A closer look at tax items in the Inflation Reduction Act

The Inflation Reduction Act includes several tax provisions, including a corporate minimum tax, a 1% excise tax on stock repurchase by corporations, and increased funding for IRS enforcement efforts.

Adam Schrom, CPA, director of product management at Bloomberg Tax, breaks down several aspects of the legislation and provides a history lesson in the process.

What you’ll learn from this episode:

• An overview of the Inflation Reduction Act’s corporate minimum tax.
• The 1986 legislation that included a business untaxed reported profits tax.
• The status of the SALT cap deduction.
• The “for and against” arguments related to stock repurchase by corporations.
• Schrom’s thoughts on funding for IRS enforcement.
• Details about some of the legislation’s energy-related tax credits.

Play the episode below or read the edited transcript:

— To comment on this episode or to suggest an idea for another episode, contact Neil Amato at Neil.Amato@aicpa-cima.com.

Transcript:

Neil Amato: This is Neil Amato, and you’re listening to AICPA & CIMA’s Journal of Accountancy podcast. The guest on today’s episode is Adam Schrom, a CPA who is director of product management at Bloomberg Tax. The focus of the conversation is legislation in Washington, the Inflation Reduction Act, and its tax provisions. You’ll hear that after this word from our sponsor.

Amato: Welcome back to the Journal of Accountancy podcast. As I said in the intro, I’m joined by Adam Schrom. Adam is going to talk today about several aspects of the Inflation Reduction Act, especially some of its tax provisions. Adam, first, welcome to the podcast.

Schrom: Thanks, Neil. Thanks for having me.

Amato: Let’s talk first, I guess, about the Inflation Reduction Act’s corporate minimum tax provision. What is it? What can you tell me about that?

Schrom: The new corporate minimum tax provision, or minimum book tax as it’s being referred to often, is effectively a new corporate alternative minimum tax, AMT, on a company’s book income. Like the old AMT, it requires essentially a separate calculation of tax owed. A company calculates its regular tax liability. They calculate their tax liability under this new book minimum tax, and whichever is higher, that’s what the corporation will pay. This is only going to apply to effectively the largest U.S. companies. Those with $1 billion annual average net book income and not revenue but book income, so actual profit. There’s a lower threshold, it’s about $100 million for U.S. subsidiaries of foreign multinationals. But that foreign multinational group still has to hit that $1 billion threshold. The JCT, the Joint Committee on Taxation, they estimated that actually only around 150 companies will be subject to this new minimum tax. But there will be many more that will ultimately have to run that calculation to determine if they’re going to be subject to it or not.

I think the interesting part of it, this new AMT, is its reliance on financial accounting, so that book income concept, based on which the computation is done. Not many will recall, but back in ’86, the 1986 Tax Reform Act, when the old AMT was actually introduced, there was a third calculation required. It was known as the business untaxed reported profits, or BURP, tax, if you can believe it. This BURP tax was similarly based on book profits, and it was actually repealed after only three years. There was a concern at the time that it would have this potential detrimental effect on the quality of financial reporting, providing incentive to underreport earnings to minimize tax.

Amato: You mentioned that tax from 1986. Why did Congress decide to bring back the corporate minimum tax, and what are the potential implications or problems with conflating accounting and tax rules?

Schrom: To start with the first question, I think it has to do with this perceived inequity of the current system. There’s a lot of companies reporting significant accounting profits to their shareholders while paying little to nothing in U.S. tax. Quite honestly, I think just that seems plain unfair to some. But I think it’s really important coming at it more from this CPA perspective to keep in mind that these two rule sets, accounting and tax, they’re really intended to do two different things. Accounting rules are designed to provide accurate, transparent information to investors and stakeholders, and so accounting rulemakers, they think about things like these principles upon which accounting is based. The matching principle requires a matching of revenues to expenses incurred to generate those revenues. Or this idea, this principle of conservatism, which states that when there’s more than one acceptable way to record a transaction, the accountant should choose the one that yields the most conservative results for the business.

These are just a couple of those exemplary principles or things that accountants and those rulemakers think about when setting accounting standards. Now tax policymakers, on the other hand, are often trying to incentivize or disincentivize certain behaviors. Take the CHIPS and Science bill that was actually just signed last week. Quite a bit of legislative activity here over the last few weeks. But that provided subsidies or will provide subsidies for semiconductor production. These tax policymakers, they have specific goals in mind, specific things that they’re trying to incentivize or disincentivize, and these priorities, they can ultimately shift with the political winds. The book tax, for example, can work to undermine the very things that previous tax policy intended to incentivize. Depreciation is actually a really good example.

