Source: RSM US LLP.
TAX ALERT | August 08, 2022
Executive Summary: Senate Passes Reconciliation Bill
On Aug. 7, 2022, the Senate passed the Inflation Reduction Act of 2022. The bill now moves to the House with a potential vote later this week. The bill includes several tax-related components including (1) a corporate alternative minimum tax, (2) a 1% excise tax on certain stock repurchases, (3) additional IRS funding including for enforcement, (4) an extension for 2 years of the excess business loss limitation provision (section 461(l)) and (5) many new energy incentives.
RSM is holding a 60-minute webcast on the Inflation Reduction Act of 2022 on Thursday, Aug. 11 at noon Eastern. Register Here
The following detailed discussion provides more in-depth information on how we arrived at where we are now, what is in and out of this bill and the next steps as the bill moves forward to the House for a likely vote this week and then, if passed as expected, to the President for signature as early as next week.
However, as we have said in the past, nothing is guaranteed in this process so please stay updated with our continuing alerts and webcasts.
Background
The Senate on Aug. 7, 2022, passed a budget reconciliation bill that contains significant tax changes affecting certain large corporations, historic clean energy tax incentives and an unprecedented increase in funding for IRS enforcement efforts.
The 51-50 party-line vote to approve the “Inflation Reduction Act of 2022” punctuated more than a year of negotiations in which Democratic lawmakers considered a litany of tax proposals and overcame internal disagreements that on numerous occasions threatened to doom the legislation. The bill now heads to the House of Representatives, which is expected to vote on it by Friday, Aug. 12.
The Senate-passed measure contains four primary revenue raisers:
- The corporate alternative minimum tax
- A 1% excise tax on certain stock repurchases
- $80 billion in additional funding for the IRS
- A two-year extension of the excess business loss limitation rules. The loss limitations now go through Jan. 1, 2029
The bill, which advances key priorities of the Biden administration to combat climate change, includes significant tax incentives for investments in clean energy and other energy-saving activities.
Tax Provisions in the Inflation Reduction Act of 2022
Senate approval of the budget reconciliation bill completed a remarkable turn of events in which Democrats regained the support of key holdout Sen. Joe Manchin of West Virginia and ultimately won the approval of Sen. Kyrsten Sinema of Arizona after certain modifications to the measure were made. The final legislation is narrower than several of the economic, climate, social and tax packages that were proposed previously during negotiations.
Here is a more detailed look at the tax provisions the Senate approved, as well as those not in the bill.
Corporate Alternative Minimum Tax
The corporate alternative minimum tax would impose a 15% tax on the “adjusted financial statement income” of certain corporations and corporate groups that meet a $1 billion average annual adjusted financial statement income test ($100 million in the case of certain U.S. corporations that are members of a foreign parented multinational group—provided the multinational group also meets the $1 billion threshold). This test is computed using the net income or loss provided on a taxpayer’s financial statement with certain adjustments.
The legislation also provides detailed aggregation rules for computation of the new alternative minimum tax. WNT professionals have reviewed the amendment containing the revised aggregation language and are preparing further analysis.
Controlled group rules: For purposes of the $1 billion income threshold, the adjusted financial statement income of certain related entities that comprise a controlled group is taken into account. The bill incorporates, generally, the controlled group rules relating to single-employer status under current law. Related entities can include not only corporations but other organizations as well (e.g., sole proprietorships, partnerships, trusts or estates). A controlled group includes a parent-subsidiary group or a brother-sister group. A parent-subsidiary group is one or more chains of organizations that are connected through ownership of a controlling interest (more than 50%) by a common parent organization. A brother-sister group is two or more organizations owned by the same five or fewer persons (individuals, estates or trusts).
The controlled group rules, however, incorporate only entities that are engaged in a trade or business. Based on the language, it appears as if a private equity partnership, in certain instances, could be excluded from the group. For example, assume a partnership holds all the stock of two operating corporations but does not engage in a trade or business directly. Assuming that five or fewer persons do not control the partnership, it may not constitute a controlled group with its corporations. Thus, the corporations may not have to aggregate their respective adjusted financial statement income for purposes of the $1 billion rule.
Foreign-parented corporation: In the case of a foreign-parented corporation, for purposes of the $1 billion AMT threshold, the adjusted financial statement income of such corporation includes the adjusted financial statement income of all members of the foreign parent’s financial reporting group—including other foreign corporations. For purposes of the $100 million threshold, the general rules with respect to controlled groups noted above will apply.
Financial statement income adjustments: The average annual adjusted financial statement income, used to determine whether the corporation meets the applicable AMT threshold, is adjusted for various items relating to, but not limited to, controlled foreign corporations (CFCs), disregarded entities (DREs), cooperatives, taxes, tax depreciation and tax amortization for qualified wireless spectrum.
Adjusted financial statement income is to be reduced for tax depreciation deductions and then increased by any book depreciation deductions. Adjusted financial statement income is also reduced by any tax amortization allowed related to qualified wireless spectrum and then increased by any book amortization related to such wireless spectrum.
Timing: The corporate alternative minimum tax would be effective for taxable years beginning after Dec. 31, 2022.
Excise Tax on Repurchases of Corporate Stock
The bill would impose a 1% excise tax on the repurchase of corporate stock based upon the fair market value of the stock. In general, the corporations covered by this rule are domestic corporations traded on an established securities market (a “covered corporation.”)
The tax would apply to stock buybacks in the following two types of situations:
(a) Where a corporation acquires its stock from a shareholder in exchange for property (regardless of whether the acquired stock is canceled, retired or held as treasury stock),
(b) Any other economically similar transaction.
