Welcome to the EY DC Dynamics podcast series, where we discuss the latest legislative and regulatory insights covering tax and health care policy and what to expect in Washington.
Ray Beeman: Congress has adjourned for the August recess until after Labor Day. So we wanted to give you a quick update on how the mostly dead Build Back Better Reconciliation bill rose from the ashes like a phoenix and made it over the finish line, finally, as the Inflation Reduction Act, which the Senate passed on August 7th and the House approved and sent to the president for his signature on August 12th. And Biden wasted no time in signing the bill on August 16th. After discussion in Congress for more than a year, the final legislative product that Democrats were able to get over the finish line finances climate and energy provisions, and an extension of enhanced Affordable Care Act subsidies with a 15% corporate alternative minimum tax, which is imposed on adjusted financial statement income for corporations with profits over $1 billion, as well as a stock buyback tax, a two year extension of the excess business loss limitation through 2028, increased IRS enforcement funding, and Medicare’s new ability to negotiate prescription drug prices. President Biden remarked before the signing that he had been waiting to do so for a year and a half. Now, you’ll recall that way back in November of 2021, we talked about Democrats landing the plane for a reconciliation bill, not knowing that it would soon be grounded and stay that way through mid-July.
That’s when Senator Joe Manchin of West Virginia, who’s been at the center of this bill for more than a year, told Senate Majority Leader Chuck Schumer from New York that he couldn’t back tax increases or climate spending on the heels of 9% year over year inflation numbers.
Well, unbeknownst to virtually everyone in DC, Senators Schumer and Manchin patched things up and resumed their talks in one of the many tucked away meeting rooms in the Capitol a few days later. Manchin had already extracted more concessions in the talks, taking the international tax changes out of the discussion over concerns about the competitiveness of U.S. companies, and because other countries were having a tough time going along with the OECD agreement as well. After the 9% inflation numbers came out, he also said the proposal to expand the net investment income tax to pass through income, which leadership had already presented as having solid support among Senate Democrats, needed to be “scrubbed”, for its potential inflationary effects.
Republicans had been already demonstrating their ability to rhetorically clobber Democrats on that one as a tax increase on small businesses. So how did the Inflation Reduction Act come together?
Well, it’s rooted in the Democratic tax aspirations going back to the 2020 election. President Biden’s original $3.6 trillion package of rate increases and other tax increases in his fiscal 2022 budget was whittled down in the House Ways and Means bill, with rate increases softened and other proposals deemed politically impracticable. Then, tax rate increases were removed entirely from the House passed BBBA at the urging of Senator Krysten Sinema of Arizona, and other alternatives, like the Corporate Alternative Minimum Tax, instead were relied upon. And then more recently, what emerged from the Schumer Manchin talks was a much smaller set of the tax proposals that could funnel through objections and gain the requisite Democratic only support in the Senate. While Democrats were optimistic for this deal, the major question mark in the wake of the surprise announcement was Senator Sinema, who was said to be unaware of the burgeoning deal. Notably, the agreement included the extension of the carried interest holding period from three years that was set in the 2017 Tax Cuts and Jobs Act, to five years, even though Sinema previously opposed the same carried interest provision that had been dropped from the House bill at her insistence. As for the corporate Alternative minimum tax, it has gone through many iterations. One of the earliest versions of which was Senator, and at the time presidential candidate Elizabeth Warren’s, proposed real corporate profits tax of 7% on a corporation’s book income of over $100 million, which she proposed during the 2020 presidential campaign. The idea was picked up in the fiscal year 2022 Biden budget, and Democrats turned to that after Senator Sinema signaled last year that she wouldn’t support straight tax rate increases, which until then had been the focus of tax increase proposals. Now, after eight days of suspense, she said she could support the measure with changes. So the new bill was changed yet again, with the five year carried interest holding period falling out and being replaced by a stock buyback tax, which Democrats for years have been pushing, especially after arguing that buybacks soared after the Tax Cuts and Jobs Act was enacted in 2017. Now, even after bringing Senator Sinema on board, the last minute drama was far from over. What was supposed to be the final version of the bill came out on Saturday, August 6th, and it changed the corporate AMT language to protect tax depreciation deductions, as well as amortization deductions, specifically for qualified wireless spectrum, again at the insistence of Senator Sinema.
Then, the next day after the Senate had been in all night and there was light at the end of the tunnel in terms of exhausting Republican amendments to the bill in the marathon vote-a-rama, a late objection surfaced to some technical language in the corporate AMT that Senator Sinema and others feared would be detrimental to private equity investments. And this created an uncertain few hours when no one knew if the situation could ice the bill for a while or even kill the whole effort. Sinema and others sought to narrow the corporate AMT so that portfolio companies owned by private equity firms would not be considered to be part of the common ownership of the private equity firms, and combined with other portfolio companies. This change had bipartisan support, but needed to be paid for, and Senator John Thune appeared to be putting Democrats in a bind by offering an amendment to strike the common ownership language and have the $35 billion that was lost, paid for by a further extension through 2026, of the $10,000 state and local tax deduction cap. This clearly would have posed problems for Democratic senators from high tax states in supporting the bill overall. But Democrats had an end game plan, and in the end, Democratic Senator Mark Warner offered an amendment to replace the SALT cap extension with a different two-year extension of the limitation originally imposed by the Tax Cuts and Jobs Act on deducting excess pass-through business losses through 2028. This was approved 51 to 50, with Vice President Harris breaking the tie, and the bill finally passed in this form to cheers in the chamber for an effort that has taken well over a year to come together and was declared dead or close to it more than once.
