On August 16, 2022, President Biden signed the Inflation Reduction Act of 2022 [IRA22] into law with spending and tax breaks of $790 billion and a net deficit reduction of $385 billion as stated by the nonpartisan Congressional Budget Office. One item of note for the national deficit hawks out there, this legislation is the largest deficit reduction bill since the Budget Control Act of 2011.
The IRA22 is significantly smaller is size than the original efforts by the Democratic controlled Congress to pass the “Build Back Better” bill introduced in November 2021 which proposed spending of $6 trillion.
The IRA22 was passed without a single Republican vote in the Senate with Vice President Harris passing the tie-breaker vote under budget reconciliation rules. The House of Representatives passed the bill with a vote of 220-207 with all votes following party lines.
In the analysis below, we will review some the major tax provisions:
Three major revenue generating provisions:
- IRA22 Act provides for a corporate alternative minimum tax (AMT) calculated as 15% of a company’s “adjusted financial statement income” effective for taxable years beginning after 12/31/22. This AMT only applies to corporations with an average annual net financial statement income of more than $1 billion for the three prior tax years. The “adjusted financial statement income” calculation includes several adjustments to the financial statement net income, one of which is the use of tax depreciation amounts as opposed to GAAP/Book depreciation amounts which generally requires a longer depreciation period and will often have the impact of lowering the AMT tax base. This provision is estimated to raise $222.25 billion over 10 years.
- The Act includes a one percent excise tax on stock repurchases by domestic corporations whose stock trades on an established securities market effective after 12/31/22. NOTE – this revenue raiser was added to a revised version of the bill to make up for lost revenue when the “carried interest” provision for hedge fund investors was removed. This provision is estimated to raise $73.69 billion over 10 years.
- The Act also includes an extension to the IRC 461(l) excess business loss limitation as it applies to sole proprietors and pass-through entity (Partnership and S-Corporation) owners. This provision was set to expire in 2026 but will now be applicable through 2028. This provision is estimated to raise $11.72 billion over 10 years.
First introduced in 2017, the excess business loss provision prevents non C-Corporation taxpayer loss deductions in excess of an annual threshold amount, and instead, that excess carries forward as a net operating loss, subject to NOL rules. For 2022, the threshold amount is $270,000 ($540,000 if Married and Filing Jointly).
IRS funding:
IRA22 has the following IRS funding increases over a 10-year period:
- $45.6 billion for enforcement
- $25.3 billion for operations support
- $4.8 billion for business systems modernization
- $3.1 billion for taxpayer services
The increase in the enforcement efforts represents at 69% increase from current funding amounts.
While these expenditures are not tax increases, they are intended to raise revenue by increased compliance and reducing the “tax gap.” The tax gap is the difference between the tax revenue the IRS should collect compared to the actual tax collections and the most recent estimate from the IRS is the tax gap is $441 billion annually. Treasury Secretary Janet Yellen has publicly requested the additional IRS enforcement funds not be used to increase audit rates for taxpayers with taxable income below $400,000 (this income threshold aligns with President Biden’s campaign promise to not raise income taxes on those earning less than $400,000).
While not included in the revenue projections, the Congressional Budget Office estimates the increase in IRS funding to boost revenues by $203.7 billion over 10 years.
At RDG, we expect to see an increase in tax return audits in the coming years. We believe the IRS will spend the next year training the new auditors and then push them into the field to enforce the tax laws via taxpayer audits. Specifically, we anticipate a team of IRS auditors who will be charged with reviewing PPP forgiveness applications as well as Employee Retention Credit claims will begin in late 2022. The IRS has been granted a five-year window to audit ERC claims and the SBA has up to six years to audit PPP forgiveness applications. Additionally, President Biden signed two bills into law on August 5, 2022, that gives the Federal government 10 years to investigate fraud related to PPP applications and SBA EIDL loans. Now is the time to review your support and documentation if your business benefited from these pandemic related programs to ensure any audits will result in no changes (these are the audits we like best!).
