President Biden signs major reconciliation tax bill

President Joe Biden signed into law Aug. 16 a sweeping tax reconciliation bill with more than $450 billion in tax increases and $260 billion in energy tax incentives.

The legislation, known as the “Inflation Reduction Act” (H.R. 5376), passed the House on Aug. 12 by a vote of 220-207, after passing the evenly divided Senate on Aug. 7. Democrats used the reconciliation process in the Senate to bypass procedural hurdles and pass the bill with the barest 51-50 majority after Vice President Kamala Harris cast the deciding vote. The bill was unanimously supported by congressional Democrats, while no Republicans voted for the package.

The bill’s enactment is a major victory for Democrats after a tortured legislative process that stretched more than 18 months. The effort appeared doomed at least twice when Sen. Joe Manchin, D-W.V., walked away from negotiations, though Senate Majority Leader Chuck Schumer, D-N.Y., was finally able to cut a deal with Manchin on July 27. The last remaining holdout, Sen. Kyrsten Sinema, D-Ariz., agreed to support the bill after Democrats struck a carried interest provision from the package and softened the 15% minimum tax on financial statement income. Sinema pledged to work with Sen. Mark Warner, D-Va., on future reform of the tax treatment of carried interest, but Warner said he was not confident of success.

Financial statement income for the minimum tax now will be adjusted for accelerated tax depreciation, with the lost revenue from the adjustment replaced by a 1% excise tax on stock buybacks from publicly traded companies. Democrats also stripped out an expansion of the common control test for the minimum tax that targeted private equity. They instead extended the loss limitation under Section 461(l) for two years.

The deal falls well short of the massive Build Back Better tax bill originally envisioned by Democrats, but still includes a handful of targeted tax provisions that will have a significant impact, including provisions that:

• Impose a 15% minimum tax on financial statement income for large corporations
• Create a 1% excise tax on stock buybacks by publicly traded corporations
• Reinstate a Superfund excise tax on crude oil and petroleum products at a rate of 16.4 cents per barrel
• Extend the limit on losses under Section 461(l) for two years through 2027
• Add a $268 billion package of new, expanded, and extended energy incentives
• Double the cap on R&D credits refundable against payroll taxes for eligible small businesses

The legislation leaves many Democratic and bipartisan tax priorities unfinished. More than $1 trillion in additional tax increases previously proposed by Democrats were left out—though it is possible that specific provisions pick up traction in the future. Stand-alone revenue raisers, once proposed, are always in danger of being repurposed for other priorities. But barring unexpected election gains, there seems to be little hope for Democrats to resurrect anything approaching the scale of their original ambitions in the next two years. Although results should not be taken for granted, most pollsters currently expect Republicans to win the House and possibly the Senate in November.

Lawmakers will likely now turn their focus to bipartisan tax priorities. The reconciliation bill does not address the amortization of research expenses under Section 174, as many lawmakers hoped. Significant bipartisan support remains for restoring full expensing retroactively for 2022, but the provision still needs a legislative vehicle. The best opportunity may be a year-end bipartisan agreement on other expiring and expired tax “extender” provisions. Such an effort could also include extending 100% bonus depreciation, which is scheduled to revert to 80% for property placed in service in 2023. Democrats are less likely to support relief from the interest deduction limit under Section 163(j) without major concessions from Republicans.

The biggest hurdle to a potential extenders package may be flagging momentum. The list of expiring provisions has been getting shorter every year, and the reconciliation bill addresses many of the temporary energy credit provisions that drive Democratic participation in extender deals. Lawmakers have unfailingly managed to address the extenders in recent years, but the dwindling list of important provisions raises questions over whether that remains sustainable.

The more long-term source of contention among lawmakers may be implementation of the global minimum tax deal the Biden administration reached with the Organisation for Economic Co-operation and Development (OECD) on the Pillar 2 framework. The administration originally hoped to get the U.S. compliant as part of the reconciliation legislation, but Manchin opposed the changes over worries that early U.S. implementation would hurt domestic companies. Now the Biden administration could have difficulty enacting the needed changes as the rest of the world works toward implementation beginning in 2024.

