The Inflation Reduction Act: What financial professionals need to know

By Andy Blocker and Jennifer Flitton

Congressional Democrats finally ended what may have been the longest game of will-they-or-won’t-they in recent memory when the US House of Representatives passed the Inflation Reduction Act (IRA) on Aug. 12 in a party-line vote. For over a year, Democrats tried — and failed, and tried again — to deliver on President Joe Biden’s social spending agenda, formerly known as Build Back Better. Although the end result was much narrower than many progressives would have hoped — focusing solely on climate, health care, and tax — it was a major legislative victory for Biden and Democratic leadership.

Let’s take a look at how Democrats pulled it off, what the Inflation Reduction Act entails, and how it may impact your clients.

Getting Democrats aligned

In August 2021, the Senate and House adopted a concurrent budget resolution along party lines, which unlocked the budget reconciliation process to be used as a tool to pass what was at the time Biden’s Build Back Better proposals by a Sept. 30, 2022, deadline.

Although the House passed its version of the Build Back Better Act in November 2021, the legislation subsequently stalled in the Senate due to policy objections from Senators Joe Manchin (D-West Virginia) and Kyrsten Sinema (D-Arizona). With a 50-50 Senate, Democrats needed all of their members on board. These disagreements ultimately led Senator Manchin to declare Build Back Better “dead” in February 2022.

A few months later, Senate Majority Leader Chuck Schumer (D-New York) and Manchin reignited their negotiations under the stipulation that the bill passed through reconciliation was to be a new proposal focused on climate, tax, and health care — and thus, the Inflation Reduction Act was born.

Running parallel to these discussions was the Chips and Science Act — a historic investment in the semiconductor industry and in research and development to ensure American leadership in science and technology. Several Republicans, including Senate Minority Leader Mitch McConnell (R-Kentucky), indicated that they would not support the Chips and Science Act if Democrats moved forward with their reconciliation bill.

Reports then surfaced in mid-July that Manchin had pulled out of negotiations with Schumer on the climate and tax portions of the bill, which enabled Senate Democrats to garner enough Republican support to pass the Chips and Science Act on July 27, 2022. In a surprise twist that shocked both Democratic and Republican Senators alike, Manchin and Schumer announced just a few hours later that they had reached an agreement to add the Inflation Reduction Act, with its climate, tax, and health care portions, to the budget reconciliation bill.

After a tense week, Sinema — who had previously expressed concern with some of the tax provisions — announced her support of the bill. The Inflation Reduction Act passed the Senate on Aug. 7 in a party-line vote. The House then followed suit on Aug. 12, and Biden signed the bill into law on Aug. 16.

What’s in the bill?

The Inflation Reduction Act is a sweeping package of Democratic priorities that will impact both individual taxpayers and businesses. The legislation is a historic investment that aims to combat the climate crisis, fight inflation by lowering costs for Americans, increase jobs, and reduce the deficit.

The bill raises $737 billion from tax provisions and prescription drug pricing reform, while it invests $437 billion in energy security and climate change measures, extends Affordable Care Act (ACA) subsidies, and supports drought resiliency. In total, the IRA is estimated to reduce the federal deficit by $300 billion and aims to reduce carbon emissions by roughly 40% by 2030.

Additionally, the bill includes several provisions to strengthen rural communities and empower agricultural producers. For example, the IRA invests $20 billion to support climate-smart agriculture practices, as well as grants to support forest conservation and restoration of coastal habitats. Several other decarbonization measures are included in the legislation, including funds for a new Advanced Industrial Facilities Deployment Program to reduce emissions from the largest industrial emitters and a Methane Emissions Reduction Program.

Major provisions of the IRA

Tax

• Corporate tax: Imposes a 15% corporate minimum tax on large businesses that earn more than $1 billion in annual profit. Also includes a 1% excise tax on stock buybacks by publicly-traded corporations.
• IRS: Invests $80 billion over the next 10 years for tax enforcement and compliance.
• Closing tax loopholes: Extends the limitation on excess business losses for two years to help prevent the wealthiest Americans from sheltering their nonbusiness income.