The benefits of bonus depreciation, which generally provides for accelerated tax deductions for the purchase of tangible personal property could’ve been nullified if not for this 11th-hour addition of a modification to the calc for the purposes of the new AMT. What that modification does is it allows a taxpayer to subtract tax depreciation from its book income instead of book depreciation for purposes of that AMT calculation. Of course, this was done with a specific intent to help rather not harm companies in the industry that make outsize investments in physical property to operate and grow their business, like manufacturing. But just from that simple concept right there, you’re taking book income, you’re subtracting tax depreciation, you’re adding back book depreciation, and you can already start to see how convoluted this can get, and it really begins to blur the line between accounting and tax.

To that point the FASB, the Financial Accounting Standards Board, this seven-member board of accounting rulemakers in Norwalk, Connecticut, they now have a rather, or will have, a rather large influence over the amount of tax that our largest companies pay in a given year. Take, for example again, the revenue recognition rules issued in recent years. These would have had a material impact on the amount of tax that some companies would pay under this new AMT. The FASB was actually established in Connecticut precisely to avoid that potential influence of legislators and lobbyists in the D.C. area. But the last thing I’ll say on this is that this tension created between wanting to report high profits to investors and low taxable income to taxing authorities, it could have a bit of a balancing effect, so we’ll have to stay tuned. It’ll be really interesting to see how this all plays out this time around.

Amato: How does this minimum tax relate to the global minimum tax efforts underway by the OECD, the Organisation for Economic Co-operation and Development?

Schrom: The short answer is it doesn’t. These new book minimum tax rules are different from the global minimum tax rules, which, if enacted by the U.S. — and I think that’s a big if, despite Treasury Secretary [Janet] Yellen’s involvement in the negotiations — would in effect be yet another minimum tax regime.

You’d have the book minimum tax, this new minimum tax. You’d have regular tax, your regular tax liability. You’d have this global minimum tax regime. Essentially three different regimes, if you will.

This is in addition to GILTI or global intangible low-taxed income, which is a provision that was enacted as part of the TCJA, the Tax Cuts and Jobs Act, which already acts as a minimum tax, at least on foreign earnings. There’s some questions that remain to be seen of how exactly these rules will be viewed under the Pillar 2 framework, GILTI, for example. But we’ll see how that plays out over the coming years. And whether or not the U.S. even makes any real or meaningful progress toward implementing global minimum tax rules.

Amato: The House of Representatives voted to enact the Inflation Reduction Act on Friday, August 12. We’re recording on Monday, August 15. The bill is not yet signed into law, but by all indications, it will be. In a little more than four months, I guess, what are some of the ways the IRS or FASB might be able to provide relief so companies will have time administratively to calculate the corporate minimum tax?

Schrom: Your listeners may recall it’s more time than companies had for TCJA, again, Tax Cuts and Jobs Act, I think it was about nine days from the signing of that law, enactment, to some of those provisions going into effect. So a little more time than that. But in all seriousness, the closest reporting period for the calendar-year companies is Q1 2023. This Q1 provision, Q1 financial reporting, which generally happens in April. The good news from a tax perspective is that this isn’t expected to be overly burdensome in Q1 because the effects, again, from a financial reporting perspective, should be largely temporary in nature.

What I mean by that is this minimum tax if owed by a company, it will end up generating a minimum tax credit that can be used to offset future regular tax liability. Again, temporary in nature. What that means for tax accounting, that is, what companies will report on their Q1 financials for tax, is that it isn’t expected to impact the effective tax rate that companies report. This should lessen the burden as compared to many of those TCJA provisions enacted just prior to 2018.

That said, this is a new provision with a lot of unanswered questions, many of which won’t likely be answered prior to Q1. It’s very possible that there are still going to be some issues around things like valuation allowances, uncertain tax positions that some of these companies will encounter and especially because we’re talking about some of the most complex companies at least from a tax perspective in the world that this tax will apply to.

