Inflation Reduction Act of 2022: Key Issues for Business Taxpayers
Senate Democrats passed a sweeping climate and economic package called the Inflation Reduction Act of 2022 (“IRA”) on August 7, 2022, through the budget reconciliation process in a party-line vote of 51-50 with Vice President Kamala Harris casting the tie-breaking vote. The House returned from its August recess to also approve the legislation by a party-line vote of 220-207 on August 12, 2022. President Biden signed the bill into law on August 16, 2022, giving Democrats a key legislative victory before the upcoming midterm elections in November.
SUMMARY OF THE INFLATION REDUCTION ACT of 2022
The IRA includes targeted corporate tax increases, increased funding for the IRS, incentives to promote climate change mitigation and clean energy, and provisions to promote health care affordability. It is also expected to provide deficit reduction savings of nearly $300 billion over 10 years.
Key non-tax provisions include changes to federal prescription drug pricing policies under Medicare and a three-year extension of expanded Affordable Care Act health care benefits through 2025. In addition to the energy and climate tax incentives described below, the bill also includes significant grants to address climate and energy issues.
The legislative text of the bill as approved by the House and Senate can be found at Inflation Reduction Act of 2022.
After the first draft of the Senate bill was released by Senators Schumer (D-NY) and Manchin (D-WVa), the IRA was changed to eliminate the provision that would have limited the favorable tax treatment afforded to carried interests in order to gain the support of Senator Kyrsten Sinema (D-AZ). A corporate tax on stock repurchases was added in order to offset the revenue lost from removing the carried interest provision. The IRA was also amended to extend the limitation on excess business losses under Section 461(l) to offset revenue lost from modifications that limited the impact of the new corporate alternative minimum tax provision.
Several amendments were offered on the Senate Floor, but nearly all failed. One exception was a change to the corporate alternative minimum tax that was paid for with a provision related to the excess business loss rule as summarized below. No changes were made to the IRA prior to or during House Floor consideration of the legislation.
DETAILED SUMMARY OF THE IRA
The IRA includes the following key tax issues:
- Corporate alternative book minimum tax (“BMT”): The IRA imposes a 15% minimum tax on adjusted financial statement income (“AFSI”) for corporations with average annual AFSI over 3 years in excess of $1 billion (called the “book minimum tax” or “BMT”), effective for taxable years beginning after December 31, 2022.
- Excise Tax on Corporate Stock Repurchases: The IRA would impose a nondeductible 1% excise tax on publicly traded corporations on the value of its stock repurchases (net of its stock issuances), effective for repurchases occurring after December 31, 2022. The tax would not apply to regulated investment companies or real estate investments trusts, stock contributed to retirement accounts, pensions, or employee stock ownership plans, or if stock repurchases are less than $1 million during the tax year.
- 2-Year Extension of the Excess Business Loss Rules: The IRA would extend the limitation on excess business losses for noncorporate taxpayers under Section 461(l) for 2 years. This provision was scheduled to sunset after 2026, but the IRA would extend it through tax year 2028.
- Reinstatement of the Superfund tax: The IRA would reinstate and increase the Superfund financing rate on crude oil and imported petroleum products, indexed to inflation, effective after December 31, 2022, and until January 1, 2033.
- Climate and energy tax provisions: A wide range of energy and climate tax incentives are included in the IRA. Many of the proposals are similar to those included in the House-approved version of the Build Back Better Act (“BBBA”), although there are key changes. Highlights of this package include:
- Wind and solar tax credits – multiyear extension at full rates
- New tax credits for emerging technologies, including energy storage and clean hydrogen
- Carbon capture tax credit rules simplified and expanded
- Direct pay option included in certain cases
- EV and charging infrastructure credits
- IRS Funding: The IRA includes funding for the IRS of $80 billion over ten years for taxpayer services, enforcement, IRS operations support, and IRS business systems modernization.
The IRA also includes the following key non-tax provisions:
- Extension of the expiring Affordable Care Act health care subsidies for three years
- Authority for the Centers for Medicare and Medicaid Services to negotiate drug prices
- Dedication of $300 billion to federal debt reduction
- Significant investment of $369 billion to increase US energy production and combat climate change through increases in renewable energy and carbon emission reduction investments
Key Business Tax Issues Not Included in the Final Version of the IRA
The IRA does not include a wide range of tax proposals that would have increased taxes on businesses and high-income individuals that were included in the House-approved BBBA. It also does not directly address international tax issues related to the OECD Pillar Two rules and does not include related changes to specific issues such as the R&D expensing rules and the cap on state and local tax (“SALT”) deductions.