Heath care

• Drug pricing: Empowers Medicare to negotiate the price of 100 prescription drugs over the next decade, beginning in 2023. Caps Medicare patients’ out-of-pocket costs at $2,000 per year.
• ACA credits: Extends the enhanced Affordable Care Act (ACA) subsidies enacted under the American Rescue Plan for another three years.
• Electric vehicles: Includes a $4,000 consumer tax credit for lower/middle income individuals to buy used clean vehicles and up to $7,500 tax credit to buy new clean vehicles. It also extends an existing tax credit for electric vehicle charging.

Energy and environment

• Consumer home energy: Invests $9 billion in consumer home energy rebate programs, plus 10 years of consumer tax credits to make homes energy efficient.
• Production tax credits: Extends and expands the production tax credits for wind, biomass, geothermal, solar, landfill gas, and hydropower.
• Investment tax credits: Directs $10 billion to investment tax credits for clean technology manufacturing facilities including solar, wind, and electric vehicle.
• Carbon oxide sequestration: Extends and enhances the availability of federal tax credits for carbon oxide sequestration under Section 45Q.
• Nuclear production tax credit: Establishes a new tax credit for the existing nuclear fleet, which takes effect in January 2024.
• Biofuels: Institutes tax credits and grants to support the domestic production of biofuels.
• Clean aviation fuel: Establishes a new credit for the sale or mixture of sustainable aviation fuel.
• ?Environmental justice: Invests $60 billion in environmental justice priorities to clean up pollution in disadvantaged communities, including Environmental and Climate Justice Block Grants, Neighborhood Access and Equity Grants, and money for clean heavy-duty vehicles.
• Domestic manufacturing: Includes $10 billion in investment tax credits to build clean technology manufacturing facilities.

How will these policies impact individual taxpayers?

From the beginning of Biden’s presidency, he pledged to never raise taxes on individuals earning less than $400,000 per year — and Democrats contend this bill complies with that requirement. Some independent tax groups have done analyses showing that, for the most part, this is true — or at least the change in share of after-tax income is effectively zero.

For example, in one analysis done by the Tax Policy Center, the average taxes of middle-income households would fall by $100. In a separate analysis done by the same group, they’d go up $20. However, taxes would rise for households in the top 1%. The Tax Policy Center estimates, “Taxes would rise by $6,060 (0.3% of after-tax income) in 2023 for households in the top 1% — with incomes greater than about $1 million. Households in the top 0.1% (those with over $4.4 million of income) would bear an additional burden of $41,580 (0.4% of after-tax income).”(1)

Similarly, the Tax Foundation found that the bill would decrease long-run American incomes by less than 0.05% and would raise marginal income tax rates faced only by higher earners and corporations.(2) However, the Tax Policy Center analysis also points out that under a broader view, households with incomes below $400,000 might bear some of the burden of corporate tax increases through lower wages or retirement account returns.(1) The Senate also voted to include a last-minute amendment from Sen. Mark Warner (D-VA) to extend the current $250,000 net operating loss limitations for individuals through Jan. 1, 2029.

There are also provisions in the bill that seek to close the $1 trillion gap between what Americans owe in taxes and what the government collects. Some Republicans have argued that funding to empower nearly 100,000 new IRS agents over the next 10 years to crackdown on tax evaders would result in more average Americans receiving tax audits. However, IRS Commissioner Chuck Rettig has stated that the IRS will ensure that individuals who earn under $400,000 will not see any increase in their audit rate.(3) Overall, the IRS will receive an additional $3.2 billion for taxpayer services, $45.6 billion for enforcement, $25.3 billion for operations support, and $4.8 billion for business systems modernization.

How will it impact corporations?

The IRA will also have a significant impact on corporations. The bill imposes a 15% alternative minimum tax on US-headquartered corporations earning more than $1 billion in global profit. Foreign-headquartered corporations are also subject to the tax if they have average domestic revenue of at least $100 million over the previous three years. According to the Congressional Research Service (CRS), the tax would still apply to new corporations in existence for less than three years “based on the earnings in the years of existence.”(4) The provision would exclude regulated investment companies (RICs) and real estate investments trusts (REITs). The Joint Committee on Taxation estimates that only 150 companies will be subject to the corporate minimum tax.(5)

Additionally, the IRA imposes a 1% excise tax on stock buybacks purchased after Dec. 31, 2022. The tax would not apply if buybacks are less than $1 million or are contributed to an employee benefit plan. According to CRS, the tax would not be deductible and would apply to purchases of corporation stock by a subsidiary of the corporation, including purchases by a US subsidiary of a foreign-headquartered company.

