President Joe Biden signed into law a sweeping tax reconciliation bill on August 16 with more than $450 billion in tax increases and $260 billion in energy tax incentives.
The legislation, known as the “Reduction of Inflation Act” (HR 5376), passed the House on August 12 by a vote of 220 to 207, after passing the equally divided Senate on August 7. Democrats used the reconciliation process in the Senate to circumvent procedural hurdles and pass the bill with the minimum 51-50 majority after Vice President Kamala Harris cast the deciding vote. The bill was unanimously backed by congressional Democrats, while no Republicans voted for the package.
The bill’s passage is a major victory for Democrats after a tortured legislative process that lasted more than 18 months. The effort seemed doomed at least twice when Sen. Joe Manchin, DW.V., walked away from negotiations, though Senate Majority Leader Chuck Schumer, DN.Y., was finally able to reach an agreement with Manchin on July 27. Remaining recalcitrant, Sen. Kyrsten Sinema, D-Arizona, agreed to back the bill after Democrats removed a deferred interest provision from the package and relaxed the 15% minimum income tax from financial statements. Sinema pledged to work with Sen. Mark Warner, D-Va., on future reform of the tax treatment of deferred interest, but Warner said he was not convinced of success.
Financial statement income for minimum tax will now be adjusted for accelerated tax depreciation, with revenue lost due to the adjustment being replaced by a 1% excise tax on share buybacks of publicly traded companies . Democrats also removed an extension of the common control test for the minimum tax that targeted private equity. Instead, they extended the loss limitation under section 461(l) for two years.
The deal falls far short of the massive Build Back Better tax bill originally envisioned by Democrats, but still includes a handful of targeted tax provisions that will have a significant impact, including provisions that:
- Impose a minimum tax of 15% on income from financial statements for large corporations
- Create a 1% excise tax on share buybacks by listed companies
- Reinstate a Superfund excise tax on crude oil and petroleum products at a rate of 16.4 cents per barrel
- Extend the loss limit under Section 461(l) by two years to 2027
- Add $268 billion package of new, expanded, and expanded energy incentives
- Double the ceiling for R&D credits reimbursable against payroll taxes for eligible small businesses
The legislation leaves many Democratic and bipartisan tax priorities unfinished. More than $1 trillion in additional tax increases previously proposed by Democrats have been left out, though specific provisions may expand in the future. Own-source revenue generators, once offered, are always at risk of being reassigned to other priorities. But barring unexpected electoral gains, there appears to be little hope for Democrats to resurrect anything approaching the scale of their original ambitions in the next two years. While the results shouldn’t be taken for granted, most pollsters currently expect Republicans to win the House and possibly the Senate in November.
Lawmakers are likely to focus now on bipartisan fiscal priorities. The reconciliation bill does not address the write-off of research expenses under Section 174, as many lawmakers had hoped. Significant bipartisan support remains for reinstating full spending retroactively to 2022, but the provision still needs a legislative vehicle. The best opportunity may be a year-end bipartisan agreement on other expired and expired tax “drawback” provisions. Such an effort could also include extending the 100% bonus depreciation, which is expected to revert to 80% for assets put into use in 2023. Democrats are less likely to support easing the interest deduction cap in under Section 163(j) without major concessions by Republicans.
The biggest obstacle to a potential expansion package may be slowing momentum. The list of expiring provisions grows shorter every year, and the reconciliation bill addresses many of the temporary energy credit provisions that drive democratic participation in extension agreements. Lawmakers have unerringly succeeded in tackling extenders in recent years, but the dwindling list of important provisions raises questions about whether it remains sustainable.
The longer-term source of contention among lawmakers may be the implementation of the comprehensive minimum tax agreement the Biden administration reached with the Organization for Economic Co-operation and Development (OECD) on the framework. of Pillar 2. The administration originally hoped the United States would comply under the reconciliation legislation, but Manchin opposed the changes, fearing that early U.S. implementation does not harm national companies. Now, the Biden administration may struggle to implement needed changes as the rest of the world works to implement from 2024.
Most Republican lawmakers oppose the international agreement and seem reluctant to work with the US administration on implementation. The Biden administration hopes American businesses will start pushing for implementation once the rest of the world moves forward, as American businesses could potentially suffer adverse consequences if implementation is widespread without the United States. The new 15% minimum tax on financial statement income could be modified to accommodate an undertaxed profit rule as part of its implementation, but full compliance would require major legislative changes. The fight to implement Pillar 2 in the United States could be the defining tax policy issue of the next two years.
The tax provisions of the Reducing Inflation Act are described in more detail below.
Corporate minimum tax
The legislation will impose a minimum “accounting” tax of 15% on corporations that report a three-year average annual “adjusted financial statement income” (AFSI) of more than $1 billion. The threshold for domestic corporations with foreign parent will be $100 million if the international filing group has revenue of $1 billion. A late-breaking change treats domestic branches carrying on a trade or business in the United States as domestic corporations for tax purposes. The tax will be imposed on public and private C corporations, but not on S corporations, real estate investment trusts or regulated investment companies. The entities will be brought together under the common control rules in Section 52, but an amendment removed language expanding those rules to target private equity. Democrats claimed in summaries that only about 150 to 200 businesses would pay the tax.
The 15% rate will apply to the AFSI, which will start with the “net income” of an applicable financial statement (defined in Section 451(b)(3)) and then be modified by numerous statutory adjustments specific, including:
- For foreign companies, only income actually connected to the United States will be taken into account
- Domestic corporations will add a pro rata share of income to the financial statements of each controlled foreign corporation where the domestic corporation is a U.S. shareholder
- Foreign and domestic taxes will be added
- AFSI will be adjusted by amortization and depreciation for tax purposes under Sections 167 and 168 as well as depreciation deductions under Section 197 for wireless spectrum acquired by wireless operators after 2007 and before the date of promulgation.
- AFSIs of taxpayer-owned disregarded entities will be included
- The treatment of pension plans will be aligned with tax principles rather than accounting principles
- Newly Defined “Financial Statement” Net Operating Losses Could Offset Up to 80% of AFSI