Here is a short summary of some of the outstanding issues that were not included in the IRA:
- Carried Interest Limitations: A provision that would have revised Section 1061 to extend the holding period requirement for long term capital gain treatment on carried interests from three years to five years was dropped prior to consideration on the Senate Floor due to the opposition of Senator Sinema (D-AZ) to the provision. The stock repurchase excise tax provision (described below) was added to the bill to fill the revenue gap created by dropping the carried interest provision and modifying the book income tax to address depreciation issues.
- R&D Expensing: A provision that would have reinstated the expensing of Section 174 research expenditures that became subject to capitalization beginning January 1, 2022, as enacted in the Tax Cuts and Jobs Act (TCJA) in 2017 was not included. Discussions were undertaken to include this in the recently enacted Creating Helpful Incentives to Produce Semiconductors for America Act (“CHIPS” Act) without success.
- OECD Pillar Two-Related Proposals: International tax reform proposals that would have addressed the OECD Pillar Two global minimum tax rules proposed by the OECD were not included.
- State and Local Tax (SALT) Proposal: A provision that would have increased or repealed the current $10,000 cap on itemized deduction for state and local taxes was not included.
Potential Issues for a Lame-Duck Session Tax Bill
When Congress returns from its August recess in September, there is likely to be some discussion of the prospects for a lame-duck session tax bill, possibly as an addition to the expected year-end FY 2023 spending bill. In addition to the items listed above that were not included in the IRA, these tax issues remain outstanding and may be considered:
- Bipartisan retirement legislation
- 2021 and 2022 tax extenders (other than those addressed in the climate and energy section of the IRA)
- Technical corrections
- TCJA-related items such as the Section 163(j) EBIDTA fix and the upcoming phase-out of 100% bonus depreciation
New 15% Book Minimum Tax on Corporations
The IRA imposes a 15% minimum tax on AFSI for corporations with average annual AFSI over 3 years in excess of $1 billion (called the “book minimum tax” or “BMT”), effective for taxable years beginning after December 31, 2022.
The BMT imposes a tax on any “applicable corporation” equal to the excess of:
- 15% of the applicable corporation’s AFSI for the taxable year, reduced by its “corporate AMT foreign tax credit,” for the taxable year (tentative minimum tax), over
- Its regular tax liability plus any base erosion and anti-abuse tax (BEAT) imposed under Section 59A for the taxable year.
The proposal is a modified form of the provision in the House-approved version of the BBBA. It is expected to raise $222 billion over ten years according to the Joint Committee on Taxation (“JCT”).
An “applicable corporation” subject to the BMT is a corporation (other than an S corporation, regulated investment company, or real estate investment trust) that meets an AFSI test in one or more of its previous tax years ending after December 31, 2021. A corporation meets the AFSI test if its average AFSI (determined without regard to the adjustment for financial statement net operating loss carryovers) over the three years ending with the relevant tax year exceeds $1 billion.
For purposes of the BMT, a corporation must include the AFSI of all persons with which it is treated as a single employer under Section 52(a) or (b). The original draft of the IRA would have aggregated the income from unrelated portfolio companies under common ownership of an investment fund or partnership resulting in each company being subject to the AMT even though they individually did not meet the BMT. An amendment offered during Senate Floor debate deleted that language.
A US corporation that is a member of a foreign-parented multinational group must include the AFSI (with some modifications) of all members of the worldwide group in applying the $1 billion test, but it is an applicable corporation only if its three-year average AFSI exceeds $100 million, taking into account the AFSI of US members, US trades or businesses of foreign group members that are not subsidiaries of US members, and foreign subsidiaries of US members. A foreign-parented multinational group includes two or more entities included in the same applicable financial statement for a taxable year if (1) at least one entity is a domestic corporation and another is a foreign corporation, and (2) the common parent of the entities is a foreign corporation (or is deemed to be under future guidance that may be issued).
