Congress passes the Inflation Reduction Act

Congress just passed the Inflation Reduction Act of 2022 (the Act), sending it to President Joe Biden for his signature. Passage caps months of negotiations that started last summer over the Build Back Better (BBB) bill and subsequently transformed as negotiations to obtain approval of all 50 Democratic senators progressed. Estimated to raise $740 billion, the Act invests heavily in climate change remediation efforts, empowers Medicare to negotiate prescription drug prices, extends Affordable Care Act subsidies and directs funding to the IRS to enhance its enforcement capabilities and operational infrastructure. An estimated $300 billion will go toward deficit reduction.

Many of the substantial tax increases initially considered last fall were not included in the final legislation. Specifically, there are no rate increases or surtaxes on individual taxpayers, no expansion of the net investment income tax and no changes to the carried interest provisions proposed in the initial draft of the Act, which were dropped during final negotiations. The state and local tax (SALT) cap was left in place without any modification, in favor of a two-year extension of the limitation on the deductibility of a noncorporate taxpayer’s excess business losses. This alert will focus on energy incentives, the corporate minimum tax and the excise tax on stock redemptions.

Energy provisions

The Act’s “energy security” subtitle includes numerous tax provisions providing credits and incentives for the production and consumption of clean energy, carbon emissions reduction, electric vehicle purchases and, among other items, promoting domestic energy security and manufacturing. A detailed discussion of the subtitle’s tax provisions will be included in our forthcoming year-end tax letter. In the interim, a high-level overview is as follows:

Clean vehicle credits

The credit for new qualified plug-in electric drive motor vehicles is overhauled and retitled as the clean vehicle credit (CVC). The maximum credit for a clean vehicle remains $7,500, though the manner in which it is computed has changed. The first $3,750 is contingent upon the percentage of the vehicle’s battery that is made up of critical materials (i.e., aluminum, lithium, zinc, etc.) that were either:

• Extracted or processed in the U.S. or any country with which it has a free trade agreement, or
• Recycled in North America.

The second $3,750 is dependent on the percentage of the vehicle battery’s other components (apart from critical minerals) that were manufactured or assembled in North America. Final assembly of the vehicle must occur in North America for it to be credit eligible.

Critical limitations: The credit is not allowed for vehicles with manufacturers’ suggested retail prices that exceed certain thresholds ($80,000 for vans, SUVs and pickup trucks; $55,000 for any other vehicle). Additionally, no portion of the credit is available to a taxpayer whose modified adjusted gross income (MAGI) exceeds certain amounts ($300,000 for joint filers, $225,000 for head of household, $150,000 for all other filers).

After 2023, a taxpayer can make the election at the time of purchase to transfer the credit to the dealership, in exchange for cash or a credit toward payment for the clean vehicle. This is neither taxable income to the purchaser nor deductible by the dealership; however, if the credit would not be allowable under the provision’s numerous rules, the purchaser’s tax liability for the tax year they placed the vehicle in service would be increased by the amount of payment they received from the dealership.

Effective for vehicles sold after 2022, the Act eliminates the per-manufacturer limitation on the number of vehicles eligible for the credit. For vehicles placed in service after 2023, no credit is available for any vehicle whose battery components were manufactured or assembled by a “foreign entity of concern”; for vehicles placed in service after 2024, no credit is available for any vehicle whose battery’s critical minerals were extracted, processed or recycled by a “foreign entity of concern.” The credit expires after 2032.

The Act additionally introduces a new credit for certain used clean vehicles acquired after 2022 and before 2033, equal to the lesser of $4,000 or 30% of the vehicle’s sales price. No credit is available if the taxpayer’s MAGI for the year of purchase or the preceding year exceeds $150,000 in the case of a joint filer or surviving spouse, $112,500 for a head of household, or $75,000 for others.

Expansion of energy-efficient commercial buildings deduction

The Act makes several significant permanent changes to the energy-efficient commercial buildings deduction under section 179D, including but not limited to:

• The energy consumption reduction percentage qualifying property must satisfy to be eligible for a deduction is reduced to 25% from 50%.
• The dollar amount multiplied by the building’s square footage to determine the allowable deduction is reduced to a base 50 cents amount from $1.80. This base amount can be increased to a maximum of $1 per square foot, by 2 cents for each percentage point by which the building’s energy and power costs are reduced by a percentage greater than the aforementioned 25%.
• The above-described $1 maximum is increased up to $5 per square foot in the instance of property placed in service in connection with a project that meets certain prevailing wage and apprenticeship requirements.
• The lifetime cap on the maximum deduction allowed with respect to an item of property is replaced with a more favorable three-year cap (i.e., the deduction claimed in a given year would be reduced by the total deductions claimed by the taxpayer with respect to the building over the three previous tax years, rather than all previous tax years).
• Taxpayers are allowed to elect an alternative deduction for energy-efficient retrofit building property, in the year the retrofitting plan is certified to reduce the building’s energy usage intensity by at least 25% (versus the reduction of energy consumption required by the standard 179D deduction).

