In a surprise to many, last week Senate Democrats released the Inflation Reduction Act of 2022, a slimmed-down version of the now-dead Build Back Better Act that passed the House in fall 2021. While the fate of this latest bill is still not clear, Democrats are optimistic about its chances of getting enacted. The Joint Committee on Taxation preliminarily estimated the bill will raise $68.2 billion, despite including a number of energy tax incentives and other expenditures. In addition to increases in IRS funding primarily focused on increasing enforcement that the Congressional Budget Office estimates will raise $124 billion, the expenditures in the bill are offset by a new corporate minimum tax and further limitations on the preference for carried interests, which are estimated to raise $326.2 billion.
Inflation reduction bill: A mixed bag
Corporate minimum tax
The bill would impose a new 15% corporate minimum tax on corporations with financial statement income with certain modifications of more than $1 billion. A corporation can use net operating losses and credits to reduce its corporate minimum liability. If a corporation pays the minimum tax, it would get a credit in future years to use against its income tax. The corporate minimum tax would apply to tax years beginning after Dec. 31, 2022. This provision alone is estimated to raise $313.1 billion.
Carried interests
Under current law, IRC Section 1061, which was enacted by the Tax Cuts and Jobs Act of 2017, limits preferential long-term capital gains treatment for certain carried interests, referred to as applicable partnership interests (APIs), that are not held for more than three years. The proposed bill would expand this limitation effective for tax years beginning after Dec. 31, 2022. The following are highlights of the bill’s changes to IRC Section 1061:
- The holding period to qualify for long-term capital gains treatment generally would be extended from three years to five years.
- The extended, five-year limitation would not apply to individuals with less than $400,000 of adjusted gross income or to income recognized with respect to an API that is attributable to a real property trade or business (as defined in IRC Section 469(c)(7)(C)).
- The scope of income subject to the limitation would include IRC Section 1231 gains, qualified dividends, and other items ordinarily taxed at long-term capital gains rates.
- Rather than looking solely at the holding period of the partner or the partnership as under current law, the holding period would be determined with reference to both the partner’s holding period in the API and the holding period that starts when the partnership acquires substantially all of its assets. Because many investment funds raise capital over multiple years before acquiring assets, a “substantially all” test likely will extend the effective holding period of APIs beyond five years for those seeking long-term capital gains treatment. Missing from the current proposal is a definition of “substantially all” and how the holding period applies in tiered structures.
- Modifications would result in the recognition of all gains from any transfer of an API, even if the transaction otherwise would be tax free.
Clean energy incentives
The bill adds new energy credits and enhances or extends some existing credits and deductions, including:
- Extension and modification of credits for carbon sequestration
- New credits for advanced technologies relating to nuclear power, hydrogen production, clean fuel production, aviation fuel, and energy storage
- Enhanced solar and wind credits, including extension of certain expiration and phase-out dates
- Extension of certain expiring energy credits through 2024, such as credits for biodiesel and renewable diesel, alternative fuel, and alternative fuel mixtures
- Extension and enhancement of the credit for energy efficient homes
- An expanded deduction for energy efficient commercial buildings