If a corporation has been in existence for less than three taxable years, the BMT is computed based on the period in existence instead of the three-year period. For a short taxable year, the income is annualized based on the number of months in the short year. Once the BMT applies to a corporation for a taxable year, the corporation will continue to be treated as an applicable corporation subject to the BMT unless an exception applies, regardless of its average AFSI in subsequent years.
Determination of AFSI
AFSI is defined as the pre-tax net income or loss of the taxpayer reported on its applicable financial statement for the taxable year, subject to the following adjustments:
- For members of a consolidated group, the group’s applicable financial statement is treated as the taxpayer’s applicable financial statement. The group AFSI is adjusted to (1) take into account items allocable to members of the consolidated group, and (2) exclude income items of any non-member affiliates that are included on the applicable financial statement but not on the consolidated return. Note, however, that dividends from a non-member affiliate are included in the computation of AFSI.
- For a taxpayer who is a partner in a partnership, only its distributive share of the partnership’s net income or loss is taken into account. For the sole owner of a disregarded entity, the disregarded entity’s AFSI is included.
- If a taxpayer is a US shareholder of one or more controlled foreign corporations (“CFCs”), the taxpayer’s AFSI is adjusted to take into account its pro rata share of the CFC’s net income or loss stated on their applicable financial statements. If this adjustment is negative for a taxable year, the current year AFSI does not take into account the adjustment, but instead it is carried forward and may reduce an adjustment in a succeeding taxable year.
- If the taxpayer is a foreign corporation, Section 882 principles will apply for effectively connected income for purposes of determining the foreign corporation’s AFSI.
- Taxpayers are allowed to reduce their AFSI by depreciation deductions with respect to tangible property under Section 167, including bonus depreciation. However, taxpayers cannot adjust for amortization deductions under Section 197, except in the case of certain qualified wireless spectrum used in a telecommunications business.
The rule allowing for deductions of accelerated cost recovery expenditures was added to the bill after the first draft with the cost partially offset by the inclusion of the stock repurchase excise tax. The rule applicable to wireless spectrum was a last-minute change intended to assist the US wireless industry in its efforts to continue to deploy 5G service without being penalized for financial liability resulting from purchases of previously acquired spectrum assets.
A taxpayer’s AFSI is computed before US federal income taxes or foreign income taxes (under Section 901). To avoid double taxation, however, the IRA would require Treasury and the IRS to issue regulations providing for an exception allowing taxpayers to consider their foreign taxes paid to jurisdictions where they elect not to claim any foreign tax credits (“FTCs”). In contrast, a taxpayer who elects to claim FTCs may reduce its AFSI by its “corporate AMT FTC” for the taxable year. The IRS defines “corporate AMT FTC” and includes a limit on this adjustment and carryforward rules.
There are also rules governing the use of financial statement net operating losses (“NOLs”), which can offset up to 80% of the taxpayer’s AFSI in a subsequent taxable year, computed without regard to any NOL carryforward. There are rules defining financial statement NOL.
The BMT includes rules that allow taxpayers to benefit from some general business credits, such as research and development credits, but the amount is limited to 75% of that taxpayer’s net income tax (including BEAT) in excess of $25,000.
An applicable corporation is allowed to offset its regular tax liability (including BEAT) for the current taxable year by the amount of its BMT in prior years to the extent the BMT has not been credited against the applicable corporation’s regular tax liability in prior years, similar to rules for corporate AMT credits before TCJA. The amount of the credit allowed is limited to the excess of the taxpayer’s regular tax liability over its tentative minimum tax, which equals 15% of its AFSI minus any corporate FTC.
Issues to be Handled by Treasury Guidance
The BMT proposal was also included in the House-approved BBBA with the same effective date of taxable years beginning after December 31, 2022. With enactment now in late 2022, very little time is left for Treasury and the IRS to issue necessary guidance on how this proposal will be implemented.