These changes are effective for taxable years beginning after Dec. 31, 2022, with the exception of the alternative deduction, which will apply to property placed in service after Dec. 31, 2022, pursuant to a retrofit plan established after such date.

Clean energy and efficiency incentives for individuals

The Act modifies, extends and increases various credits for individuals to make energy efficiency improvements to their homes.

Nonbusiness energy property credit. Under prior law, individuals were allowed a tax credit for specified “nonbusiness energy property” expenditures if the property was placed in service before Jan. 1, 2022. Nonbusiness energy property includes building envelope components (i.e., insulation, exterior windows and doors, certain roofing materials) as well as building system components, such as water heaters, heat pumps, central air, etc. that meet specified energy efficiency standards. The credit included a principal residence requirement and was subject to a lifetime limit. The credit for a tax year was limited to the excess of $500 over the aggregate credits allowed to that taxpayer for all previous tax years ending after 2005.

The new law increases the amount of the credit and extends the credit to Jan. 1, 2033. The Act revises the energy efficiency certification requirements for building envelope components and substantially expands the definition of residential energy property expenditures. In addition, the new law repeals the requirement that expenditures must be made with respect to the taxpayer's principal residence. Finally, the Act repeals the lifetime credit limitation and instead limits the allowable credit to $1,200 per taxpayer per year. These provisions generally apply to property placed in service after Dec. 31, 2022.

Residential energy-efficient property credit. Under prior law, individuals could claim the “residential energy-efficient property” credit for solar electric, solar hot water, fuel cell, small wind energy, geothermal heat pump and biomass fuel property installed in residences in years before 2024. In contrast to the nonbusiness energy property credit described above, the principal residence requirement did not apply to most categories of property under the rules for this credit, thus making expenditures on equipment at second homes and vacation homes eligible for the credit. The amount of the credit was 26% of qualified expenditures for property placed in service after Dec. 31, 2019, and before Jan. 1, 2023, phasing down to 22% for property placed in service after Dec. 31, 2022, and before Jan. 1, 2024.

The Act extends the life of the credit, making it available for property installed in years before 2035. The Act also increases the amount of the credit to 30% (for property placed in service after Dec. 31, 2021, and before Jan. 1, 2033 (reduced to 26% and 22% for 2033 and 2034, respectively).

New energy efficient home credit. This credit is available to qualified contractors for qualified new energy-efficient homes acquired by a homeowner. The Act extends the credit for homes acquired before Jan. 1, 2033 (Jan. 1, 2022, under prior law). In addition, under the new law the amount of the credit ranges from $500 to $5,000 depending on which energy efficiency requirements the home satisfies and whether the construction of the home meets prevailing wage requirements. These provisions generally apply to dwelling units acquired after Dec. 31, 2022.

Incentives to encourage clean energy production

The Act includes a long list of incentives to encourage clean energy production (the following is not an all-inclusive list):

Renewable electricity production credit. This credit applies to energy produced from qualified energy resources at a qualified facility and sold to an unrelated person. Qualified energy resources include wind, closed-loop biomass, open-loop biomass, geothermal, solar, small irrigation power, municipal solid waste, qualified hydropower, marine and hydrokinetic renewable energy. Under old law, the base credit was 1.5 cents per kilowatt-hour (kWh) with various reductions for tax-exempt financing/subsidies and certain categories of facilities. Construction on qualified facilities generally was required to begin prior to Jan. 1, 2022. The Act extends the construction start deadline to Jan. 1, 2025, adds a prevailing wage and apprenticeship requirement to obtain the full 1.5 cents per kWh credit, adds a 10% domestic content bonus for components of the facility, increases the bonus if the facility is located in a qualified energy community and makes other modifications.

