Reconciliation Transformation: Inflation Reduction Act of 2022August 2, 2022
The path forward for budget reconciliation legislation in the Senate took an unexpected turn when Majority Leader Chuck Schumer (D-N.Y.), and Sen. Charles Manchin (D-W.Va.), unveiled the Inflation Reduction Act of 2022—a $739 billion tax-and-spending package that includes some targeted corporate and individual tax increases, a large increase in funding for the Internal Revenue Service, $433 billion in incentives to promote climate change mitigation and clean energy, and provisions to promote health care affordability. Now with the August recess looming ahead, Democrats are pushing to pass the bill before the upper chamber leaves for a month.
At a high level, the new agreement between Sens. Schumer and Manchin includes revenue-raising provisions that would impose a 15 percent book minimum tax on certain large corporations, modify the tax treatment of income from carried interests, and provide a special allocation of $80 billion (over 10 years) to fund IRS compliance and enforcement efforts. A one-page summary from Schumer and Manchin notes that “[t]here are no new taxes on families making $400,000 or less and no new taxes on small businesses.”
Some of the revenue from those provisions—and from nontax provisions to modify the Medicare prescription drug pricing rules—would offset the cost of several investment and production tax incentives for clean energy (from certain fossil fuels as well as alternative sources) and an extension (through 2025) of enhanced premium subsidies for certain individuals who purchase health insurance through one of the Affordable Care Act exchanges.
A portion of the revenue raised under the measure would be allocated to deficit reduction—something that has been a key priority for Sen. Manchin.
Corporate Minimum Tax
The Inflation Reduction Act does not propose to increase the top corporate income tax rate; however, it would impose a 15 percent minimum tax on adjusted financial statement income for corporations with average adjusted annual financial statement income over a three-tax year period more than $1 billion. Corporations generally would be eligible to claim net operating losses and tax credits against the AMT and would be eligible to claim a tax credit against the regular corporate tax for AMT paid in prior years, to the extent the regular tax liability in any year exceeds 15 percent of the corporation’s adjusted financial statement income. The proposed minimum tax would be effective for taxable years beginning after December 31, 2022. The proposal is estimated by JCT staff to raise $313 billion over 10 years, according to a summary released by Senate Democrats.
A similar provision was included in the Build Back Better Act that was passed by the House in November 2021. Unlike the House-passed provision, the Inflation Reduction Act proposal would (1) disregard any book income, cost, or expense with respect to defined benefit pension plans, and (2) include any item of income or deduction included in the computation of taxable income with respect to defined benefit pension plans.
Increased Holding Period for Carried Interests
The Inflation Reduction Act proposes several changes to the carried interest rules, most notably by requiring generally that net capital gain attributable an applicable partnership interest be held for more than five years to qualify for long-term capital gain treatment. The three-year holding period under current law would remain in effect for real property trades or businesses and for taxpayers with adjusted gross income of less than $400,000.
Additional proposed changes would, among other things:
- Reform the holding period rules for purposes of measuring the three- or five-year holding period (including in the context of tiered partnerships),
- Modify the rules so that they apply to all transfers and not just to certain related persons, and
- Extend regulatory authority under the provision to address carry waivers.
These changes, which are substantially like those in a version of Build Back Better legislation approved by the House Ways and Means Committee last September, would be effective for taxable years beginning after Dec. 31, 2022.
IRS Funding Increase
The Schumer-Manchin bill would provide the Internal Revenue Service approximately $80 billion in additional appropriations (available over 10 years) to enhance its tax enforcement and compliance efforts. The Congressional Budget Office (CBO) has projected that increasing IRS enforcement funding by $80 billion would increase federal revenues by $200 billion, to provide a net federal revenue increase of $120 billion. However, these CBO projected savings are not permitted to be counted for official scoring purposes under Senate budget reconciliation rules. The proposal expressly states that the additional funds are not intended to increase taxes on any taxpayer with a taxable income below $400,000.
The provision also provides $15 million for the IRS to prepare and deliver a report to Congress on the cost of developing and running a free direct e-file tax return system. The provision permits the Secretary to exercise greater flexibility with respect to personnel, including certain “direct hire” authority.