Initial guidance is likely to come through IRS notices or Frequently Asked Questions (“FAQs”) explaining how to compute the new tax and how to comply with the rules, specifically with respect to 1Q 2023 estimated tax payments. It seems certain that significant guidance will be issued, not only because of the general complexity of this new tax, but also due to the number of specific provisions in the IRA that explicitly direct Treasury to issue guidance clarifying those rules. More specifically, the IRA authorizes Treasury to issue regulations or other guidance on items that include:
- Determining when a corporation otherwise subject to the BMT should be exempted;
- Creation of a simplified method for determining whether a corporation satisfies the $1 billion and $100 million tests;
- A method by which the BMT applies when a corporation changes ownership;
- Modifications to calculating AFSI, including treatment of current and deferred taxes; and
- Determination of whether guidance is needed on the AMT FTC.
OECD Pillar Two Compliance
This 15% BMT is unlikely to meet the requirements of the Pillar Two tax outlined in the OECD project and it is structured differently, including with respect to the tax base and the fact that the BMT does not impose a minimum tax on a country-by-country basis. Treasury has reportedly acknowledged this but has also commented that this tax is an important first step in ensuring that large companies pay a fair level of tax.
On December 20, 2021, the OECD published model Global Anti-Base Erosion (“GloBE”) rules intended to provide countries with guidance on how to impose a minimum level of tax on large multinational enterprises (“MNEs”). These rules impose top-up taxes on MNE profits arising in a specific country if the effective rate, determined by the country’s rules, is below a minimum rate of 15%. As required by the BMT, these rules require that top-up taxes be calculated on the basis of financial accounting income of entities in an MNE group.
One important difference between the BMT and the GloBE rules, however, is that the BMT is calculated based on a corporation’s worldwide book income or loss, including a pro rata share of the income of its CFCs. The GloBE rules require a country-by-country top-up tax calculation.
There has previously been consensus that without legislative changes to the Global Intangible Low-Taxed Income (“GILTI”) rules that would require determination on a country-by-country basis, the GILTI tax would not be a qualifying Income Inclusion Rule (“IIR”) under the GloBE rules. For the same reason, the BMT also may not qualify as an IIR.
There is a question about whether the GILTI tax and the BMT would be deemed to be a “qualifying CFC Tax Regime” under the GloBE rules, which could help to reduce the incidence of a non-US top-up tax imposed on the book income of a CFC. It will be necessary for Treasury to issue guidance to address this issue and explain how GILTI taxes are allocated back to CFCs for purposes of Pillar Two. Similarly, the BMT would require US shareholders in the MNE group to include a pro rata share of their CFCs’ book income in the minimum tax calculation, so guidance will be necessary to determine how the BMT is allocated back to CFCs for purposes of Pillar Two.
Treasury will have to address several complex technical issues about the mechanics and operation of the BMT including questions about how the BMT might interact with Pillar Two requirements.
New Excise Tax on Stock Buybacks
The IRA would impose a nondeductible 1% excise tax on publicly traded corporations on the value of its stock repurchases (net of its stock issuances). The tax would not apply to regulated investment companies or real estate investments trusts, stock contributed to retirement accounts, pensions, or employee stock ownership plans, or if stock repurchases are less than $1 million during the tax year.
This proposal is expected to raise $73.6 billion over ten years. The provision was added in place of the carried interest restrictions that were dropped prior to passage of the bill. A similar provision was included in the House-approved BBBA. Two new changes update the effective date and clarify the rule for stock issued to employees of the corporation or specified affiliates.
The new excise tax would apply to repurchases of stock made after December 31, 2022. The announcement or approval of the share buyback program is not determinative of whether the excise tax applies, and there is no grandfather rule for shares that are repurchased in 2023 pursuant to a share repurchase program that was approved prior to the effective date.
The stock repurchase excise tax applies broadly and could apply to share repurchases whether or not they are part of a share buyback program. Share repurchase programs will likely continue to be used by publicly traded corporations, but the new excise tax will affect decisions about when and how to initiate them. The prospective effective date should be utilized by taxpayers to consider whether they want to implement new or enhanced stock buyback programs prior to the 2023 effective date.
The new tax is an excise tax which applies at a flat rate which does not relate to whether the corporation has taxable income or loss, and it is a nondeductible expense.
The tax applies to “covered corporations,” defined as a domestic corporation the stock of which is traded on an established securities market. A “repurchase” is defined as a redemption (under Section 317(b)) of the corporation’s stock and any other “economically similar transaction” as determined by Treasury.
