August 9, 2022
August 9, 2022
The Inflation Reduction Act approved by the Senate on Aug. 7 would raise more than $700 billion in new revenue over a decade by closing corporate tax loopholes, empowering the IRS to enforce the tax laws on the books, taxing stock buybacks, and extending a limitation on deductions for business losses. The IRA – if passed by the House and signed by the President – would be the most substantial corporate tax reform in decades. Which tax provisions remain, and which were changed before final passage? Here’s a rundown:
Corporate Minimum Tax
Revenue impact: $223 billion over a decade
Corporations with more than $1 billion in profits over the previous three years would be required to pay taxes of at least 15 percent of their worldwide “book” profits. Book profits are the profits that corporations make public for shareholders and potential investors and are sometimes much larger than the profits they report to the IRS for tax purposes. If the total taxes (US taxes and foreign taxes) paid comes to less than 15 percent of those profits, this provision would require them to pay additional tax to raise their effective worldwide tax rate to 15 percent.
Sen. Elizabeth Warren’s office published a report relying on ITEP data in November identifying corporations that would have paid the minimum tax if it was already in effect in recent years.
The corporate minimum tax in the initial version of the IRA would have raised $313 billion over a decade, but Senate Democrats made two changes that reduced the revenue impact. (The revenue was replaced by other provisions, described further on.)
- A carve-out for accelerated depreciation reduced the revenue impact by $55 billion over a decade before the bill went to the floor.
Accelerated depreciation allows companies to write off the costs of investments in equipment more quickly than the equipment wears out and loses value. The most likely outcome is that this rewards companies for making investments they would have made absent any tax break. Such depreciation breaks are a major reason why some corporations pay little in US taxes. Senate Democrats made this change in response to claims that the minimum tax would otherwise harm manufacturing, claims that were always untrue.
- A carve-out for corporations owned by private equity funds, added by amendment on the Senate floor, reduced the revenue impact by $35 billion.
The Senate approved an amendment from Sens. Thune and Sinema creating a loophole in the minimum tax for corporations owned by private equity funds. Private equity funds are structured as partnerships rather than C corporations that are required to pay the corporate income tax. A large corporation made up of several subsidiary corporations could be subject the minimum tax but a functionally equivalent private equity fund that owns several corporations would not be, as a result of the Thune-Sinema amendment.
These two changes reduced the 10-year revenue impact of the corporate minimum tax from $313 billion to $223 billion, but the following two provisions were added to the bill, which more than made up for that revenue loss.
1 Percent Excise Tax on Stock Buybacks
Revenue impact: $74 billion over a decade
Corporations would pay a 1 percent excise tax when they purchase their own stock from shareholders, which would reduce the tax advantages for stock buybacks. Stock dividends and stock buybacks are both ways that corporations transfer profits to shareholders, but only dividends are taxed under current law. Shareholders pay income tax on stock dividends in the year they receive them. Stock buybacks, on the other hand, result in capital gains (because they increase the value of the stocks) that may not be taxed for years and in many cases are never taxed at all. The 1 percent excise tax will reduce, but not eliminate, this advantage.
Extension of Limit on Deductions for Business Losses
Revenue impact: $52 billion over a decade
Under rules enacted as part of the Tax Cuts and Jobs Act (TCJA), when business owners report losses, they cannot use these losses to offset more than $250,000 of their non-business income (or $500,000 of non-business income in the case of married couples). This prevents high-income taxpayers from deducting business losses that exist on paper only to reduce the other income they report to the IRS. The limit on pass-through losses was set to expire with most of the other TCJA personal income tax changes after 2025. The CARES Act controversially suspended it for 2020 and retroactively for 2018 and 2019. The American Rescue Plan Act extended it for one year, through 2026. The IRA would extend it for another two years.
Increased Funding for Tax Enforcement
Revenue impact: $204 billion over a decade
The IRA would provide $80 billion in additional funding for the IRS which would result in $204 billion in additional revenue collections. (The Treasury Department points out that the real revenue impact would likely be $400 billion over a decade.) The new funding would reverse a decade of cuts to the IRS enforcement budget that have left the agency with fewer auditors than at any time since World War II. These have caused the agency to dramatically reduce audits of wealthy individuals and large corporations and focus instead on audits that are easier to perform—which are audits on poor people. The funding comes with instructions that people whose actual income is less than $400,000 would not be targeted for increased audits.
What Else Was Removed from the Bill? A Provision to Further Clamp Down on the Carried Interest Loophole that Would Have Raised $14 Billion
“Carried interest” is a share of profits in a business venture and is one type of compensation paid to private equity fund managers in return for investing and managing someone else’s money. But unlike other compensation paid for work, the fund managers claim that carried interest is capital gains and thus eligible for lower income tax rates than would normally apply to earned income. The 2017 tax law put some weak limits on the loophole by barring the use of the capital gains tax rates for carried interest unless it comes from investments that were held for more than 3 years. The provision in the IRA as originally drafted would have increased that to 5 years, which would have reduced the amount of carried interest eligible for the lower rates.
The carried interest loophole is part of a much bigger problem: Our tax code treats income from wealth, which mostly goes to very well-off households, more generously than income from work. President Biden has proposed comprehensive changes to address this problem, which could be the starting point for the next round of tax reform in a future Congress.