With the Democrats’ $437 billion climate and tax package poised for passage, businesses may want to give some more thought to the second part of that description: taxes.
In a Friday vote, the Inflation Reduction Act (IRA) passed the House of Representatives along party lines. The legislation, which already passed the Senate and now makes its way to President Biden for a signature, aims to clamp down on record high inflation by reducing the federal deficit and lowering drug prices, while also making a sprawling $369 billion investment in clean energy. It’s the largest investment in fending off climate change to date. Taxes on wealthier individuals and large corporations, along with a reform on prescription drug pricing, will largely fund the law.
Notably, lawmakers claim the IRA does not raise taxes on small businesses. But that doesn’t mean that entrepreneurs are unaffected by the law. Here’s some key changes to look out for.
A Stronger IRS
The Internal Revenue Services will get an $80 billion boost under the IRA, as more than half of that chunk will go toward enforcement, largely in an effort to close the difference between taxes owed and the amount of taxes the government collects. That gap is believed to total $600 billion per year, according to the U.S. Treasury Department. The IRS estimates that individuals are the largest culprit behind the tax gap, rather than corporations, according to an analysis of IRS data from 2011 to 2013.
The investment is expected to enhance the IRS’ lagging technological capabilities, which could help the agency close the tax gap as it ramps up enforcement. Though this increased authority aims to make the tax system more effective, experts say that it will increase audits as well. Those that do see unpaid taxes clawed back will likely face penalty fees as well.
Businesses should get proactive by hanging onto documents beyond their traditional tax forms, according to Wendy Walker, a solution principal of the Wilmington, Massachusetts-based tax platform Sovos. That’s because business tax filings, by design, tend not to be comprehensive, so it’s a good idea to hold onto chargeback records, refund records and voided transactions and maintain an effort to stay organized. “Businesses need to be able to reconcile between the 1099-K form amount that’s reported versus what they’re actually reporting as income on their tax return,” Walker says.
Stock buyback excise tax
A former version of the law took aim at the private equity industry in an attempt to close the so-called carried interest tax loophole. However in the latest version of the bill, that line item was supplanted with a one percent fee on stock buybacks. Such a tax would kick in if a publicly-traded company repurchases its own stock to increase the value of remaining shares on the market.
While that clearly seems to affect only publicly traded companies, one stakeholder remains at risk: employees. Robert Kimball, a partner at the Houston, Texas-based law firm Vinson & Elkins points out that the tax may hurt employees by penalizing the benefits of stock repurchases.
The tax could potentially ding access to capital, too, says Jennifer Blouin, an accounting professor at Wharton. “A lot of entrepreneurs are getting seed money or investments from large public companies, then all of a sudden that capital just became a little bit more expensive.”
Excess loss limitation
Limitations to the amount of losses a business can write off will get a two-year extension. The provision, called Limitation on Excess Business Losses, was first authorized under the 2017 Tax Cuts and Jobs Act, which Donald Trump signed into law. It was set to expire in 2026. The limitation affects pass-through companies, or entities that don’t face corporate income taxes and instead, report their income onto their owners’ tax returns.
The cap currently limits the amount of losses that a businesses can try to offset with their income: the threshold in 2022 is $270,000, or $540,000 for joint returns. The provision, which had already been extended for one year under the American Rescue Plan Act, is set to sunset in 2028 under the IRA.
So what does this extended limitation mean for you? It may take longer for some firms to recoup their losses, according to Garrett Watson, a senior policy analyst at the Tax Foundation, a Washington, D.C.-based tax policy think tank. And Wharton’s Blouin says that in the long-term, the provision makes people less inclined to put capital at stake to take a risk and start a new business.
The book tax
Large American corporations now face a 15 percent minimum tax on their domestic profits. Meaning that firms that generate north of $1 billion in income will face a minimum 15 percent tax on all of the revenue generated from U.S. consumers stateside. Many Democrats praise the measure, claiming that corporations aren’t taxed enough.
Proponents of the law say it levels the playing field between large and small companies. But the latest version of the book tax goes a step beyond with bonus depreciation, a provision that cuts minimum tax bills for corporations that go on an investing spree. The provision allows companies to immediately subtract the cost of new investments. Though the benefit will phase out between 2023 to 2026, it should encourage investments in innovative technology in the meantime, as it reduces the payback period on capital expenditures.
A few other areas to be aware of include the following:
- Research and Development: The research and development tax credit cap doubled to $500,000, which helps cover expenses for the small businesses and entrepreneurs investing in R&D.
- Climate Incentives: To encourage clean energy investments, credits will be available for those who use renewable energy (think solar panels) and take advantage of energy efficient buildings and retrofittings.