For purposes of calculating the tax, the fair market value (“FMV”) of the repurchased stock is reduced by the FMV of any stock issued by the covered corporation during the taxable year, including stock issued or provided to employees of the covered corporation and employees of specified affiliates.
Purchases of covered corporation stock by specified affiliates would be treated as repurchased by the covered corporation. The tax would also apply to repurchases of stock of certain foreign corporations.
The new excise tax would not apply to certain transactions, including if:
- The repurchase is part of a reorganization under Section 368(a) and the shareholders do not recognize gain or loss on the repurchase;
- The repurchased stock is contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan;
- The total value of stock repurchased during the tax year does not exceed $1 million;
- The repurchase is by a dealer in securities in the ordinary course of business;
- Repurchases by a regulated investment company or real estate investment trust;
- To the extent the repurchase is treated as a dividend; or
- The repurchase is part of a repayment of debt, including long-term debt that is considered a “security” for subchapter C purposes.
Treasury is authorized to issue guidance necessary or appropriate to carry out or prevent the avoidance of the provision. They are also given the authority to expand the application of the excise tax by allowing the inclusion of “economically similar” redemptions.
Excess Business Loss (“EBL”) Rule Extension
The IRA would extend the limitation on excess business losses (“EBLs”) for noncorporate taxpayers under Section 461(l) for 2 years. This provision was scheduled to sunset after 2026, but the IRA would extend it through tax year 2028. This proposal is expected to raise $52.7 billion over ten years.
Why was this amendment added to the IRA? Senator Thune (R-ND) offered an amendment, which was approved, to remove an expanded aggregation rule under Section 52 that would have applied to the corporate BMT. The cost of this change was $35 billion. His amendment would have replaced that revenue with a one-year extension of the cap on SALT deductions, which was already a controversial issue, especially in the House. Senator Warner (D-VA) immediately offered an amendment to substitute the extension of the EBL for two years for the SALT provision, and that amendment was also approved, thereby providing $52 billion in revenue that more than offset the removal of the aggregation rule.
Background on the EBL provision: The EBL limitation, codified in Section 461(l), was originally created by the TCJA. Applying to taxpayers other than corporations, this provision limits the amount of trade or business deductions that can offset nonbusiness income. The limitation for the 2018 tax year was $250,000 (or $500,000 in the case of a joint return), with these threshold amounts indexed for inflation in subsequent years.
Section 461(l) went into effect for tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, making 2018 through 2025 filings subject to the limitation. However, the Coronavirus Aid, Relief, and Economic Security (CARES) Act retroactively delayed the implementation of section 461(l) from tax years beginning after Dec. 31, 2017, to tax years beginning after Dec. 31, 2020. Taxpayers who had already filed 2018 or 2019 returns with the EBL limitation had an opportunity to amend returns and fully claim business losses.
Reinstatement of the Superfund Tax
The IRA would reinstate and increase the Hazardous Substance Superfund Excise Tax at the rate of 16.4 cents per barrel on crude oil and imported petroleum products, indexed to inflation, effective after December 31, 2022, and until January 1, 2033. This tax would apply in addition to the current 9 cents-per-barrel Oil Spill Liability Excise Tax. The Superfund tax is imposed on crude oil received at a US refinery, and petroleum products (including crude oil) entered into the US for consumption, use, or warehousing. This proposal is expected to raise $12 billion over ten years.
The Infrastructure Investment and Jobs Act enacted in the fall of 2021 reinstated and modified other Superfund taxes through December 31, 2031.
Extension of the Black Lung Disability Trust Fund Tax
The IRA permanently extends the tax imposed on the sale of coal, which finances the Black Lung Disability Trust Fund. The extension is effective for sales in calendar years beginning after the date of enactment. This provision is expected to raise $1.2 billion over ten years.
Small Business Research Credit against Payroll Taxes
The IRA would increase the amount of research credit that can be applied against payroll tax liability from $250,000 to $500,000 for years beginning after December 31, 2022. Also, the legislation provides that the first $250,000 of the credit limitation will be applied against the FICA payroll tax liability and the second $250,000 of the limitation will be applied against the employer portion of Medicare payroll tax liability imposed under Section 3111(b). This proposal is expected to cost $168 million over ten years.
