Inflation Reduction Act of 2022

On Friday, Congress passed the Inflation Reduction Act of 2022 (“the Act”), a much-scaled back version of the Biden administration’s original “Build Back Better” spending plan that was introduced last year. The new law is expected to be signed by the president next week. While the Act provides for substantial increases in spending mostly in the areas of energy, prescription drugs, climate change, and IRS administration, the tax aspects of the legislation will likely have a narrow impact among most taxpayers. Below are some of the more significant tax changes:

• The Act revives a new version of the corporate alternative minimum tax as a 15% tax on the “book” income of domestic corporations that exceed more than $1 billion in average annual financial statement income over a 3-year period. The tax will be applicable to tax years starting after December 31, 2022.
• The new law includes a 1% excise tax that will be assessed against domestic corporations that engage in stock buy-back programs. With certain exceptions, the tax will be applied to the fair market value of stock repurchases beginning after 2022.
• The Act extends through 2025 the subsidies of the Affordable Care Act by enacting certain adjustments and expansions of the premium tax credit, including an allowance for taxpayers with income above 400% of the federal poverty line to qualify for the credit thereby expanding access to more middle-income families.
• The Act continues the current suspension until 2025 of the tax deduction for state and local taxes. It also extends the limitation on excess business losses of noncorporate taxpayers through 2028.
• Treasury will reinstate the ‘Superfund’ excise tax on crude oil imposed against U.S. refineries at a rate of 16.4 cents a barrel beginning in 2023. This provision will have no sunset.
• While not a change in the tax law, a significant revenue raiser will be the increased $79.6 billion funding of the IRS for operations, technology, and enforcement through the fiscal year 2031. Over the 9-year period it is estimated to raise an additional $204 billion in revenue.

Observation: While the tax changes are mostly focused on large, publicly-traded corporations, this will likely have some eventual downstream impact on consumers with businesses passing along the increased costs. More relevant to most taxpayers, however, is the notion of increased IRS enforcement which is currently being highlighted in the media. Though the increased funding will certainly lead to increased hiring of agents, the Service will actually be replacing thousands of agents recently lost through retirement and other attrition. Audits of high-earning taxpayers can be expected to increase nominally over time as a result of the funding, but it will be a gradual process of incremental change.

A significant part of the Act includes drug pricing provisions intended to mitigate the rising cost of medications for taxpayers. The law authorizes the Department of Health and Human Services to negotiate certain drug prices with manufacturers under Part D of Medicare starting in 2025, with companies not providing the drugs at prescribed price levels having to pay a civil penalty. It also initiates a program to require drug manufacturers to provide rebates to Medicare for drug prices that outpace inflation, and it provides additional Part D caps on cost-sharing and out-of-pocket drug costs for Medicare beneficiaries. Particularly, the law intends to cap co-pays for insulin at $35 per month and maximum out-of-pocket drug costs at $2,000.

Observation: Some of the drug pricing provisions were intended to be extended to privately-insured taxpayers as well. However, the provisions were required to be removed under Senate parliamentary rules in order to pass the law under the reconciliation process.

The most dramatic spending provisions under the new bill were reserved for energy and climate change expenditures with $369 billion set aside, including $68 billion in restored, expanded, and new tax credit incentives generally aimed at solar, wind, geothermal, and biomass energy production. Carbon sequestration projects and other alternative fuels are also included. Many of these provisions provide two investment tax credit components: a lower base credit (generally at 6%) and a bonus rate (up to 30%). The bonus rate is equal to five times the base amount and is available only when requirements related to “prevailing wages” and “apprenticeships” are met. Under certain provisions, the Act also further incentivizes the use of “domestic content” and placement in identified communities, e.g., so-called “energy communities” or low-income communities. Another unique feature of the new law is that it permits taxpayers, in particular situations, to elect a “direct pay” option in lieu of a tax credit, or the option to monetize the credits by transferring them to another entity. Starting in 2025 the industry-specific tax credits will start to transition to new credits that are ‘technology-neutral’ and tied to minimal greenhouse gas emissions.

Observation: The transferability and monetization of these federal tax credits will be advantageous to taxpayers and create planning opportunities by removing an obstacle that previously inhibited the efficiency of making such investments.

For individuals, additional tax credits will be allowed for the purchase of both new and used “clean” energy vehicles, though the credits will be phased out and disallowed for vehicles above a retail price threshold and disallowed for taxpayers above certain adjusted gross income thresholds. The maximum credit for new vehicles will be up to $7,500 and up to $4,000 for previously-owned vehicles. Other credits for clean commercial vehicles and constructing alternative fuel refueling property will also be available.

Homeowners may benefit from the extension and expansion of the Nonbusiness Energy Property Credit and the Residential Clean Energy Credit, while home builders may utilize the New Energy Efficient Home Credit. These incentives provide tax credits for the purchase of qualifying residential energy property such as windows, doors, insulation, and energy-efficient HVAC products. For commercial building owners, the Section 179D deduction is also expanded by liberalizing the efficiency requirements and increasing the base and bonus deductions.

Appropriations totaling nearly $148 billion will be invested in various government departments to provide substantial resources in combating pollution and climate change, while at the same time protecting and expanding traditional oil and gas development. Significant funding of the Environmental Protection Agency (EPA), Department of Agriculture (USDA), Department of the Interior (DOI), and Department of Energy (DOE) are intended to improve air quality, promote conservation, invest in climate-smart and improved infrastructure, and encourage domestic energy and transportation technologies. Much of the funding will be provided to state and local jurisdictions and tribal governments in order to target low-income communities, communities of color, and rural communities that are oftentimes disadvantaged and disproportionately exposed to toxic pollution. Combined with the tax incentives mentioned above, these expenditures are widely considered to be the most ambitious step by the U.S. government in addressing climate change and a major step in securing the country’s future energy independence.

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