Most Republican lawmakers oppose the international deal and seem disinclined to work with the administration on U.S. implementation. The Biden administration is hoping that U.S. businesses will begin lobbying for implementation once the rest of the world moves forward, as U.S. businesses could potentially suffer adverse consequences if implementation is widespread without the United States. The new 15% minimum tax on financial statement income could be amended to fit an undertaxed profits rule as part of implementation, but full compliance would require major legislative changes. The fight over implementation of Pillar 2 in the U.S. could be the defining tax policy issue of the next two years.

The tax provisions in the Inflation Reduction Act are discussed in more detail below.

Corporate alternative minimum tax (CAMT)

The legislation will impose a 15% minimum “book” tax on corporations that report three-year average annual “adjusted financial statement income” (AFSI) exceeding $1 billion. The threshold for foreign-parented domestic corporations will be $100 million if the international reporting group has $1 billion in income. A last-minute change treats domestic branches operating a trade or business in the U.S. as domestic corporations for purposes of the tax. The tax will be imposed on both public and private C corporations, but not S corporations, real estate investment trusts, or regulated investment companies. Entities will be aggregated under the common control rules of Section 52, but an amendment removed language expanding these rules to target private equity. Democrats claimed in summaries that only about 150 to 200 companies will pay the tax.

The 15% rate will apply to AFSI, which will start with “net income” from an applicable financial statement (defined under Section 451(b)(3)), and then will be modified by many specific statutory adjustments, including:

• For foreign corporations, only U.S. effectively connected income will be considered
• Domestic corporations will add a pro rata share of financial statement income of each controlled foreign corporation where the domestic corporation is a U.S. shareholder
• Both foreign and domestic tax will be added back
• AFSI will be adjusted by amortization and depreciation for tax purposes under Sections 167 and 168 along with amortization deductions under Section 197 for wireless spectrum acquired by wireless carriers after 2007 and before the date of enactment
• AFSI from disregarded entities owned by the taxpayer will be included
• Pension plan treatment will be aligned to tax principles rather than book principles
• Newly defined “financial statement” net operating losses could offset up to 80% of AFSI

General business credits will be allowed against the minimum tax subject to the general limit under Section 38, and there are specific foreign tax credit rules. Any minimum tax paid will be creditable against regular tax in future years. The proposal will be effective for tax years beginning after Dec. 31, 2022.

This new tax regime will be fraught with many technical issues, and Treasury will be tasked with providing extensive guidance. The proposal originally came under fire for creating potential tension between the measurement of income for tax purposes and for financial statement purposes, which serve different purposes. A similar tax was created in 1986, but quickly abandoned because lawmakers believed companies were manipulating financial statements to avoid it. The provision also cedes control over the definition of “taxable income” for purposes of the tax to the accounting industry, which generally sets financial statement income standards.

Excise tax on corporate stock buybacks

The legislation will impose a 1% excise tax on publicly traded U.S. corporations for the market value of any stock that is repurchased by the corporation during the taxable year. The provision is nearly identical to the provision that passed the House in 2021, except that the effective date has now been postponed one year to apply to repurchases of stock after Dec. 31, 2022. The provision is estimated to raise $74 billion—down from $124 billion from the November estimate—reflecting shifting economic projections.

The term “repurchase” means a redemption within the meaning of Section 317(b) with regard to the stock of such corporation, and any other economically similar transaction as determined by Treasury. The tax will not apply to:

• Tax-free reorganizations
• Stock contributed to an employee pension plan, ESOP or similar plan
• Stock repurchases of less than $1 million in a year
• Stock purchased by a dealer in securities in the ordinary course of business
• Repurchases treated as a dividend
• Repurchases by a regulated investment company or real estate investment trust

IRS funding

The agreement will increase IRS funding by $80 billion over the next 10 years, which the Congressional Budget Office estimated will raise $204 billion in revenue for a net increase of $124 billion.

Superfund

The legislation will resurrect the Hazardous Substance Superfund excise tax on crude oil received at a U.S. refinery and petroleum products entering the United States. The tax was last in place at 9.7 cents per barrel rate in 1996. Beginning in 2023, it will be effective at 16.4 cents per barrel, indexed to inflation.

R&D credit

The legislation doubles the $250,000 annual cap in refundable research credits that eligible small businesses can claim against payroll taxes. Eligible small businesses generally must have $5 million or less in gross receipts in the year of the claim and no gross receipts prior to the last five years, including the year of the claim. The proposal is effective in tax years beginning after 2022.