Under current law Section 41(h), a qualified small business may elect to apply up to $250,000 of its research credit computed under Section 41 against the employer portion of its FICA payroll tax liability imposed under Section 3111(a) for up to five tax years. A qualified small business is a partnership, corporation, or person with gross receipts of less than $5 million for the current tax year and no gross receipts for any taxable year preceding the five-year period ending with the current taxable year.
The IRA provides $80 billion in additional appropriations over 10 years to the IRS, primarily to enhance its tax enforcement and compliance efforts. $45.6 billion is allocated for tax enforcement activities. The Congressional Budget Office (“CBO”) projection is that this funding will result in an additional $203 billion in tax revenue.
The additional appropriated funds will be available until September 30, 2031. The IRS is required to provide a report to Congress detailing how the funds will be spent. After the first report, the IRS must file quarterly reports with Congress outlining the implementation of its plan.
The bill also provides $15 million of funds for the IRS to prepare and deliver a report to Congress within 9 months of enactment on the cost of developing and operating a free direct e-file tax return system.
One key provision was deleted from the original Schumer-Manchin proposal that would have given the IRS greater flexibility with respect to personnel, including certain “direct-hire” authority. This authority was specifically requested by IRS officials based on the position that it would give the IRS the ability to attract experienced tax professionals because they could onboard new hires in 30-45 days.
The additional funding would be allocated in this way:
- $45.6 billion for tax enforcement activities including determining and collecting owed taxes; providing legal and litigation support; conducting criminal investigations and using investigative technology in the investigations; providing digital asset monitoring and compliance activities; enforcing criminal statutes related to violations of internal revenue laws and other financial crime; and purchasing and hiring passenger motor vehicles;
- $3.2 billion for taxpayer services covering pre-filing assistance and education, filing and account services, and taxpayer advocacy services;
- $25.3 billion for operations support; and
- $4.8 billion for business systems modernization, such as development of callback technology and other technology to enhance customer service.
Treasury Secretary Yellen released a memorandum she sent to IRS Commissioner Charles Rettig outlining a strategic plan for deploying these new funds. The memorandum is intended to provide a roadmap for the most significant funding stream that has been targeted for the IRS in many years. It is also designed to provide transparency on the goals for using the funds in order to deflect criticism and speculation about what how the IRS will use the funding.
The IRS already has significant efforts underway to increase the number of personnel assigned to enforcement activities, so it is already positioned to take advantage of these funds, and it has identified pandemic relief programs as a high priority for review, investigation, and enforcement. It may take several years, however, before the IRS starts to see results from the additional money because it can take years to train auditors, select cases, and resolve audits. The CBO estimates that only $3 billion of the $203 billion will be collected in 2023.
Taxpayers who have taken advantage of pandemic relief programs such as the Employee Retention Credit (“ERC”) should be aware of the fact that increased scrutiny from the IRS may be forthcoming as part of the increased enforcement.
Climate & Energy Tax Provisions
The IRA includes a $376 billion package of provisions designed to address climate issues and provide incentives for clean energy. These provisions are intended to encourage investments by traditional energy companies as well as companies in the manufacturing, real estate, and transportation industries. The legislation provides for significant enhancements to the benefits of the tax incentives if projects meet prescribed wage, domestic content, or location requirements. The goal of these provisions is to reduce carbon emissions by 40% by 2030.
Many of the proposals are similar to those included in the House-approved version of the BBBA, although there are key changes to some tax incentives. The JCT’s preliminary estimate is that the tax benefits in the package would reduce federal revenue by $258 billion over ten years.
Note that one tax incentive from the House-approved BBBA is not included in the IRA, specifically a proposed investment tax credit for the manufacturing of semiconductors and semiconductor tooling equipment, including buildings and equipment that are integral to such manufacturing. That tax credit was enacted in the CHIPS bill on August 9, 2022.
Highlights of the energy and climate package include:
- Wind and solar tax credits – multiyear extension at full rates
- New tax credits for emerging technologies, including energy storage and clean hydrogen
- Carbon capture tax credit rules simplified and expanded
- EV and charging infrastructure credits
Several of the tax incentives are structured as two-tiered incentives with a “base rate” and a “bonus rate.” The bonus rate would equal five times the base rate and would apply to projects that meet certain labor and apprenticeship requirements. A taxpayer must satisfy both requirements to receive the bonus credit rate.
