On August 16, 2022, President Joe Biden signed into law the Inflation Reduction Act of 2022 (Act), a budget reconciliation bill that projects to raise $739 billion in revenue from tax increases to cover $369 billion in increased climate spending, $64 billion in increased health care spending, and approximately $300 billion in deficit reduction. The key tax law changes included in the Act are a 15 percent minimum tax on certain corporations, a one percent tax on stock repurchases, and an extension of the IRC Section 461(l) excess business loss limitation. The Act also includes an $80 billion increase in Internal Revenue Services (IRS) funding and some enhanced energy credits.
The Act is a smaller version of the Build Back Better Act passed in the House of Representatives in November 2021 and is significantly narrower than President Biden’s original tax proposals. Notably, the Act does not include changes to the taxation of carried interest under IRC Section 1061 and does not increase the deduction limit for state and local taxes. The tax on stock repurchases, which was included in the November 2021 House bill, was added to make up for changes in the final version of the Act that reduced projected tax revenue (specifically, the removal of the carried interest provision and the allowance of accelerated depreciation deductions in calculating income subject to the corporate minimum tax).
15 Percent Minimum Tax
The Act amends the alternative minimum tax (AMT) under IRC Section 55, effective January 1, 2023, to impose a “tentative minimum tax” on “applicable corporations” equal to the excess of: (1) 15 percent of the “adjusted financial statement income” (AFSI) over (2) the corporate AMT foreign tax credit for the subject tax year. If an applicable corporation’s tentative minimum tax exceeds its regular tax liability, then it must pay the difference as AMT.
An applicable corporation is generally any corporation (other than an S corporation, a regulated investment company, or a real estate investment trust) with an average annual AFSI of more than $1 billion for the three preceding taxable years ending with the subject tax year. This annual AFSI test is applied to tax years ending after December 31, 2021.
In determining whether a corporation meets the $1 billion threshold, the AFSI of all persons treated as a single employer with such corporations under IRC Section 52 generally is treated as the AFSI of the subject corporation. The income is determined without regard to the adjustments for partnerships under Section 56A(c)(2)(D)(i) and defined benefit pensions under Section 56A(c)(11).
For corporations in existence for less than three tax years, the threshold test applies to the period in which the corporation has existed. For short tax years, AFSI is annualized.
A corporation can be exempted from the minimum tax if it has a number of taxable years (to be specified by regulation) in which its AFSI does not meet the threshold and the Treasury Secretary determines that it would not be appropriate to apply the minimum tax. The Treasury Secretary’s determination would not apply if the corporation meets the three-year average annual AFSI threshold for any taxable year beginning after the first taxable year for which the exemption was granted.
Certain foreign-owned corporations with AFSI over $100 million are also subject to the minimum tax.
Adjusted financial statement income (AFSI)
The Act defines AFSI (under the newly added IRC Section 56A) as the taxpayer’s net income or loss as reported on the taxpayer’s applicable financial statement (as that term is defined in IRC Section 451(b)(3) or in future regulations) for the year. Numerous adjustments are to be made to AFSI, including adjustments for: statements covering different tax years; related entities; certain items of foreign income; effectively connected income; certain taxes; disregarded entities; and income from partnerships.
AFSI is also reduced by accelerated depreciation deductions and for amortization deductions related to qualified wireless spectrum. The adjustment for accelerated depreciation means depreciation deductions have the same effect on a corporation’s tax base for AMT purposes as they do for regular tax purposes, including any benefit of bonus depreciation under IRC Section 168(k). This adjustment is beneficial for any year in which the depreciation deduction for tax purposes is greater than the depreciation deduction for book purposes.
Additionally, AFSI is decreased by the lesser of: (1) the aggregate amount of financial statement net operating loss (NOL) carryovers to the tax year; or (2) 80% of AFSI computed without regard to financial statement NOLs. A financial statement NOL for any tax year may be carried over to each tax year following the tax year of the loss. “Financial statement NOL” is defined as the amount of net loss on the corporation’s applicable financial statement, after applying the AFSI adjustments, for tax years ending after December 31, 2019.