What did the IRA leave out?

Of particular interest to financial professionals may be the following list of individual income and business pass-through taxes for the House-passed bill that did NOT make it into the final bill:?

Corporate/international tax provisions not in the IRA

• Changes to the Global Intangible Low-Taxed Income (GILTI) rate:

o? Sets deduction for GILTI at 5% for a tax rate of 15%

o? Requires calculation on a county-by-county basis

o? Reduces the foreign tax credit haircut to 5%, prohibits foreign tax credit carrybacks

o? Sets the deduction for Qualified Business Asset Investment at 5%

• Sets Foreign-Derived Intangible Income tax rate at 15.8%
• Modifies the Base Erosion and Anti-Abuse Tax for multinational corporations
• Limits the interest deduction of certain domestic corporations that are members in an international financial reporting group to an allowable percentage of 110% of the net interest expense
• Sets a limitation on foreign company base sales and services income

Individual income taxes not in the IRA

• Extends the expanded Child Tax Credits (CTC) from the American Rescue Plan and permanently makes the CTC fully refundable
• Extends the American Rescue Plan’s expanded Earned Income Tax Credits
• Establishes an $80,000 State and Local Tax deduction cap from 2026 through 2030 and a $10,000 cap in 2031
• Imposes a tax equal to 5% of a taxpayer’s modified adjusted gross income in excess of $10,000,000, and an additional tax of 3% of a taxpayer’s modified adjusted gross income in excess of $25,000,000

Pass-through business taxes not in the IRA

• Expands the base of the 3.8% Net Investment Income Tax to apply to active business income for pass-through firms
• Makes the active pass-through loss limitation enacted in the 2017 Tax Cuts and Jobs Act permanent (IRA extends the limitation through 2028)

Other tax provisions not in the IRA

• Institutes a federal excise tax on nicotine
• Green energy tax credits, including:

o? Investment credit for electric transmission property

o? Credit for qualified wildfire mitigation expenditures

o? Qualified fuel cell motor vehicles tax credit

o? Credit for new electric bicycles

o? Credits for the labor costs of installing mechanical insulation property

o? Advanced manufacturing investment credit

o? Qualified environmental justice program credit

• Health care credits, including:

o? Makes the health coverage tax credit permanent, removing the uncertainty of annual extensions, and increases the amount of the qualified health insurance premium covered by the credit from 72.5% to 80%

o??Extends section 9663 of the American Rescue Plan through 2025, which provides that a taxpayer can receive 36 (B) premium tax credits as if the taxpayer’s household income was no higher than 150 percent of the FPL for individuals receiving unemployment compensation

With contributions from KDCR Partners. Founded by principals who have a depth of experience on Capitol Hill, in the Executive Branch, and the private sector, Kountoupes Denham Carr & Reid provides legislative and regulatory advice and critical insight to its prestigious and diverse clientele whose businesses are engaged in health care, technology, telecommunications, retail, energy, environment, and other important sectors of the US and global economy. KDCR’s principals collectively have nearly 15 decades of experience in both public and private sectors, and they have served in senior leadership positions for a variety of elected officials, as trade association executives, and in government affairs consulting.

1 Source: Tax Policy Center, “The Inflation Reduction Act Primarily Impacts Top 1 Percent of Taxpayers,” Aug. 11, 2022

2 Source: Tax Foundation, “Details & Analysis of the Inflation Reduction Act Tax Provisions,” Aug. 12, 2022

3 Source: PBS News Hour, “How the Inflation Reduction Act could affect your taxes,” Aug. 10, 2022

4 Source: Congressional Research Service, “Tax Provisions in the Inflation Reduction Act of 2022 (H.R. 5376),” Aug. 10, 2022

5 Source: Joint Committee on Taxation, Aug. 1, 2022

Important information

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Invesco does not provide tax advice. Investors should always consult their own legal or tax professional for information concerning their individual situation.

The opinions referenced above are those of the author as of Sept. 6, 2022. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.