The Inflation Reduction Act does not include other significant business, international, and individual tax increase proposals that have been proposed by President Biden and other Democrats. Tax increases in the House-passed bill were estimated by the JCT staff to raise $1.5 trillion over 10 years. In addition, Senator Manchin has pointed out specifically that the Inflation Reduction Act does not include any changes to the current-law $10,000 cap on the federal itemized deduction for state and local taxes, an issue that has been a priority for several House and Senate Democrats.
The Inflation Reduction Act also does not include the House-passed bill measure that would reinstate the expensing of Section 174 research expenditures that became subject to capitalization in 2022 under a provision of the 2017 tax reform act.
Excise Tax on Certain Pharmaceutical Manufacturers
The Schumer-Manchin bill also includes an excise tax of up to 95 percent that would be imposed on pharmaceutical manufacturers that do not participate in proposed mandatory negotiations with the government on Medicare prescription drug pricing.
Reducing Consumer Energy Costs
The bill would extend several tax credits aimed at bringing down the cost of residential energy-efficiency improvements such as heat pumps, rooftop solar systems, and electric HVAC systems and water heaters.
The measure also calls for a $4,000 credit to make it more affordable for certain lower- and middle-income individuals to purchase used clean-energy vehicles. A credit of up to $7,500 would be available for the purchase of new clean-energy vehicles. Sen. Manchin had contended that similar incentives in earlier iterations of the Build Back Better legislation were focused on more expensive vehicles that were intended to appeal primarily to affluent taxpayers.
Promoting Energy Security and Domestic Manufacturing
The measure includes tax and nontax provisions intended to improve reliability of the U.S. energy grid and promote domestic clean-energy manufacturing. Among the tax-focused provisions are production tax credits to accelerate U.S. manufacturing of solar panels, wind turbines, and critical minerals processing. Also included is an investment tax credit to build clean technology manufacturing facilities that produce electric vehicles, wind turbines, solar panels, and similar clean-energy property.
The bill calls for an array of tax and nontax provisions aimed at reducing emissions from energy production, transportation, industrial manufacturing, buildings, and agriculture. Specifically, it includes tax credits for clean sources of energy and energy storage, tax credits for clean fuels and clean commercial vehicles to reduce emissions within the transportation sector, and tax credits to reduce emissions from industrial manufacturing processes.
Affordable Care Act
Finally, the legislation would extend a temporary increase in the Affordable Care Act (ACA) premium assistance tax credit for three years, through 2025; this ACA credit was expanded temporarily as part of the 2021 American Rescue Plan Act and are scheduled to expire at the end of this year.
With an agreement in place the focus for Democratic leaders now turns to the process of ensuring they have sufficient support among their members in both chambers of Congress and that the bill can pass muster with the Senate parliamentarian. However, one sticking point is that Sen. Kyrsten Sinema (D-Ariz.) has not yet taken a position on the Manchin-Schumer proposal. It’s unclear if she will support the bill’s carried interest reform that would affect private equity investors. The chamber is scheduled for a four-week recess beginning August 5 and running through Labor Day, but senators could remain in town into the weekend of August 6 if necessary to complete passage. Additionally, no Republicans are expected to support the revised reconciliation package.
As part of the budget reconciliation process, the Senate will also have to go through what is known as a vote-a-rama, a process that allows for an unlimited number of amendments that are briefly debated before being voted on. These amendments—specific to budget-related measures—are often used for political messaging rather than to modify the underlying bill, and the process can take many hours. The upcoming vote-a-rama, which will be preceded by up to 30 hours of debate on the underlying reconciliation bill, is not expected to begin until at least August 3. A final vote on passage will follow the vote-a-rama.
The House began its own recess on July 29 and is not scheduled to return until September 13, but Democratic leaders are already planning to bring the chamber back to Washington briefly in August if the Senate passes a reconciliation bill while the House is out of session. Majority Leader Steny Hoyer (D-Md.) told his members on July 28 that the target return date for the House is August 8 but that it will remain fluid based on the Senate’s work.
Legislative Text: Inflation Reduction Act of 2022