Energy credit. This credit is available to all businesses and investors, not just producers for resale. It applies to a broad range of property, including Type 1 solar property (used to generate electricity, heat or cool a structure or provide solar process heat), Type 2 solar property (used to illuminate a structure using fiber-optic distributed sunlight), geothermal deposit energy property, qualified fuel cell property, qualified microturbine property, combined heating and power (cogeneration property), qualified small wind energy property, ground water heating and cooling property, and waste energy recovery property. The new law extends the construction start dates for various types of property and adds various technologies. The Act also restructures the credit to a 6% base amount, with increases for prevailing wage/apprenticeship requirements, small projects, domestic content, energy communities and environmental justice facilities.

New clean hydrogen production credit. The Act provides a new credit for clean hydrogen production, available for the first 10 years that qualified clean hydrogen production facility is in service. The amount of the credit depends on how clean the qualified clean hydrogen production facility is. The base credit is 60 cents per kilogram of clean hydrogen produced per year; however, the credit is multiplied by five (i.e., the 60 cents credit increases to $3) if the qualified clean hydrogen production facility pays prevailing wages and adheres to certain apprentice requirements. Effective for hydrogen produced after Dec. 31, 2022.

New clean energy production/investment credits. The new clean energy production credit and the new clean energy investment credit are emissions-based incentives that don’t favor a particular clean technology. These credits are for clean energy production facilities or new investments in clean energy placed in service after 2024 until certain emissions targets are achieved or 2032, whichever is later. Taxpayers will choose between the new clean energy production credit or the new clean energy investment credit.

New clean fuel production credit. The Act adds a new clean fuel production credit for low-emissions transportation fuel. The taxpayer must produce the fuel in the United States while being registered with IRS as a producer of clean fuel. The credit base amount is 20 cents per gallon (35 cents per gallon for aviation fuel) multiplied by an applicable emissions factor. If prevailing wage and apprenticeship requirements are met, a higher base amount of $1 per gallon ($1.75 per gallon for aviation fuel) applies. The credit applies to transportation fuel produced after Dec. 31, 2024, but will not be available for transportation fuel sold after Dec. 31, 2027.

Five-year depreciation for certain green energy property

Effective for property placed in service after 2024, the Act creates new categories of depreciable property, each with a five-year life: qualified facilities (QFs) eligible for the clean energy production credit, and qualified property (QP) and energy storage technology (EST) eligible for the clean electricity investment credit. QFs are those used for the generation of electricity with a greenhouse gas emissions rate not greater than zero; QP is generally tangible personal property constructed by the taxpayer, or acquired as original use property (i.e., not used property) by the taxpayer; EST is generally property which receives, stores and delivers energy for the conversion to electricity. These properties will be eligible for bonus depreciation, though note the bonus depreciation percentage for property placed in service after 2024 is 40%.

Other credits and incentives

The Act includes several additional clean energy credits and incentives that were not covered in this alert. Some of these will be included in our forthcoming expanded discussion in our annual year-end tax letter. A list can be found here:

Clean electricity and carbon emissions reduction

• Section 48 amended to increase the energy credit for solar and wind facilities placed in service in connection with low-income communities
• Extended and modified section 45Q credit for carbon oxide sequestration
• New zero-emission nuclear power production credit

Clean fuels

• Extended section 40A biodiesel and renewable diesel credit
• Extended section 40 incentive for qualified second-generation biofuel incentives
• New sustainable aviation fuel credit

Clean vehicles

• New credit for qualified commercial clean vehicles
• Extended and modified section 30C alternative fuel refueling property credit

Investment in clean energy manufacturing and energy security

• Extended section 48C advanced energy project credit
• New advanced manufacturing production credit

Superfund

• Section 4611(c)(2)(A) hazardous substance Superfund financing rate modified and adjusted for inflation

Incentives for clean electricity and clean transportation

• Adds a new section 48E clean electricity investment credit

Credit monetization

• Adds a new section 6417, allowing elective payment of applicable credits for energy property and electricity produced from certain renewable resources

Excise tax on repurchase of corporate stock

The Act imposes a 1% excise tax on the fair market value of any stock repurchased by a domestic corporation if its stock is traded on an established securities market (covered corporation).

The excise tax also applies if a specified affiliate acquires covered corporation stock from other shareholders. A specified affiliate generally is a partnership or corporation in which the covered corporation owns a greater than 50% equity interest. In such cases, the acquisition will be treated as a stock repurchase by the covered corporation.

Adjustments. The amount taken into account in regard to any taxable stock repurchase is reduced by the fair market value of any stock issued by the covered corporation during the taxable year, including the fair market value of any stock issued or provided to employees or employees of a specified affiliate during the taxable year, whether or not such stock is issued or provided in response to the exercise of an option to purchase such stock.