After Q1 provision, priorities will likely shift quickly to compliance for these companies. So they’ll have to do these calculations in full and ultimately report them on their tax return. Now currently there are no transition relief provisions, but what we’ve seen in the past and, especially again in this case, is that likely there will be additional regulations that are required to clarify parts of the legislation. To the extent those regulations are finalized over an extended period of time, it’s expected that there will be procedures provided to facilitate amended returns or adjustments.

Again, going back, for example, with Tax Cuts and Jobs Act, TCJA, there were similar provisions provided for GILTI, for example. There was general penalty relief in the first year. There were some temporary amended return procedures to retroactively elect certain exceptions in the rule. I expect we would see similar things along that line this time around.

Amato: Now, what’s specifically happening with the SALT cap deductions, SALT standing for state and local taxes? It had been discussed as part of the legislation, but it was taken out of the final bill, I guess late in the process.

Schrom: The bill does not include a total repeal of, or an increase to, that SALT deduction. It’s still $10,000. A little bit of background for those unfamiliar: That $10,000 SALT deduction cap was imposed, again, back in 2018 as part of TCJA. It expires in 2025 when it reverts back to unlimited. Obviously, this is particularly burdensome to taxpayers in states like California, some of the states on the East Coast with high taxes. Build Back Better had included a provision to increase that cap to $80,000.

Obviously, that did not come to fruition. Again, as I mentioned, this bill does not include anything to address or modify the SALT cap. There were some attempts to move out the expiration of the cap to 2027 during the course of the negotiations. But ultimately, those attempts failed; they were taken out of the final text of the bill.

There was a small group of House Democrats from New Jersey and New York actually last year that formed this caucus. They called it the “No Salt, No Deal” caucus. A number of Republicans actually also joined from some of these high-tax states. Their goal, or essentially what they stood for, was that they were going to say no, they were going to vote no on any changes to the tax code unless there was either a removal of or significant increase to this $10,000 SALT cap.

Going a little further back in history, the SALT deduction, it actually predates our current federal income tax system. During the Civil War, President Lincoln signed this Tariff Act of 1862, which imposed the national income tax to finance the Union’s Civil War efforts. As part of that national tax system, a deduction was allowed against income for state and local taxes, for SALT.

At the time the SALT deduction was described by the Senate at the time as of vital importance to preserve that principle of federalism and necessary to ultimately avoid double taxation. That system, that national tax system enacted during the Civil War was eventually repealed.

There was an attempt about 20 years later to institute another national tax, but that also failed as [it was] determined by the Supreme Court to be unconstitutional. Precisely because, interestingly, it was not apportioned among the states. In other words, there wasn’t this deference to the states’ taxing authority.

Fast forward, just a little bit further, another 20 years or so, the 16th Amendment was ratified. That modified the Constitution on the issue and that ultimately is what gave Congress the power to impose taxes without this apportionment among the states. In that same year, Congress passed the Revenue Act of 1913, which established the current federal income tax system as we know it today.

As was the case back in 1862 during that Civil War, Congress again found that the SALT deduction was extremely important. It was based on the same principles, federalism, avoiding double taxation. Back to the present, the House passed this bill, as we know, again, on Friday.

They didn’t have any trouble from this “No Salt, No Deal” caucus. They didn’t ultimately stick to their guns on this issue. Their rationale ultimately for acquiescing was, there’s no increase to personal income taxes, addresses climate change, boosts domestic manufacturing, lowers prescription drug costs.

Ultimately, they felt like they got enough positives, enough benefits for their constituents that they were willing to give on this SALT issue despite it being such a sticking point over the last year or two. The same day the bill passed, last Friday, a group of five House Democrats from that “No Salt, No Deal” caucus, they sent a letter to Ways and Means Committee Chairman Richard Neal, asking that the restoration of the SALT deduction be considered with any tax extender package that the committee takes up this year.

Bottom line, still no movement on this issue, but there are a number of members in Congress still pushing for it. Again, as it currently stands, it’ll end up expiring in 2025.

Amato: Now, about the 1% excise tax on stock repurchase by corporations, I guess a part sponsored by Senator [Ron] Wyden of Oregon. The excise tax seems relatively small, 1%, but it seems to have generated plenty of controversy. Why is that?

Schrom: Quickly, like you said, the excise tax is a 1% tax on the value of a publicly traded U.S. corporation’s repurchase of its stock. It’s effective for repurchases after 2022. It’s one of the pay-fors in the bill to help offset the cost of other provisions. There are some limited exceptions, I believe small buybacks under a million dollars.