Some of the tax incentives include bonus rates based on the domestic content of the property to which the tax credit would apply.
Under the IRA’s prevailing wage requirements, the taxpayer must ensure that any laborers and mechanics employed by contractors and subcontractors are paid prevailing wages during the project construction and, in some cases, for the alteration and repair of the project for a defined period after the project is placed into service. Under the apprenticeship requirements, the taxpayer must ensure that no fewer than the applicable percentage of total labor hours are performed by qualified apprentices. For most of the credits in the IRA, meeting these requirements will allow taxpayers to claim a bonus rate tax credit that is five times the base rate credit.
Domestic Content Rules
Under the IRA’s domestic content requirements, the taxpayer must ensure that the facility is composed of steel, iron, or products manufactured in the United States. These domestic content requirements generally apply for purposes of the production tax credits (“PTCs”) and investment tax credits (“ITCs”). Projects that meet the requirements could receive higher-value credits. Project that do not meet the requirements may be restricted in the amount of the credit that is eligible for the direct pay elections allowed with respect to most credits included in the IRA.
Credit Monetization: Direct Pay and Transferability
The IRA would allow certain eligible taxpayers to be treated as having made a payment of tax equal to the value of the credits, called the Direct Pay Option. Taxpayers who are ineligible for the Direct Pay Option may opt to transfer any applicable credits to another taxpayer under the Transfer Option.
Under the Direct Pay Option, “applicable entities” may elect a Direct Pay Option for several of the tax credits including the Section 48 ITC, Section 45 PTC, the Section 45Q credit for carbon capture and sequestration, the Section 45V clean hydrogen production credit, and the Section 45W credit for qualified commercial clean vehicles (EVs). The Direct Pay Option treats the generated tax credits as a tax payment.
Note, however, that the definition of “applicable entities” is limited to tax-exempt entities, state and local governments, tribal governments, the Tennessee Valley Authority, and certain rural electric cooperatives. This limitation on applicable entities is not applicable for purposes of the tax credits under Sections 45Q, 45V, or 45X (advanced manufacturing credit) for the first five years. This rule is narrower than the Direct Pay Option rule that was included in the House-approved version of BBBA.
The Direct Pay Option is available on a facility-by-facility basis and must be made in the taxable year when the facility is placed in service. Once elected, the Direct Pay Option applies for the entire tax credit period.
However, the IRA does include a new Transfer Option. Taxpayers who are not eligible for the Direct Pay Option may elect to transfer any applicable credits to another unrelated taxpayer. This transfer may be for all or a portion of a credit, but any credit (or portion thereof) can only be transferred once. Credits that are eligible to be transferred include the Section 45 renewable electricity PTC, the Section 45Q credit for carbon oxide sequestration, the Section 45V clean hydrogen production credit, the Section 45X advanced manufacturing credit, and the Section 48 energy ITC as well as several other tax credits.
Under the Transfer Option, the transferred credit must be exchanged for cash and is not included in the transferor’s income, nor is it deductible by the transferee. The transferee cannot retransfer any credits it receives in a transfer. “Applicable entities” (as described above) may not transfer credits. The transfer of credits is made on a facility-by-facility basis.
A 20 percent penalty may apply for both the Direct Pay Option and the Transfer Option where excessive payments have been made.
Wind and Solar Power
The IRA removes the current ITC and PTC sunset and stepdown provisions for renewable energy facilities placed in service after 2021. ITC and PTC eligibility is extended for solar (with solar projects now eligible for the PTC) and onshore and offshore wind facilities that begin construction before 2034.
Certain interconnection costs for smaller facilities (i.e., not more than 5 megawatts) would also become eligible for the ITC. Eligibility for a full ITC or PTC and an enhanced credit may be available if wage and apprenticeship standards are met.
The IRA provides a new annual PTC under Section 45V for “qualified clean hydrogen” produced and sold or used after December 31, 2022. The PTC would apply for the 10-year period beginning on the date that the eligible facility is placed in service. “Qualified clean hydrogen” is defined as hydrogen produced through a process that results in a lifecycle greenhouse gas emission rate of not greater than 4 kilograms of CO2e (greenhouse gas emissions) per kilogram of hydrogen.
