On August 7, the Senate passed the Inflation Reduction Act of 2022 (the “IRA”). The tax provisions in the bill that was passed vary from the bill that was originally released on July 27, 2022 by Senator Joe Manchin (D-W.Va.) and Senate Majority Leader Chuck Schumer (D-NY) in four significant respects: The carried interest proposal was removed, the 15% corporate alternative minimum tax now allows accelerated depreciation deductions to reduce annual adjusted financial statement income (as explained below), a 1% excise tax on stock buybacks was added, and the excess business loss limitation rules were extended by two years. This blog post summarizes the version of the IRA that was passed by the Senate.
- Removal of carried interest proposal
As originally introduced, the IRA would have extended the holding period for long-term capital gain treatment for certain carried interests from three years to five years (or, in certain circumstances, longer).
The carried interest provision has been removed from the IRA.
- Modification of corporate alternative minimum tax
The IRA would impose a 15% corporate alternative minimum tax based on the financial statement income of corporations or their predecessors with a three-year taxable year average annual adjusted financial statement income in excess of $1 billion. The corporate alternative minimum tax would be effective for tax years beginning after December 31, 2022.
The 15% corporate alternative minimum tax would be equal to the difference between a corporation’s “adjusted financial statement income” for the taxable year and the corporation’s “alternative minimum tax foreign tax credit” for the taxable year. A corporation’s tax liability would be the greater of its regular tax liability and the 15% alternative minimum tax.
As originally proposed, the IRA would not have allowed a corporation to reduce its adjusted financial statement income by taking into account accelerated deductions for depreciation. As modified, the IRA would exempt accelerated depreciation deductions from a corporation’s adjusted financial statement income.
A corporation’s annual adjusted financial statement income would be based on its book income, with certain adjustments, such as to account for a corporation’s activities undertaken indirectly through a consolidated group, a partnership, or a disregarded entity. The adjusted financial statement income would also be adjusted for certain taxes, such as federal income and excess profits taxes, and accelerated depreciation.
The average annual adjusted financial statement income of a corporation would include any other entities that are treated as a single employer with the corporation under section 52 to determine whether the corporation satisfies the $1 billion threshold.[1] This may cause corporations with less than $1 billion of adjusted financial statement income to be subject to the proposal.
As originally proposed, the IRA was unclear whether the portfolio companies of an investment fund would be aggregated with the fund’s ultimate parent under section 52 to determine whether each company would satisfy the $1 billion threshold. An interim version of the IRA would have treated an investment fund as engaged in a trade or business, which would have resulted in the aggregation of portfolio companies. A last minute amendment by Senator John Thune (R-SD) removed the modification; accordingly, portfolio companies of an investment fund generally will not be aggregated with other portfolio companies for purposes of the $1 billion threshold.
For corporations in existence for less than three years, the three-year income test would be applied over the period during which the corporation was in existence. The adjusted financial statement income of a corporation with a taxable year shorter than 12 months would be applied on an annualized basis.
Corporations would generally be eligible to claim net operating losses and tax credits against the alternative minimum tax. Adjusted financial statement income would be reduced by the lesser of (i) the aggregate amount of financial statement net operating loss carryovers to the taxable year and (ii) 80% of adjusted financial statement income (reflecting the tax rule that net operating losses are permitted to offset only 80% of taxable income). The proposed clean energy credits and other business credits would be limited to 75% of a corporation’s alternative minimum tax. In addition, a corporation would be eligible to claim a credit for corporate alternative minimum tax paid in prior years against the regular corporate tax if the regular tax liability exceeds 15% of the corporation’s adjusted financial statement income.
The corporate alternative minimum tax would apply to a foreign-parented corporation (i.e., a U.S. subsidiary of a foreign parent) if its three-year taxable year average annual adjusted financial statement income exceeds $100 million and that of the foreign-parented multinational group exceeds $1 billion.[2] It is not clear whether the $100 million threshold is tested on a separate basis or on aggregate basis so that, for example, the adjusted financial statement income of two domestic subsidiaries of a common foreign parent (neither of which would separately meet the $100 million threshold) would be aggregated. The Secretary would have the authority to issue regulations on the threshold tests.
The corporate alternative minimum tax would not apply to S corporations, regulated investment companies, or real estate investment trusts. In addition, the tax would not apply to corporations that have had a change in ownership or has a specified number of consecutive taxable years that will be determined by the Secretary.