Also, that buyback value that’s ultimately subject to the excise tax can be offset with the value of certain share issuances to reduce the base for the tax. But back to your question, back to this debate about it. This debate has been going on for some time. In fact, most share repurchases or buybacks were actually illegal until 1982 because they were seen at the time as a form of market manipulation, and many still view them that same way.

There are a number of academic arguments for and against buybacks, but I want to highlight just a few. On the for side, a company can buy back its shares when it believes they’re undervalued. This can send a signal to the market. But it also can hold those shares and resell them at a later date if and when the stock appreciates — so raising additional capital for the company. Another argument for buybacks is that it recycles cash back into the economy to investors, and they can more productively spend or invest that cash more than the company can. But a dividend can also do that, so I think it’s important to point that out. Lastly, a share repurchase is often more tax-efficient — more on that in a second.

So what are the arguments against? I think this is where most of that controversy you alluded to comes from. First, and probably most prominent in the media, is this idea that executives can use buybacks to game their own compensation metrics, in a way, especially, that is generally not possible with dividends. So when the number of shares in circulation goes down, because the company repurchases them, that share price and then the EPS, or earnings per share, generally go up, at least in the near term. That gets to the second argument, that a buyback, instead of being invested in growth initiatives, meaning more jobs, more asset investment to support those initiatives, it’s returned to shareholders. Again, in a manner that can be viewed as self-serving in nature.

Then the last argument against, I think, is tax on the flip side, tax again. This converse argument to it being tax-efficient is that it exploits the perceived loophole in the system. If there’s two ways for corporations to return value to shareholders — stock buybacks and dividends — why should they be treated differently for tax purposes? What is the tax treatment behind the argument? Let’s just take an example.

Take a $10 million share repurchase versus a $10 million dividend. Both return $10 million to investors. A few distinctions for tax purposes: First, in a stock repurchase, a shareholder can essentially choose whether or not to participate. Companies generally either purchase shares in the open market or they make a tender offer at a particular price at which they’re willing to buy back those shares, and only the shareholders that choose to participate will end up having a taxable event.

Those who don’t sell generally reap the benefit of an increased share price, which for tax purposes is an unrealized gain, meaning they won’t get taxed on it now; they would only get taxed on it when they go to sell the stock. But even for the shareholder that chooses to sell, that gain on the sale, if they have a gain at all, it’s limited to the difference between the sales price, or the cash received, and the shareholder’s tax basis in the shares.

If I receive $100 for my shares and I have $80 in tax basis, I only have a taxable gain of $20. Contrast that with this hypothetical dividend of $20 to every single shareholder. That full amount, that full $20 would be taxable to every shareholder.

To me, if I’m that shareholder that chose to sell, that total taxable amount would not be different. But in the event it’s not treated as a qualified dividend if I’m receiving the dividend, it is possible that I could be paying tax at ordinary rates instead of the preferential rates applied to long-term capital gains.

When you take that all and you think about it, combining this difference in tax treatment with the potential for self-serving manipulation, that’s ultimately where you see people coming together to want to address this. I think the policy intent of the excise tax is to theoretically equalize the tax treatment of dividends and buybacks so at least tax considerations don’t determine the decision to either buy back stock or pay a dividend. But in terms of the macro effect, I think many believe that such a low tax as 1% likely won’t have a significant impact on the number of share repurchases that ultimately do take place.

It’s possible that this ends up simply being a pay-for in the bill that punishes a perceived abuse of the system. It’s not necessarily a bad place to be.

Amato: Speaking of things that are generating a lot of discussion, there’s talk about the increased funding for IRS enforcement. The IRS has said it will take on more audits of high-wealth taxpayers if it has more resources. How do you see that playing out?

Schrom: It’s a good question. The Republicans in Congress have criticized this increase in funding because they believe it will lead to more middle-class taxpayers and small businesses being audited. I think in response and to allay those concerns, Secretary Yellen actually sent a letter to IRS Commissioner [Charles] Rettig specifically directing that the new funding not be used to increase audits on taxpayers earning less than $400,000 annually. What will the funding actually go towards? There’s about $80 billion in new funding for the IRS to be used through 2031, it is, I believe. $46 billion or so is earmarked for enforcement. Things like legal and litigation support, criminal investigations, digital asset monitoring, and compliance activities, etc. There’s $25 billion, a significant amount for simply operations support. Things like paying the rent.