Certain foreign corporations. The 1% excise tax will apply to certain repurchases of foreign corporation stock. The rules governing the application of the tax in the international context are beyond the scope of this Tax Alert.

Exceptions. The excise tax will not apply:

• To the extent the repurchase is part of a tax-deferred corporate reorganization and no gain or loss is recognized on such repurchase by the shareholder
• If the stock repurchased is, 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
• If the total value of the stock repurchased during the taxable year does not exceed $1 million
• Under IRS regulations, in cases in which the repurchase is by a dealer in securities in the ordinary course of business
• To repurchases by a regulated investment company or a real estate investment trust
• To the extent that the repurchase is treated as a dividend

Effective date. The excise tax will apply to stock repurchases occurring after Dec. 31, 2022.

Business losses of noncorporate taxpayers.

The Act extends the limitation for noncorporate taxpayers with “excess business losses.” For this purpose, excess business losses are the amount by which business deductions exceed gross business income. This provision would limit such losses to $500,000 (married filing jointly, $250,000 others) per year with both amounts indexed for inflation. This provision was scheduled to sunset but has been extended through taxable years beginning before Jan. 1, 2029.

15% corporate minimum tax

The Act imposes a new corporate alternative minimum tax (AMT). Rather than basing the AMT on federal taxable income with certain adjustments, the revised AMT is assessed on adjusted financial statement income (AFSI). The Joint Committee on Taxation currently estimates that only 150 corporations will be subject to the new AMT.

The AMT is equal to the excess of (1) 15% of AFSI (with a reduction for the AMT foreign tax credit), over (2) the sum of the corporation’s regular tax and base erosion and anti-abuse tax (BEAT). The AMT applies to any corporation if the average annual AFSI for the three-taxable-year period ending with such taxable year exceeds $1 billion. Once the income threshold is exceeded, a corporation remains subject to the tax in perpetuity; however, exceptions are provided for (1) corporations that have a change in ownership, or (2) do not meet the $1 billion threshold for a specified number of years under terms and conditions to be determined under future IRS regulations. S corporations, regulated investment companies and real estate investment trusts are not subject to the tax.

Corporations must apply complex aggregation rules to determine if the $1 billion income threshold is met using average annual adjusted financial statement income for the three-year period referred to above. If the aggregated entities are treated as a single employer under IRC sections 52(a) or (b), taxpayers must aggregate their financial statement income for purposes of determining if the threshold is met. Further, if a corporation is a member of a foreign-parented multinational group, the $1 billion threshold is determined by including the financial statement income of all members of the group and the corporation will be subject to the tax if its average applicable financial statement income for the three-year period exceeds $100 million.

A number of adjustments must be made to the applicable financial statements in reaching AFSI. Several of the adjustments are listed below:

• Conforming the financial statement income to the taxable year in cases where the financial statements cover a period other than the taxable year
• If a corporation is not included in the consolidated return of an affiliated group, the AFSI of the affiliated consolidated group with respect to such other corporation includes only dividends received and other amounts which are includible in gross income or deductible as a loss
• For taxpayers that are partners in a partnership, the AFSI with respect to the partnership includes only the taxpayer's distributive share of AFSI of the partnership
• Adjustments are made for certain items of foreign income from controlled foreign corporations
• Certain federal and foreign income taxes are disregarded
• AFSI is reduced by allowable tax depreciation to the extent such depreciation exceeds book depreciation, which is intended to benefit corporations that make large capital investments, such as manufacturers; presumably, the IRS will issue regulations that will address cases where book depreciation exceeds current tax depreciation

If there are AFSI losses in a given year, the adjusted financial statement net income in a later year is reduced by the lesser of (1) the aggregate financial statement loss carryover to the taxable year, or (2) 80% of the adjusted financial statement net income computed without regard to the deduction. This is similar to the current rule that limits net operating losses for regular tax purposes. All carryovers are allowed until used; they do not expire after a certain period.

As with the former AMT and as stated above, a corporation is subject to the additional tax to the extent that the AMT exceeds the regular tax. To the extent an AMT is incurred, it is allowed as a credit in future years. The credit can offset regular tax to the extent that the regular tax exceeds the AMT.

The revised AMT is effective for taxable years beginning after Dec. 31, 2022. Given the complexity of the AMT and questions already raised by practitioners, it is expected that the IRS will need to issue regulations prior to the effective date.

Please reach out to your Baker Tilly advisor if you have questions regarding your tax position. We continue to monitor legislative developments and will issue additional alerts as warranted.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.