Q&A: Breaking Down the Inflation Reduction Act

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For this edition, I invited my colleague Todd Simmens, BDO’s Technical Practice Leader of Tax Policy and Legislation and former legislation counsel to the U.S. Congress Joint Committee on Taxation, for a conversation about the Inflation Reduction Act and the impact of federal tax policy changes ahead.

Matt: Thanks for joining me today, Todd. The Senate and House passed the Inflation Reduction Act relatively quickly, and it includes multiple changes to federal tax policy that have implications for businesses. What do you see as the most significant parts of the legislation from a tax perspective?

Todd: Happy to be here, Matt. The most important aspect of the legislation is the 15% minimum tax on domestic profits of large corporations. It applies to large corporations other than S corporations, RICs or REITs that meet an applicable financial statement income test (AFSI) in one or more years prior to 2022. A corporation would meet the test if its average AFSI, over the three years ending with any year after 2022 exceeds $1 billion in income. The Joint Committee on Taxation (JCT) estimates it will raise $222 billion over 10 years. That is a considerable amount of additional tax, particularly for those businesses that may have had a lower tax liability or no tax liability prior to the new minimum tax. The $1 billion threshold is also relatively low and could apply to many businesses.

A minimum tax is not unheard of, and we have had them in the past. But the unique aspect here is that this 15% minimum tax applies to book income — the earnings corporations report to investors on financial statements under GAAP. Additionally, once a corporation is subject to this tax, it may be entitled to a foreign tax credit offset.

Matt: Yes, there are not many taxes that apply to book income. What do businesses need to know about that aspect of the minimum tax?

Todd: There are some important differences between how companies keep records for tax purposes as opposed to for accounting purposes. For example, many companies use an accrual method to report book income, whereas the Internal Revenue Code (IRC) recognizes additional reporting methods — such as cash or hybrid methods — as valid for tax purposes.

The impact of tax accounting methods on the calculation of AFSI can be significant. For example, there are 14 adjustments to a company’s net income or loss as reported in financial statements, including depreciation and certain amortization. The true impact of these adjustments may not be known until regulations or other guidance are issued.

Currently, some businesses are incentivized to spend capital because accelerated depreciation (including bonus) can change your tax base. Although the inclusion of tax depreciation deductions, rather than book depreciation, for purposes of calculating AFSI is helpful for companies that invest in depreciable property, the net adjustment may not be as beneficial in every situation (e.g., if book depreciation exceeds tax depreciation in the current year). ?

Matt: So, these changes to tax policy could bring new uncertainty for businesses as they evaluate tax planning strategies. How does this bill differ from the 2017 Tax Cuts and Jobs Act (TCJA)?

Todd: Overall, the bill introduces new complexities for corporate taxation. It preserves most of the tax cuts signed into law under the TCJA, including retention of the flat 21% corporate tax rate. However, many companies pay a lower current tax rate due to accelerated tax deductions and other credits, so the 15% minimum tax would apply to some of those companies.

Some companies may want to adjust their business strategy to meet the 15% minimum. For example, if you pay 13% now, then you would pay 15% under the minimum after this year, so it could make sense to adjust your tax posture to meet the minimum. Other businesses may be mindful of staying under the income threshold of $1 billion, because that triggers the minimum tax.

In general, corporate leaders should work closely with their tax departments and experienced advisors to gain clarity about how the changes will impact their business. These leaders should take the time to understand how to maximize available deductions to AFSI and how to maximize foreign tax credits to offset the AMT.

Matt: That is a great point. We often encourage companies to take a strategic approach to tax planning and involve tax departments in operational decision-making. The new policy changes could have major implications for those decisions. What about the tax on stock buybacks and some of the new tax credits?

Todd: It seems like the non-deductible 1% excise tax on stock repurchases is intended to address what some lawmakers see as gaps in taxation. Under the current system, in some cases, foreign investors and certain shareholders in the U.S. do not pay tax on stock repurchases as opposed to dividends. I have seen speculation that the policy change could also lead to a rush of buybacks during the remainder of 2022, but we shall see.

As for the tax credits, the bill includes $260 billion for clean energy credits to incentivize wind, solar and other renewables. There is also money for electric vehicle infrastructure and other areas. Tax credits offset your tax liability, but they may not necessarily offset the 15% minimum tax. Businesses should plan carefully to reap potential benefits from the credits.

Non-taxpayers and tax-exempt entities can also sell or transfer those credits for cash. Previously, they could not do so without entering into a partnership structure. Those new changes make some specific tax credits more easily transferrable and monetizable.

Matt: That is all helpful perspective and good food for thought. Thanks very much for joining me, Todd.

For more information on the Inflation Reduction Act, read our deep dive here.?