There’s this $3 billion for taxpayer services. There’s going to be immediate focus on improving phone and online services. I think this was a significant focus. In fact, the national taxpayer advocate, which is a group within the IRS that specifically looks out for the taxpayer, said that the IRS was only able to answer about one in every nine calls last tax season. This $3 billion will hopefully go towards improving that. Then similarly, there’s another $5 billion for business systems modernization specifically, which will improve some of these systems like development of a callback technology and other technology to provide a more personalized customer experience when working with the IRS. A lot, again, going towards helping out the taxpayer in this case.

I think there’s some practical implications or challenges, I guess, if you will, with this funding, a significant amount of funding, but the IRS does face recruiting and training challenges. They plan to hire, I think, upwards of 87,000 new employees over 10 years as part of this funding. But they are expected to lose almost 50,000 just to general attrition. It’s a lot of money to put to use in an effective way, and it’s a tall task to do so. But, yeah, that’s where we’re at.

Amato: How can this whole process be monitored, of potential greater IRS enforcement, I guess?

Schrom: Yeah. It’s a good question, and transparency is always key, I think, when you’re thinking anything IRS and especially new funding for the IRS. There is an organization, and it’s called TIGTA or Treasury Inspector General for Tax Administration. TIGTA was established in 1998 to provide independent oversight of IRS activities. Their mission is actually to promote integrity, economy, and efficiency in the administration of the nation’s tax system, which is ultimately done through oversight of the IRS. The bill, the Inflation Reduction Act, allocates $400 million in additional funding for TIGTA to carry out their core functions, presumably, again, related to the increase in funding that we just talked about. Regardless, it’s crucial always for, I think, the IRS to keep Congress and the public sort of updated on spend effectiveness.

If things aren’t going well for whatever reason, Congress always can seek to reduce the amount or annual appropriations in the future if the IRS doesn’t adequately communicate how well they are using it. There will be multiple ways in which folks will be monitoring this process in order to make sure that it’s being executed effectively.

Amato: One key imperative of the bill is incentivizing clean energy. What can you say about how the bill seeks to achieve that generally?

Schrom: The bill extends several existing credits and also introduces some new ones. I think there are a number of them, and so I won’t bore you with all of the details, but I’ll go through some of the more common ones or some of the well-known ones. There’s this renewable electricity production tax credit. This is one of the existing credits, and this credit is for corporations generating electricity from renewable energy sources. There’s also the energy investment tax credit. This credit is for corporations owning or investing in clean, renewable projects, energy storage, etc. There’s an extension of the credit there. There’s a residential energy-efficient property credit. This credit is for individuals for residential improvements. Think energy-efficient exterior windows, doors, and skylights, things of that nature. They increased the cap on that one and then they extended that one as well. There’s an electric vehicle credit. This one exists, but there’s various new mechanics and limitations that they’ve implemented. It extends this existing credit up to $7,500 to individuals for purchases of qualifying electric vehicles through 2032. Again, there’s some price limitations, there’s some income phaseouts. There’s a whole host as well of some new credits. Broadly, I think these new credits also seek to encourage, like you mentioned, clean energy production and usage. There’s a zero-emission nuclear power production credit. There’s a credit around clean hydrogen production and sustainable aviation fuel. Again, there’s a few more in that list, but I think for time’s sake I’ll leave it there.

Amato: Adam, we appreciate the conversation and the insight today. Anything you’d like to add as a closing thought?

Schrom: Yeah. A lot of different priorities in this bill, I think, that the Democrats have been able to accomplish that were long-standing priorities for them. I think what it means for us tax professionals and tax practitioners is more complexity. We talked a lot about the minimum tax, how it interacts with some of the other provisions. There are also lots of new credits, this new excise tax. There’s always the talk, there’s often talk about simplification of the tax code. This does not do that, but we’ll wait and see how that all plays out. I think we’ll expect some new regulations, obviously, over the coming months, and I think that’ll be welcome for taxpayers to answer some of these open questions that still remain with this legislation.

Amato: Adam, thank you very much.

Schrom: Thanks, Neil. Thanks for having me.