Research & Development Credit:
Beginning in 2016, qualified small businesses that have less than $5 million of receipts over five years have had the option to claim a portion of their R&D credit against payroll taxes. The IRA22 increases the R&D credit that can be used to offset payroll taxes from $250,000 to $500,000 per year for tax years beginning after 2022.
Also, as a reminder, effective for tax years beginning after 12/31/21, the Tax Cuts and Jobs Act of 2017 changed the deductibility of research expenditures. Under these new rules, taxpayers will no longer have the option to deduct research or experimental expenditures but will be required to capitalize and amortize them (domestic expenditures are amortized over five years and foreign expenditures over 15 years).
For RDG clients with R&D credits, we suggest a review of your projected R&D expenditures and the impact of the new amortization requirements on taxable income and cash flow.
Green Energy:
The largest area of spending in the IRA22 is intended to put the U.S. on a path to reduce greenhouse gas emissions by 40 percent below 2005 levels by 2030 through tax credits and budgetary appropriations aimed at incentivizing production of, and investments in, renewable energy. Some energy related credits have been extended and/or expanded, such as those for residential energy property and electric vehicles. However, the Act also creates new credits, such as credits for the production of clean electricity and credits that will replace the existing production tax credit and investment tax credit.
The Act allows tax-exempt organizations and state/local governments to elect a cash payment option whereby the entity is treated as if it had made a tax payment equal to the credit which is refundable.
The Act also allows eligible taxpayers to transfer all or a portion of eligible credits to a different taxpayer in exchange for cash. The payments are not included in gross income of the selling taxpayer nor are they deductible for the purchasing taxpayer. By allowing the essential sale of tax credits the need for complex tax equity financing structures that allows a tax equity investor to have an indirect ownership in qualifying facilities will most likely no longer be necessary to monetize certain tax credits.
The IRA22 impact on existing energy related tax credits
Residential Energy Tax Credits and Incentives:
The Energy Efficiency Home Improvement Tax Credit, formerly known as the Nonbusiness Energy Property Credit, which expired at the end of 2021, is modified and extended through 2032 by the IRA22. This credit applies to energy efficient windows and doors, as well as certain HVAC systems and heat pumps, and the lifetime maximum for the credit is replaced with an annual limit of $1,200.
The old, expired credit was worth 10% of the costs of installing certain energy-efficient insulation, windows, doors, roofing, and similar energy-saving improvements in your home. You could also claim the credit for 100% of the costs associated with installing certain energy-efficient water heaters, heat pumps, central air conditioning systems, furnaces, hot water boilers, and air circulating fans. However, there was a lifetime limit of $500 for the credit meaning credits taken in previous years counted towards the limit. There was also a $200 lifetime limit for new windows. These limits severely restricted the overall value of the credit.
The credit is revived for the 2022 tax year, and the old rules apply. However, starting in 2023, the credit will be equal to 30% of the costs for all eligible home improvements made during the year. It will also be expanded to cover the cost of certain biomass stoves and boilers, electric panels and related equipment, and home energy audits. Roofing and air circulating fans will no longer qualify for the credit, though.
Beginning in 2023, the annual tax credit limits for energy efficient improvements are:
- Up to $150 for home energy audits
- Up to $250 for an exterior door ($500 total for all exterior doors)
- Up to $600 for exterior windows and skylights; central air conditioners; electric panels and certain related equipment; natural gas, propane, or oil water heaters; natural gas, propane, or oil furnaces or hot water boilers.
- Up to $2,000 for electric or natural gas heat pump water heaters, electric or natural gas heat pumps, and biomass stoves and boilers (for this one category, the $1,200 annual limit may be exceeded).
For eligible home improvements after 2024, no credit will be allowed unless the manufacturer of any purchased item creates a product identification number for the item, and the person claiming the credit includes the number on his or her tax return.
Because the $500 lifetime credit limit will be replaced by a $1,200 annual limit, homeowners who spread out qualify projects over multiple years can claim the maximum credit each year.
