The Inflation Reduction Act, Could It be Hello, Goodbye?

The proposed act consists of three different bills, introduced together as one package. The three bills are called the Build It in America Act (H.R. 3938), the Small Business Jobs Act (H.R. 3937) and the Tax Cuts for Working Families Act (H.R. 3936).

The proposed act, if passed, could provide tax benefits for many Americans, including raising the standard deduction by $4,000 for joint filers ($2,000 for individual filers) for 2024 and 2025. Additionally, the proposed act could benefit small businesses, including by increasing the tax reporting threshold to $5,000 (up from $600) on Form 1099 for independent contractors and repealing a law requiring third-party settlement organizations such as PayPal and Venmo to report aggregate payments over $600 on Form 1099 (instead requiring reporting for aggregate payments over $20,000).

However, the proposed act also contains several provisions that may increase taxes for investors and day-to-day business operations. The proposed act would also roll back several energy provisions introduced by the IRA, which may have serious impacts on the energy industry and the construction of renewable energy infrastructure.

Expanding the Applicability of Qualified Small Business Stock

The proposed act would expand the ability of taxpayers to exclude gain realized on the sale of Qualified Small Business Stock (QSBS) to stock held for at least three years (as opposed to the current holding period of five years). For QSBS acquired after the enactment of the proposed act, eligible taxpayers could exclude 50%of the gain realized on a sale of QSBS held for at least three years. The exclusion would be increased to 75% for QSBS held for at least four years and 100% for QSBS held for five years or more.

The proposed act would also allow stock acquired from the conversion of a qualified convertible debt instrument to be treated as QSBS beginning on the date the qualified convertible debt instrument was acquired. Finally, the proposed act would expand eligibility for QSBS treatment from only stock of C corporations (under current law) to also include stock of S corporations, expanding the planning opportunities for small businesses and investors.

Increases in Limitations on Expensing Depreciable Assets

The proposed act would increase the ability of taxpayers to expense capital purchases by increasing the dollar limitations under section 179. Property that a taxpayer may elect to expense under section 179 includes tangible depreciable personal property, certain computer software, and certain qualified real property. Under the proposed act, the new limit for the amount of property allowed to be expensed would be $2.5 million, while current law provides for a limit of $1 million. The proposed act would also increase the threshold which triggers a phase-out of the deduction under section 179 from $2.5 million to $4 million. Thus, taxpayers could place in service up to $4 million of property per taxable year without losing benefits under section 179.

Rural Opportunity Zones

The proposed act would add a new code section allowing taxpayers to defer recognition of certain capital gain income for investments in a Qualified Rural Opportunity Fund (QROF). The gain would be deferred until the time the investment in the QROF is sold or December 31, 2032, whichever is earlier. An investment in a QROF would include an investment in a “qualified rural opportunity zone,” which would be defined as a population census tract which is located in a rural county and is in persistent poverty (as determined by the Bureau of the Census).

Deduction for Research and Experimental Expenditures

The proposed act would delay section 174, which was amended by the TCJA to require that taxpayers amortize instead of immediately deduct certain research and experimental expenditures, until taxable years beginning after December 31, 2025.

Extension of Allowance for Depreciation, Amortization or Depletion in Determining the Limitation on Business Interest

The proposed act would extend a TCJA benefit allowing taxpayers to disregard depreciation, amortization, and depletion for purposes of calculating adjusted taxable income and, by extension, the taxpayer’s business interest limitation under section 163(j). By extending this benefit, the proposed act would effectively increase the amount of interest a taxpayer is allowed to deduct in a given tax year under section 163(j). This benefit had phased out starting in 2022.

Extension of TCJA Bonus Depreciation

The proposed act would extend a TCJA benefit under section 168(k) that allows taxpayers to depreciate 100% of the tax basis of qualified property placed in service prior to December 31, 2025. Under current law, such benefit phased out as of January 1, 2023. The proposed act would extend the benefit for qualified property placed in service through December 31, 2025, and reduce the amount of available depreciation to 20% of the tax basis of qualified property placed in service after December 31, 2025, and before January 1, 2027.

Termination of Hazardous Substance Superfund Financing Rate

The proposed act would repeal an IRA provision that increased the tax rate on crude oil received at a US refinery and on petroleum products which enter the United States for consumption, use, or warehousing. Currently, the rate of tax is equal to the sum of the Hazardous Substance Superfund financing rate (16.4 cents a barrel, adjusted for inflation) and the Oil Spill Liability Trust Fund financing rate (9 cents a barrel). Accordingly, the proposed act would eliminate application of the increased rate on transactions occurring after December 31, 2022. The House Ways and Means Committee stated that this provision of the proposed act is intended to lower energy consumption costs.

Election to Opt Out of Certain Foreign Tax Credit Rules

Under the proposed act, a taxpayer may elect to determine whether any “Western Hemisphere” tax is paid or accrued for foreign tax credit purposes without regard to certain US Treasury regulations that have been published over the past couple of years. This would allow companies to temporarily avoid the stricter standards for claiming foreign tax credits that have been in place since 2021. Such an election may also be made by a controlled foreign corporation and will be binding on all the controlled foreign corporation’s US shareholders.

Imposition of Tax on Acquisition of U.S. Agricultural Interests by Disqualified Persons

Under the proposed act, if a “disqualified person” acquires a US agricultural interest, a tax of 60% of the amount paid for such interest would be levied on that disqualified person. A “disqualified person” would include any citizen of a “country of concern” (other than lawful permanent residents of the United States), any entity domiciled in a country of concern, any country of concern (or subdivisions, agencies, or instrumentalities), and any entity if a disqualified person controls 10% of the entity. Countries of concern specifically include the People’s Republic of China, the Russian Federation, Iran, North Korea, Cuba, and the Maduro Regime in Venezuela.

Repeal of the Clean Electricity Production Credit and the Clean Electricity Investment Credit

The proposed act would repeal certain energy tax credits created under the IRA, specifically section 45Y and section 48E. Section 45Y provides a tax credit for electricity produced through renewable energy technology after December 31, 2024. Section 48E provides a tax credit for investments in certain renewable energy facilities placed into service after December 31, 2024.

Modification of Clean Vehicle Credit

The proposed act would repeal certain amendments to section 30D made by the IRA. Such changes include reverting the credit amount back to the pre-IRA standard (e.g., a base credit amount of $2,500). Additionally, the proposed act would revise the section 30D critical mineral requirement such that vehicle batteries must contain at least 80% critical minerals extracted or processed in the United States or in any country with which the United States has a free trade agreement, increasing the burden of the critical mineral requirement on manufacturers.

Repeal of Credit for Previously Owned Clean Vehicles

The proposed act would repeal section 25E, which was introduced by the IRA and provides a credit to taxpayers that purchase a previously owned clean vehicle. The proposed act would provide a transition rule, however, that would allow taxpayers to claim a credit under section 25E if taxpayers (i) acquired a vehicle under a written binding contract that was in effect as of the effective date of the proposed act and (ii) placed in service such vehicle within one year of the introduction date of the proposed act.

Repeal of Credit for Qualified Commercial Clean Vehicles

The proposed act would repeal section 45W, which was introduced by the IRA and provides a credit to taxpayers that place in service a qualified commercial clean vehicle. The proposed act would not provide a transition rule for taxpayers who acquired a vehicle under a written binding contract.

The proposed act will likely undergo several rounds of revisions and has sparked what will likely be a heated debate on tax policy in the United States. To discuss how the proposed act may affect your business, please contact the tax professionals at ArentFox Schiff.