Excess business losses under Section 461(l)

The bill extends the limit on deducting excess business losses under Section 461(l) for two years. The limit was created by the TCJA, but was suspended from 2018 through 2020. The limit was scheduled to expire after 2025 along with most of the individual provisions in the TCJA. The reconciliation bill extends the limit through 2027.

Energy provisions

The legislation includes a substantial $268 billion package of energy incentives. The legislation both enhances and extends existing tax incentives—and creates many new tax credits. Most of the tax credits, both new and enhanced, will require taxpayers to meet prevailing wage and apprenticeship requirements to qualify for the full credit rate. The legislation also allows for easier monetization of credits by allowing tax-exempt entities to elect direct payment refunds and allowing other businesses to transfer the credits to other taxpayers for cash.

 

ITC and PTC

The legislation generally extends and enhances the Section 45 production tax credit (PTC) and Section 48 investment tax credit (ITC) at enhanced rates before replacing them with similar credits that are meant to be technology-neutral.

The beginning construction deadline for the PTC generally is extended through 2024 at a rate of 2.5 cents per kilowatt hour, and solar property qualifies. The full credit rate will be available only if the project meets prevailing wage and apprenticeship requirements discussed below. The requirements must generally be met during construction and for the entire 10-year period for which credits are claimed. Additional 10% boosts in the credit will be available for projects that use domestic steel, iron, and manufactured products and projects in specific “energy communities.”

The ITC generally is extended at the full 30% rate if construction begins before 2025. Like the Section 45 credit, the full credit will be available only if prevailing wage and apprenticeship requirements are met and will offer boosted rates for domestic components and projects in energy communities. Qualifying property is expanded to include energy storage technology, biogas property, microgrid controllers, dynamic glass, and linear generators. Taxpayers can continue to elect the ITC in lieu of the PTC, and taxpayers can monetize either credit under new direct pay or transferability regimes discussed below.

The credits will be replaced by equivalent technology-neutral versions under new Sections 45Y and 48E for construction beginning in 2026 or later. These new credits will then phase out by the later of 2032 or when emissions targets are achieved.

 

Prevailing wage and apprenticeship requirements

The legislation modifies many of the energy incentives to provide two different credit values: a base rate and a bonus rate five times the base rate. The bonus rate is generally available only for projects that meet prevailing wage and apprentice requirements. The wage requirements require specific minimum prevailing wages be paid based on project locations. The apprenticeship requirements require a set percentage of total labor hours on a project be performed by qualified apprentices.

The taxpayer placing the property in service and ultimately claiming or transferring the credit will be responsible for the contractors and subcontractors meeting the prevailing wage and apprenticeship requirements. The requirements will generally apply to projects that begin construction 60 days after Treasury has published relevant guidance with respect to the requirements.

Credit monetization

The legislation creates two separate regimes to allow taxpayers to monetize credits. Tax-exempt entities, state governments and entities, Indian tribal governments, the Tennessee Valley Authority, Alaska Native Settlement Corporations, and rural electricity cooperatives will be able to elect to receive the credits as refundable direct payments.

Other businesses will be able to elect to transfer the credits to other taxpayers. The transferred credit must be exchanged solely for cash from an unrelated party. The proceeds will be exempt from income but not deductible to the buyer. S corporations and partnerships will transfer the credits and make the election at the entity level.

Taxpayers will not be allowed to transfer credit carrybacks or carryforwards, so they can only elect to transfer credits in the year they would otherwise be claimed. Taxpayers can choose to transfer only a portion of credits, and Section 45, 45Q, 45V, and 45Y PTC credits will require a separate election for each facility and for each taxable year in the facility’s credit period.