It’s been widely noted that Treasury will have its hands full in providing guidance for this bill, particularly on the corporate AMT. Given the late changes to the language and swift movement of the bill in the Senate, there is no committee report or other congressional guidance to work from, and so taxpayers will be relying on Treasury for answers. And the time frame is tight because the corporate AMT goes into effect next year, only four months away.
It is also worth noting that in addition to carried interests, other provisions left on the cutting room floor include the changes to GILTI to make it compliant with the 15% global minimum tax agreement. Senator Manchin had pointedly taken them out of negotiations even before the July 27th break-through, and that will be a space to watch that could be guided by what other countries do or don’t do, and with the TCJA fiscal cliff of 2025 on the horizon for yet another major tax bill.
With regard to the historic investment in clean energy tax in the Inflation Reduction Act. The bill accomplishes what Democrats have been trying to do for years now, which is to put the nation on a long-term course to reduce climate change. Not the year-by-year approach we have seen with tax extenders in the past, and to do so by revitalizing the manufacturing industry in the United States, putting more people to work, making the parts that go into a green energy infrastructure. And that is part of what we see with the wage and domestic content requirements and some of these provisions. There has been reporting about a shift from coal jobs to a battery plant in West Virginia. And that was what this bill is trying to accomplish and why it could be supported by lawmakers like Senator Manchin and other Democratic senators from industrial states.
For electricity and fuels, the bill extends current incentives through 2024 before switching to technology neutral credits that are emissions based. And in the case of electricity, these will remain in place until emission targets are reached.
The bill also includes extensions of the 45Q Carbon Sequestration Credit, 48C Advanced Energy Property Credit, and credit for energy efficient homes, plus new credits for nuclear power, hydrogen, and sustainable aviation fuel.
Other credits would be offered for new, used, and commercial electric vehicles with income and MSRP limitations. The bill would also reinstate the Superfund tax, which has been inactive since the mid 1990s, at a rate of 16.4 cents per gallon. The Inflation Reduction Act also would create a new regime to make many of these tax credits transferable. Under new tax code Section 6418, an eligible taxpayer could elect to transfer all or any portion of an eligible credit to an unrelated transferee taxpayer. The transfer, however, would have to be paid in cash, not be included in the income of the recipient taxpayer, and not be deductible by the paying taxpayer. The bill also would provide for a direct pay option for certain credits, which would effectively treat tax credits generated by Renewable Energy project as equivalent to tax paid by the taxpayer on a filed tax return.
However, unlike the BBBA, this bill would significantly limit and restrict this option. The big thing about the new electric vehicle credit is that it removes the $200,000 per manufacturer cap that has limited the credit for years now.
But the credit now includes pretty strict income and MSRP limitations to counter the claims that the credit is for the wealthy. And it also includes domestic content requirements, that some say could severely limit the benefit of the credit, at least early on. Moreover, electric vehicles must now be assembled in the United States to be eligible for the credit, and this has drawn some criticism from other countries.
Finally, we are looking forward to the possibility of a post-election lame duck year-end tax bill to clean up many of the outstanding tax policy issues left outstanding by the Inflation Reduction Act. While the bill dealt with many of the expired or expiring tax provisions on the energy side, there are still some tax policy priorities for many in Congress that could compel a year-end tax package.
Top contenders for inclusion in the package include the TCJA cliffs that took hold this year on section 174, requiring five-year R&D amortization rather than expensing, and on the section 163J interest deduction calculation, as well as the phase down of bonus depreciation after this year.
Also, a bipartisan retirement security bill is a legacy effort for several senior tax writers who will or may retire at the end of this Congress. The child tax credit, featuring mailed payments that expired at the end of 2021, is a top piece of unfinished business for many Democrats who say it’s hard for them to vote for business tax breaks without it. But it has a big price tag, and we will see if either the Inflation Reduction Act has changed that calculus for Democrats, or whether there is some deal to be made with Republicans in a post-election environment. Don’t forget that this year end bill would need 60 Senate votes, because it would be outside of the reconciliation process that Democrats use to enact the Inflation Reduction Act without any Republican support.
So, it’s been a long and winding road, and at times a long, strange trip to get to this place. And Congress kept us in suspense all the while, as they are inclined to do. But here we are with a bill in hand. The plane came in for a landing after all. We will be back after the recess to do a post-mortem, discuss the outlook for the mid-term elections, and consider where Congress may go next down the tax policy road. And with that, I’m Ray Beeman, and this has been DC Dynamics.
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