The corporate alternative minimum tax does not conform to the “qualified domestic minimum top-up tax” proposed by the OECD/G20. As a result, if the OECD/G20 rules are adopted in their current form, the foreign subsidiaries of U.S. multinationals located or doing business in OECD countries could be subject to additional taxes by those jurisdictions.
- Excise tax on corporate stock buybacks
The IRA now includes a nondeductible 1% excise tax on stock repurchases by publicly traded corporations and certain “surrogate foreign corporations”.[3] The proposal would apply to repurchases of stock after December 31, 2022.
The tax would be imposed on the fair market value of the stock “repurchased” by the corporation during the tax year, reduced by value of stock issued by the corporation during the tax year (including those issued to the employees). The term “repurchase” is defined as a redemption within the meaning of section 317(b), which is a transaction in which a corporation acquires its stock from a shareholder (and is not a dividend for federal income tax purposes).
The tax would also be imposed on a corporation if its “specified affiliate” repurchases the corporation’s stock from another person (including another “specified affiliate”). The term “specified affiliate” is defined as (i) any corporation in which the taxpayer-corporation directly or indirectly owns more than 50% of the stock by vote or value; and (ii) any partnership in which the taxpayer-corporation directly or indirectly holds more than 50% of the capital or profits interests.
In addition, the tax would be imposed on a specified affiliate (i.e., a domestic subsidiary) of a non-U.S. publicly traded corporation that purchases the non-U.S. corporation’s stock from another person (excluding another specified affiliate of the non-U.S. corporation).
If a surrogate foreign corporation (or its specified affiliate) repurchases its stock, the tax would be imposed on the surrogate foreign corporation’s expatriated entity (i.e., its U.S. subsidiary).
Repurchases that are (i) dividends for federal income tax purposes, (ii) part of tax-free reorganizations, (iii) made to contribute stock to an employee pension plan or ESOP, (iv) made by a dealer in securities in the ordinary course of business, or (v) made by a RIC or a REIT would not be subject to the excise tax. Repurchases that are less than $1 million in a year would also be excluded.
The Secretary would have the authority to issue regulations to prevent abuse through the above exclusions and apply the rules to other classes of stock and surrogate foreign corporations. It is not clear how broad that authority is intended to be and whether the Secretary will issue guidance on certain common transactions, such as redemptions of preferred stock or of a non-publicly traded subsidiary’s debt that is exchangeable for its publicly-traded parent’s stock.
- Extension of excess business loss limitation rules
Under current law, for taxable years that begin before January 1, 2027, non-corporate taxpayers may not deduct excess business loss (generally, net business deductions over business income) if the loss is in excess of $250,000 ($500,000 in the case of a joint return), indexed for inflation. The excess loss becomes a net operating loss in subsequent years and is available to offset 80% of taxable income each year.
The IRA would extend the excess business loss limitation rules to taxable years that begin before January 1, 2029.
The IRA’s amendments would apply to taxable years beginning after December 31, 2026.
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[1] All references to section are to the Internal Revenue Code.
[2] As modified, the IRA defines “foreign-parented multinational group” as a group of two or more entities in a taxable year, in which (i) at least one is a domestic corporation and the other is a foreign corporation, (ii) the entities are included in the same applicable financial statement for the taxable year, and (iii) either (a) their common parent is a foreign corporation or (b) if there is no common parent, they are treated as having a common parent that is a foreign corporation under rules to be prescribed by the Secretary.
To determine whether a foreign-parented multinational group exists, the IRA treats a foreign corporation’s trade or business as a separate, wholly-owned domestic corporation.
As originally introduced, this provision applied to a foreign-parented “international reporting group” rather than a foreign-parented multi-national group.
[3] A surrogate foreign corporation is a foreign corporation (i) that has acquired substantially all of the properties held directly or indirectly by a domestic corporation or substantially all of the properties constituting a trade or business of a domestic partnership; (ii) the acquisition of at least 60% of the stock (by vote or value) of the entity is held, (a) in the case of an acquisition with respect to a domestic corporation, by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation, (b) in the case of an acquisition with respect to a domestic partnership, by former partners of the domestic partnership by reason of holding a capital or profits interest in the domestic partnership or (c) in the case of an acquisition with respect to a domestic partnership, by former partners of the domestic partnership by reason of holding a capital or profits interest in the domestic partnership; and (iii) after the acquisition the “expanded affiliated group” which includes the entity does not have substantial business activities in the foreign country in which, or under the law of which, the entity is created or organized, when compared to the total business activities of such expanded affiliated group.