Other than the adjustments described above, a taxpayer’s AFSI generally does not take into account other tax provisions. For example, AFSI is not adjusted to reflect:
- Limitations on interest expense deductions under section 163(j);
- Limitations on deductions for certain employee remuneration that exceeds $1 million under section 162(m); or
- Limitations on loss carryforwards under section 382.
We note that general business credits under IRC Section 38 (e.g., the research and development tax credit) are allowed for AMT purposes in the same manner as allowed for regular tax purposes, thereby preserving the value of general business credits.
In addition, similar to the prior AMT, any AMT paid by a taxpayer generates an AMT credit that can be utilized against the taxpayer’s future regular tax liability. The amount that can be utilized in a tax year is limited to the excess of the taxpayer’s regular tax liability over its tentative minimum tax.
Tax on Repurchase of Corporate Stock
The Act adds new IRC Section 4501 to impose a one percent tax on the fair market value of a stock that a publicly traded U.S. corporation (a “covered corporation”) repurchased during the tax year. The Act defines a “repurchase” as an IRC Section 317(b) redemption and any economically similar transaction. The tax applies to repurchases made after December 31, 2022.
The value of the buyback is reduced by the fair market value of any stock issued by the covered corporation during the taxable year, including stock issued or provided to employees of the covered corporation or to employees of a “specified affiliate” (defined below).
The acquisition of a covered corporation’s stock by a specified affiliate is treated as a stock repurchase by the covered corporation if the specified affiliate acquires the stock from a person other than the covered corporation or a specified affiliate of the covered corporation. A “specified affiliate” is a corporation in which the covered corporation owns more than 50 percent of the stock (by vote or by value) or a partnership in which the covered corporation owns more than 50 percent of the capital interests or profit interests.
A stock repurchase is not subject to the one percent tax if:
- The stock repurchase is part of a reorganization (within the meaning of IRC Section 368(a)) and the shareholder does not recognize gain or loss by reason of such reorganization;
- The stock repurchased, or an amount of stock equal to the value of the stock repurchased, is contributed to an employer sponsored retirement plan, employee stock ownership plan, or similar plan;
- The total value of the stock repurchased during the taxable year does not exceed $1,000,000;
- The repurchase is by a dealer in securities in the ordinary course of business;
- The repurchase is by a regulated investment company or a real estate investment trust; or
- The repurchase is treated as a dividend.
The tax also applies to the acquisition of foreign stocks. A specified affiliate’s acquisition of the stock of an “applicable foreign corporation” from an unrelated party is treated as a repurchase of stock by the covered corporation. The Act defines an applicable foreign corporation as any foreign corporation with stock traded on an established securities market (within the meaning of IRC Section 7704(b)(1)).
We note that the Act authorizes the Treasury Department to issue guidance necessary or appropriate to prevent the avoidance of the one percent tax.
Two-Year Extension of IRC Section 461(l) Business Loss Rules
The Act extends the IRC Section 461(l) excess business loss limitation for non-corporate taxpayers for two years. This limitation was set to expire on January 1, 2027, so it will now expire on January 1, 2029.
$80 Billion Increase in IRS Budget for Tax Enforcement
The Act includes approximately $80 billion in additional funding for the IRS, a Biden administration priority. The increased funding includes $45.6 billion for enforcement; $25.3 billion for operations; $4.75 billion for the modernization of business systems; and $3.18 billion for taxpayer services. The funds are to remain available until September 30, 2031. Reports indicate that the additional funding would raise an estimated $124 billion in revenue. In keeping with President Biden’s declaration that he would not increase taxes on taxpayers earning less than $400,000 a year, the Act notes that nothing in the new enforcement funding “is intended to increase taxes on any taxpayer with a taxable income below $400,000.”
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Authored by Phil MacFarlane.
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