 2022. The $700 billion-plus legislation is only a fraction of the social agenda initially sought by the Biden administration, but is still a significant climate, health care, and tax package. The final version was negotiated privately between Senate Majority Leader Chuck Schumer of New York and Sen. Joe Manchin of West Virginia, with a few late revisions by Sen. Kyrsten Sinema of Arizona. The bill was passed strictly along party lines (with all Democrats and no Republicans voting yes) last week in both chambers of Congress, with Vice President Harris casting the deciding vote in the Senate.
Climate and health care opportunities
The most significant provisions of the bill include:
- The premium tax credits aimed at lowering the cost of health insurance through marketplace coverage, as initially passed under the Affordable Care Act, were increased and expanded under the American Rescue Plan. Those expansions will now continue an additional three years, through 2025.
- For the first time, the U.S. Department of Health and Human Services will be able to directly negotiate Medicare drug pricing with pharmaceutical companies for certain qualifying prescription drugs, saving the federal government significant dollars. The provision includes up to 10 Medicare Part D drugs beginning in 2026, increasing to 20 drugs in Parts D and B in 2029.
- For Medicare beneficiaries, out-of-pocket drug costs are capped at $2,000 per year, monthly insulin co-payments are capped at $35, and cost-sharing for adult vaccines is eliminated.
- Of the $270 billion in new (and existing provisions that were renamed) energy tax incentives, clean energy was allocated the largest piece — over $98 billion — and clean electricity and clean transportation received a combined $65.6 billion.
- Individuals are expected to benefit the most from residential energy credits — including a 30% credit for certain energy-efficient remodeling costs, subject to a $1,200 annual limit beginning in 2023 (as opposed to a $500 lifetime cap under the old rules). The 30% clean energy credit — previously referred to as the residential energy efficient property (REEP) credit — for more expensive items (e.g., solar water heaters and geothermal heat pumps) that was scheduled to drop in 2023 and expire in 2024 was also extended.
- More than $14 billion in tax breaks will support clean vehicles. More than half of these funds will come from the clean vehicle credit (previously called the “new qualified plug-in electric drive motor vehicle” credit). The credit is up to $4,000 for used electric and hybrid plug-in vehicles and up to $7,500 for new qualifying vehicles. However, the final assembly of the vehicle must occur within North America to qualify for the incentive. New income restrictions also apply.
- Business owners may benefit from changes in the Section 179D tax credit for energy-efficient commercial buildings. Home builders and developers will receive higher tax breaks for qualifying energy-efficient homes.
- Other credits, grants, and programs directed at clean energy production and storage — and projects directed at communities with payroll and property taxes stemming from fossil fuel production — are provided.
The most significant tax increases — “deficit reduction” provisions under the bill — are primarily aimed at the largest corporations. To summarize:
- The bill will impose a new minimum tax on corporations with average annual income over $1 billion. The minimum tax would apply if 15% of financial statement income (plus or minus the various deductions and addbacks specifically provided) results in a higher tax than the traditional tax imposed on taxable income. Certain tax adjustments (e.g., depreciation deduction for certain industries, some defined credits) would be permitted. The new corporate tax is estimated to raise $222 billion.
- 1% excise tax on publicly traded companies on the excess of repurchased corporate stock over any new issues to employees or the public. The tax would not apply if the amount of net buybacks for a corporation is less than $1 million. The new excise tax is estimated to raise $74 billion.
Another major provision aimed at raising revenue is the appropriation of additional funds of nearly $80 billion over a 10-year period for the IRS to enhance enforcement activities, operations support, and business system modernization. (This is a significant increase in funding for the agency with a FY year 2022 budget request of $13.16 billion.)
More than half of the new funding (roughly $45.6 billion) must be used to determine and collect owed taxes, provide legal support, conduct criminal investigations, and provide digital asset monitoring and other compliance-related activities. According to Congressional Budget Office estimates, the enhanced enforcement of the tax laws will add roughly $124 billion in revenue.
A tax increase on business owners operating as a sole proprietor or pass-through entity (i.e., entities taxed as partnerships, S corporations, or LLCs) that has not garnered the same media attention as the corporate tax hikes and IRS funding is the limit on excess business losses. The complicated tax rule generally limits a taxpayer’s ability to offset investment or employment income with a business loss, even if the taxpayer is actively involved in the business. This less-well-known provision, which was extended until the end of 2028, is estimated to raise an additional $54 billion in taxes on individuals.
Tax changes left out
The vast majority of proposed tax increases on individuals were not included in the final bill. There are no changes to the individual income tax rates or added surcharges on individuals, estates, and trusts with income over certain thresholds. The proposed hike in the capital gains rate did not happen. The estate and gift tax rates, exemption amount, and related tax rules (including “stepped-up basis” upon a taxpayer’s death) are also unchanged — which means estate planning will continue to be a focus for many families and business owners until the favorable provisions passed under the Tax Cuts and Jobs Act (TCJA) sunset at the end of 2025.
The expansion of the Medicare surtax to active business income also did not occur. This is good news for materially participating business owners (including real estate professionals) who would have paid an additional 3.8% tax on a portion of their income.
Another popular provision at risk last year, but ultimately preserved, was the like-kind exchange rule that provides nonrecognition treatment on certain real estate transactions (known as “1031 exchanges”). Changes to the international tax rules to meet OECD mandates were also nixed.
The fate of a few tax proposals remained uncertain until the end of negotiations. However, the taxation of an investment manager’s profits from a private equity, hedge fund, or venture capital investment (referred to as a “carried interest”) was not changed in the final package. The extension of the $10,000 limit on a taxpayer’s deduction for state and local income taxes (the so called “SALT cap”) was similarly left out.
One business-favorable provision that had a chance, but was ultimately dropped, was the ability to immediately deduct research and development costs each year. Due to TCJA, businesses will need to amortize these costs (generally over five years) for 2022, unless retroactively addressed by Congress after the election.
How we can help
CLA can evaluate complex situations in the scope of your business and industry to help you create a proactive and tailored financial plan and discover tax alternatives and opportunities. Our team of tax professionals continues to keep tabs on how new legislation could impact your tax strategy