The tax would also include acquisitions of the covered corporation’s stock by specified affiliates of the covered corporation. These specified affiliates are (1) any corporation in which the covered corporation indirectly or directly owns more than 50% of the vote or value and (2) any partnership in which the covered corporation indirectly or directly owns more than 50% of the capital interests or profits interests.
Under a special rule, the tax can also apply to the acquisition of stock of certain foreign corporations which are traded on an established securities market when a specified affiliate of the foreign corporation (generally a domestic entity, which is one of the two specified affiliates described in the previous paragraph) acquires the stock from a person other than the foreign corporation or another specified affiliate. In this case, the specified affiliate is treated as a covered corporation and the acquisition is deemed treated as a repurchase of stock of a covered corporation by such covered corporation.
Notably, the amount taxed under the act is generally reduced by the fair market value of any stock issued by the covered corporation during the taxable year, including stock issued as compensation and stock issued in response to the exercise of an option to purchase the stock.
There are several exceptions to the excise tax, including:
- Where the buyback is part of a tax-free reorganization where no gain or loss is recognized
- Where the repurchased stock or its value is then contributed to an employee pension plan, ESOP or similar plan
- Where the total value of the stock buyback during the year does not exceed $1 million
- Where the purchaser is a dealer in securities in the ordinary course of business
- Where the purchaser is a RIC or REIT
- Where the buyback is treated as a dividend
Any tax imposed on the buyback would not be deductible for federal tax purposes.
Timing: The excise tax would be imposed on repurchases of stock after Dec. 31, 2022.
IRS Funding
The bill provides $80 billion to fund the IRS for enforcement and other IRS activities. This funding is estimated to raise a net $124 billion in revenue over the 10-year Congressional budget window. The bill appropriates funding over the 10-year period as follows:
- $3.2 billion for taxpayer services
- $45.6 billion for enforcement
- $25.3 billion for operations support
- $4.7 billion for business systems modernization.
The IRS is also directed to report to Congress on the cost of developing a free direct e-file system.
Extension of Excess Business Loss Limitations
The Inflation Reduction Act of 2022 would extend this provision (in its current form) for an additional two years through tax years beginning before Jan. 1, 2029.
Under current law, the excess business loss provisions limit a noncorporate taxpayer’s ability to deduct an “excess business loss” above a certain threshold (indexed for inflation) – for 2022, the limitation would be $524,000 for joint filers. Thus, a taxpayer filing a joint return who incurs business losses for 2022 would be able to deduct those losses against no more than $524,000 of non-business income for the year. Any losses that are suspended under this provision would be carried forward and treated as a section 172 net operating loss carryover in the following taxable year (which, for many taxpayers, likely results in a one-year deferral).
While the inclusion of the extension of the excess business loss limitation provision was a last-minute substitute provision to the Inflation Reduction Act of 2022, modifications to the loss limitation have been a mainstay in the tax provisions of several of the recent bills and proposed legislation. Indeed, the Build Back Better Act, as passed by the House, included amendments to permanently extend the provision, as well as alter the treatment of the disallowed losses in subsequent years – the House bill would have instead treated disallowed losses as excess business losses in the following year (subject to the deduction limitations of section 461(l)), as opposed to their treatment under current law as net operating losses in the following year (subject to the more lenient rules of section 172).
Energy Provisions
Energy security and reduction of carbon emissions through the growth of the domestic clean energy sector is a centerpiece of the bill. The bill provides for significant investment in renewable energy with a series of tax incentives that will affect businesses across many industries including energy, manufacturing, construction, private equity and consumer products. There are also incentives for individuals and consumers.
What’s Not Included
The FY22 budget reconciliation process that has transpired over the past year has gone through several iterations of proposed tax increases on corporations and individuals. Set forth below is a non-exhaustive list of significant prior proposals that are not included in the version of the bill that the Senate passed.
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- Increasing the corporate tax rate (some proposals suggested raising the rate from its current 21% up to 28%)
- Increasing the top marginal income tax rate on high earners to 39.6% (from the current 37%)
- An additional surcharge tax of 5%-8% on high-income individuals
- Expansion of the net investment income (NII) tax on ‘specified income’ for high-income taxpayers
- A proposed increase in top capital gains tax rates (some proposals raised the rate from its current 20% to 25% or higher)
- Taxing unrealized capital gains by eliminating the ability to step up the basis in appreciated property upon the death of the owner
- Changes to the carried interest provisions
- Addressing the current limitation on the deduction for state and local taxes (SALT)
- Limitations on section 1202 qualified small business stock gains
- Repealing the deferral of gain from like-kind exchanges under section 1031
- Expanded limitations on deduction for business interest expense
- Expanded wash sale rules
- Reduced estate and gift lifetime exemptions (the temporary increase in the exemption currently in effect will expire in 2026 under current law),
- Estate inclusion of grantor trusts and gain recognition on certain transactions with grantor trusts
- Loss of valuation discounts for certain transfers of nonbusiness assets
- Changes to the Qualified Business Income (QBI) deduction limitation (section 199A)
- Proposed IRA and retirement plan changes
- Outbound international provisions including modifications to the global intangible low-taxed income (GILTI) rules, modifications to foreign tax credit limitations, country-by-country reporting, modifications to the base erosion and anti-abuse tax (BEAT), and adopting the Undertaxed Profits Rule (in accordance with Pillar 2 of the OECD-brokered global tax agreement.)
- Modifications that would revert back to an EBITDA-like base for the business interest limitation under section 163(j)
- Modifications to allow for immediate expensing of R&D costs under section 174
- Retroactive reinstatement of the employee retention tax credit for Q4 of 2021
This article was written by Nick Gruidl, Ryan Corcoran, Deborah Gordon, Alina Solodchikova and originally appeared on 2022-08-08.
2022 RSM US LLP. All rights reserved.
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