The election to transfer credits is required by the due date of the return (including extensions) for the year in which the credit is determined, and the taxpayer receiving the credit will be required to take it into account in the first taxable year ending with or after the taxable year in which the seller makes the transfer election. The taxpayer receiving the credit will be permitted a three-year carryback period for the credits, but cannot transfer them again. Transferable credits include:

• Section 48 ITC
• Section 45 PTC
• Section 45Q credits for carbon capture and sequestration
• Section 30C alternative fuel vehicle refueling property credits
• Section 45U zero-emission nuclear power production credits
• Section 48C advanced energy project credits
• Section 45V clean hydrogen production credits
• Section 45X advanced manufacturing production credits
• Section 45Y clean electricity production credits
• Section 48E clean electricity investment credits
• Section 45Z clean fuel production credits

Section 45Q carbon capture credit

The legislation increases the Section 45Q carbon capture tax credit for direct air capture facilities to $180 per metric ton for carbon oxide captured and sequestered, and to $130 per metric ton for carbon oxide captured and used as a tertiary injectant in a qualified enhanced oil or natural gas recovery project or otherwise used in an approved manner. In addition, the legislation raises the Section 45Q credit for other qualified projects to $85 per metric ton of carbon oxide captured and sequestered and $60 per metric ton of carbon oxide captured and used as a tertiary injectant or otherwise used in an approved manner.

In order to qualify for the full credits, taxpayers will need to meet prevailing wage and apprenticeship requirements. The legislation also reduces the minimum capture requirements for carbon capture facilities to receive the credit and will extend the credit to facilities that begin construction before the end of 2031.

Fuel credits

The legislation extends several excise tax credits related to alternative fuels, biodiesel and renewable diesel, and biodiesel mixtures through Dec. 31, 2024. The credits will then be replaced by a new technology-neutral credit under Section 45Z that will be based on “well-to-wheel” lifetime emissions. Treasury will be required to publish credit rates, and the credits will be available from 2025 to 2027.

In addition, the legislation adds a sustainable aviation fuel credit under new Section 40B for sustainable fuel sold as part of a qualified fuel mixture. The sustainable aviation fuel credit will be determined on a sliding scale from $1.25 to $1.75 per gallon, depending on the reduction in lifecycle emissions of the fuel, and can be claimed as a credit against excise tax liability under Section 4041. The credit will apply to fuel sold or used after 2022 and before 2027.

Clean hydrogen production

The legislation creates a new credit for production of clean hydrogen under new Section 45V, which will be available for businesses producing clean hydrogen at a clean hydrogen facility. The amount of the credit will depend on the reduction in life-cycle greenhouse gas emissions compared to hydrogen produced by steam-methane reforming.

Energy-efficient commercial buildings

The legislation increases the maximum Section 179D energy-efficient commercial building deduction starting in 2022 and changes the maximum to a three-year cap rather than a lifetime maximum. The full deduction will generally only be allowed if the project meets prevailing wage and apprenticeship requirements. The changes to the provision will expire after Dec. 31, 2031.

Alternative fuel refueling property

The legislation extends the 30% alternative fuel refueling property for depreciable property through 2032, but the credit will only be available for property placed in low-income or rural census tracts beginning in 2023. The legislation also increases the $30,000 per location cap to $100,000 per charging station of refueling pump. The full credit will only be available for projects meeting prevailing wage and apprenticeship requirements.

 

Electric vehicles

The legislation replaces the current elective vehicle credits, which generally phase out by manufacturer based on the number of vehicles sold, with new credits that are only available if vehicles meet domestic assembly and critical mineral and battery component requirements. Credits are available for new, used and commercial vehicles through 2032 with no cap on vehicles per manufacturer.

Section 48C advanced energy project credit

The legislation revives the Section 48C credit by providing an additional $10 billion in credit allocations, with $4 billion set aside for projects in census tracts in which a coal mine or a coal power plant has closed. Taxpayers must apply for the 30% investment tax credit and must satisfy apprenticeship requirements during construction and satisfy prevailing wage requirements both during construction and in the five years after the project is placed in service.

 

Other credits

The legislation creates new credits for existing nuclear plants selling electricity to a third party (new Section 45U) and for manufacturing or solar and wind components (new Section 48X). The legislation extends and enhances:

• Nonbusiness energy property credits under Section 25C
• Residential energy efficient credits under Section 25D
• New energy efficient home credits under Section 45L

Next steps

The legislation affects a narrower subset of taxpayers than earlier drafts of the reconciliation bill, but the remaining provisions will have a significant impact on specific types of taxpayers. Businesses should assess the impact of these new provisions and continue to follow the outlook for unresolved bipartisan tax priorities now that Democrats have finally finished their core economic package.