The High Efficiency Electric Home Rebate Program allows qualified homeowners up to $14,000 in total rebates starting in 2023. In order to qualify, household income cannot exceed 150% of the area median income as calculated by the Department of Housing and Urban Development. A link to lookup the Area Median Income in your area from Fannie Mae can be found here – https://ami-lookup-tool.fanniemae.com/amilookuptool/
The high-efficiency electric home rebates are:
- Up to $8,000 to install heat pumps that can both heat and cool homes
- Up to a $4,000 on the cost of upgrading electric panels
- Up to $2,500 for electrical work services
- Up to $1,750 for heat pump water heaters
- Up to $840 for electric stoves, cooktop, range, oven, or heat pump clothes dryer
- Up to $1,600 for insulation, air sealing, and ventilation projects
Clean Vehicle Tax Credits:
The tax credit for purchasing an electric vehicle was also revamped by the IRA22 as of 08/16/22.
The credit for purchasing a new qualified clean vehicle, including electric vehicles, plug-in hybrids and hydrogen fuel cell batteries remains at $7,500, however new eligibility rules are in force if you entered into a binding contract after 08/16/22 and they apply through 2032. The new rules only allow tax credits for qualifying clean vehicles for which final assembly occurred in North America.
If you entered into a binding contract prior to 08/16/22, you claim the tax credit based on the manufacturer production rules that were in effect prior to the IRA22.
There IRS added a page to its website that provides a lookup for 2022 and 2023 model electric vehicles to determine if they meet the North America assembly requirement found here IRS webpage for EV eligible for credit under IRA22
In addition to the list of vehicles with final assembly in North America listed on the webpage above, the build location of a particular vehicle should be confirmed by the VIN or an information label affixed to the vehicle. The U.S. Department of Transportation’s NHTSA provides a VIN decoder that can be used to identify a vehicle’s build plant and country of manufacture along with other details about the vehicle. To look up a vehicle’s assembly location (build plant country), you can enter your VIN on the same webpage that lists eligible 2022 and 2023 models at the bottom under “Specific Assembly Location Based on VIN” as shown below:
Additionally, used EVs (i.e., previously owned clean vehicles that are at least two years old) will now have a separate tax credit of either up to $4,000 or 30% of the price of the vehicle, whichever is less. However, a previously owned EV can’t qualify if it’s purchased for resale.
Beginning in 2024, consumers will have the option to use the EV tax credit as a discount at the time you purchase the vehicle. Essentially, you would be transferring the credit to the dealer, who would be able to lower the price of the vehicle by the amount of the credit. This means that you won’t have to wait until you file your taxes to benefit from the EV tax break.
Although the EV tax credit will effectively be expanded, the IRA22 also imposes income and vehicle price limits as follows:
INCOME LIMITS:
- If filing Single – modified adjusted gross income must be under $150,000 to claim the credit
- If filing Married Filing Joint – modified adjusted gross income must be under $300,000 to claim the credit
- If filing as Head of Household – modified adjusted gross income must be under $2250,000 to claim the credit
VEHICLE MSRP LIMITS:
- Vans, pickup trucks and SUVs with a manufacturer’s suggested retail price (MSRP) of more than $80,000 do not qualify
- Cars with a MSRP of more than $50,000 do not qualify
- For all types of used vehicles, the purchase price must be $25,000 or less to qualify
NOTE – there are several additional tax credits/incentives that benefit taxpayers who are involved in the production of energy and/or equipment related to the production of energy which will not be discussed in this update. If you are involved in the production of energy or energy production equipment, please contact our office to discuss if any of these apply to your situation.
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The content included above supports RDG + Partners marketing of professional services and is not written tax advice directed at the specific facts and circumstances of any person or entity. If you are interested in the topics presented, we encourage you to contact us or an independent tax advisor to determine if any topics apply to your situation. This content is not intended by RDG + Partners to be used, and cannot be used, by any person or entity for purposes of avoiding penalties that may be imposed under the Internal Revenue Code. The information contained is general in nature and based on authorities that are subject to change. It is not, and should not be construed as, accounting, tax or legal advice provided by RDG + Partners to the reader as prospective or retroactive changes in tax laws or other factors could affect the information contained herein.