The amount of the Section 45V credit initially depends on the lifecycle greenhouse gas emissions rate of the facility. The credit amounts are increased by five times if the taxpayer satisfies the wage and apprenticeship standards, which means the maximum credit could be $3 per kilogram of hydrogen produced.
Taxpayers may elect to claim a capital expenditure-based, frontloaded investment tax credit (ITC) in lieu of the PTC.
The IRA would expand the current law ITC for energy storage property to apply to stand-alone energy storage facilities. It would also provide an election out of the Section 50(d)(2) “public utility property” normalization method of accounting limitation for larger energy storage facilities (i.e., capacity in excess of 500 kilowatt hours).
This is a welcome expansion for the energy storage industry since the current law ITC rules require storage to add on to solar or wind ITC generation property and allow for only limited grid charging. The election out rule for larger storage projects will allow larger regulated utilities to consider storage expansion as part of their infrastructure spending with greater value from the tax credits becoming available.
The IRA extends and broadens the existing Section 45Q tax credit applicable to carbon capture, use, and sequestration projects. The Section 45Q tax credit is available for projects beginning construction before January 1, 2033.
The Section 45Q tax credits are currently based on the amount of carbon oxide captured and sequestered, calculated by the metric ton, and the applicable method of sequestration employed (i.e., disposal, injection, or utilization). The IRA increases the tax credit rates that apply to all methods of sequestration.
In order to encourage the development of new carbon capture technologies, the IRA increases tax credit rates for projects that utilize direct air capture (DAC) systems. The IRS decreases the amount of carbon oxide that a facility must capture for Section 45Q tax credit eligibility.
Section 45Q tax credit amounts may be increased if wage and apprenticeship standards are met.
The Biden Administration has a stated goal of 50% electric vehicle (EV) adoption by 2030, and the IRA provision is intended to increase development and deployment of EVs in the US market.
The IRA extends the popular $7,500 per vehicle consumer tax credit for the purchase of electric vehicles. The tax credit will now be available for the purchase of used EVs up to $4,000.
The IRS removes the 200,000-vehicle cap for manufacturers that prevented purchasers of those brands from benefiting from the tax credit. Instead, the IRA imposes cost and income rules based on the MSRP cost of the purchased vehicle and the income of the purchaser. New cars that cost more than $55,000 as well as pickups and SUVs in excess of $80,000 will not qualify for the credits. The income of the purchaser cannot exceed $150,000 for a single filing taxpayer and $300,000 for joint filers.
Also, the tax credit will be available to manufacturer dealers as a point-of-sale rebate as opposed to purchasers having to claim the rebate on a tax return.
In order to qualify for the EV credit, the final assembly of a vehicle must occur in North America. Eligibility is restricted for vehicles manufactured by “foreign entities of concern,” which could limit the availability of the credit.
The IRA does include new content requirements for batteries. To meet the critical mineral requirement, the applicable percentage of critical minerals contained in the battery must be extracted or processed in a country with which the US has a free trade agreement, or it must have been recycled in North America. To meet the battery content requirement, the applicable percentage of the components contained in the battery used in the vehicle must be manufactured or assembled in North America. For calendar years after 2023, an EV may not contain any battery components that were manufactured by a foreign entity of concern, and after calendar year 2024, an EV may not contain any critical minerals that were extracted, processed, or recycled by a foreign entity of concern.
The Treasury Department and the Department of Energy have both issued guidance on the EV tax incentive. Treasury and the IRS issued updated information for consumers with respect to the changes to the EV tax incentive on August 16, 2022. They also released FAQs on the new IRA requirements about North American assembly. The Energy Department published a list of vehicles that will likely meet the final assembly requirements.
The IRA is legislation that includes several key tax provisions that have the potential to impact many taxpayers. The new business tax provisions are complex, and it is expected that Treasury guidance will be forthcoming in 2022 to address technical issues. The new package of energy and climate issues offers important opportunities to taxpayers to benefit from tax incentives designed to further important US energy and climate goals. These tax provisions are also complex, and Treasury has already begun issuing guidance to taxpayers on these issues.
Taxpayers are advised to review the new corporate tax changes and to analyze the potential benefits included in the IRA. If you have questions about any of the information in this True Insight, please contact a member of your TPC engagement team.