The Major Tax Provisions of the Proposed 2022 Inflation Reduction Act

Recently, Sen. Joe Manchin (D-W.Va.) announced that he would support a climate and tax bill known as the Inflation Reduction Act of 2022, which includes several provisions of the Build Back Better legislation that failed to pass the Senate last year. The new bill includes significant tax changes, although a more stringent international tax regime and a controversial “millionaire’s tax” are not included in the final version.

The legislation, which would promote climate control initiatives and domestic manufacturing efforts, would also extend health insurance subsidiaries under the Affordable Care Act (ACA) and allow Medicare to negotiate drug prices.  If passed, the legislation would represent a significant move toward countering the effects of climate change.

The most notable tax provisions are the following:

Corporate minimum tax: The corporate tax rate is currently a flat 21 percent, but many large corporations are able to effectively avoid the tax. Beginning in 2023, the act would create a 15 percent “alternative minimum tax” for corporations with an average annual adjusted financial statement income exceeding $1 billion for three consecutive tax years. In addition, a $100 million threshold would apply to certain foreign-backed corporations. The legislation also contains rules for computing “financial statement income” for this purpose.

Carried interest rules: The legislation would close the “carried interest” tax loophole. Under current “carried interest” rules, compensation paid to managers of certain investment entities is taxed at favorable long-term capital gain rates instead of high-taxed ordinary income rates, after a three-year holding period is met. Generally, these managers would have to meet a five-year holding period to qualify for long-term capital gain. That tax perk allows private equity and hedge fund managers to pay lower capital gains tax rates, which top out at 23.8%, rather than the 37% income tax rate, on a portion of their earnings.

This is a provision that Sen. Kyrsten Sinema (D-Ariz.), a holdout on previous policy measures supported by Democrats, has opposed in the past. It’s not clear whether she will support it this time around.

Eliminating carried interest is a relatively small change dollar-wise in the context of the $739 billion in tax provisions in the bill. It would only raise about $14 billion additional tax dollars over the course of the decade. If Sinema were to object to repealing carried interest, it could be stripped from the bill without large consequences on other spending priorities, but it could be politically difficult for other Democrats to hand a win to hedge funds and private equity firms.

Energy credits: The legislation would extend or expand a wide range of energy credits for the business sector. In addition, buyers of new electric vehicles would be eligible for a $7,500 credit for such vehicles placed in service before 2033, while the manufacturer’s limit is eliminated for electric vehicles sold after 2022.  Also, a credit of up to $4,000 would be available on purchases of previously owned electric vehicles. Finally, the residential energy property credit for homeowners would be extended until it begins to phase out in 2033.

IRS enforcement and administration: The legislation would appropriate $3.18 billion for the IRS to provide taxpayer and other services. It would also appropriate $45.6 billion to the IRS for necessary expenses, as a means of closing an estimated $441 billion tax gap. This latter appropriation would expand the IRS’s ability to determine and collect taxes; provide legal and litigation support; conduct criminal investigations (including investigative technology); provide digital asset monitoring and compliance activities; enforce criminal statutes related to violations of the Internal Revenue Code and other financial crimes; purchase and hire passenger motor vehicles, and provide other services.

The legislation would back up President Joe Biden’s pledge that none of the IRS appropriations will result in tax increases for taxpayers with taxable income below $400,000.

Galleros Robinson will continue to monitor the progress of the bill and provide timely updates.

The information presented here should not be construed as legal, tax, accounting, or valuation advice. No one should act on such information without appropriate professional advice and after a thorough examination of the particular situation.