Inflation Reduction Act (IRA) was signed into law on August 16th, 2022, aimed at promoting clean energy, lower health care cost, revitalize American manufacturing and the most importantly, tax code reforming. With so many grand objectives in the agenda, what does this plan really do to us individuals?
To answer this question, we first will look at the tax code reform as it is one of the most impactful areas to you – our clients. Then we will discuss the other goals entailed within. In the end of this article, we will elaborate more on the impact of what this IRA means to you.
Tax Code Reform
Companies with at least $1 billion in income would be required to calculate their annual tax liability in two ways: one using longstanding tax accounting methods, which is 21% of profits less deductions and credits; the other by applying the 15% rate to the earnings they report to shareholders on their financial statements, commonly known as book income. Whichever amount is greater would be what they owe.
The tax only applies to
- Domestic corporations with book income over $1 billion for the three prior years
- Domestic corporations in a foreign-parented multinational group where:
- the domestic corporation has an average book income of at least $100 million
- the foreign group has an average book income of more than $1 billion, for the three prior years
- S corporations, regulated investment companies (typically mutual funds and closed-end investment companies) and Real Estate Income Trust (REIT) are not affected under this rule
In addition, beginning December 31, 2022, a 1% excise tax on corporate stock buybacks is enforced. The act imposes a 1% excise tax on the fair market value of any stock repurchased by a domestic corporation listed on an established securities market during a taxable year. This 1% excise tax on stock repurchases ensures that profits on corporate stock buybacks are subject to some type of income tax, more similarly to the way that dividends are taxed. The excise tax is not tax deductible. The tax does not apply in the following cases:
- tax-free reorganizations
- employer-sponsored retirement plans
- stock options, or similar plans
- total value of the stock repurchased during the year does not exceed $1 million
- repurchases by a dealer in the ordinary course of business
- repurchases by a regulated investment company or a real estate investment trust
- repurchases treated as a dividend
Most of our clients are small business owners. There is an extension of “Pass-through” tax limit within IRA which will impact this group the most. Why? Because a pass-through business is one that reports its income on the tax returns of its owners, then the income is taxed at their individual income tax rates. Examples of pass-through include sole proprietorships, some limited liability companies, partnerships and S-corporations. The extension of tax limit is not a good thing: it prolongs the period of putting a cap on how the business owners can offset their business loss to their other income. The cap in 2022 is $270,000 for the tax filed as Single and $540,000 for the tax filed as Married Filing Jointly (MFJ). This tax limit was supposed to end in 2025 but it is now extended to 2027.
Another prevailing headline from the IRA is that the Internal Revenue Service (IRS) will be receiving $80 billion in funding over the next 10 years. As we all probably know, IRS has been under-funded and under-employed for a very long period so they sometimes could not even deliver their duties on time. The IRS has been processing the U.S taxpayers’ tax returns on paper as a strong proof to this argument. Fortunately, around $5 billion will be allocated to the technology modernization to fix this problem. Moreover, there will be more auditors hired through this funding to revisit the taxpayer’s tax documents for anyone who makes more than $400,000.
Here is a snapshot of where is this $80 billion going to within IRS:
Source: Tax Foundation
Clean Energy Promotion
Tax credit to qualifying Electric Vehicles (EV) to reduce carbon emissions
EV is certainly a hot topic everywhere these days, not only because of how Elon Musk’s dramatic personality brought the exposure into this section, but also because of the practical usage of these environmentally friendly minions on the road. The effective date of the credits will be after December 31, 2022 and will stay in place through 2032.
In general, you can get up to $7,500 in tax credits for new EV and $4,000 for used EV. Moreover, certain qualification requirements are needed at the side of the taxpayers as well as the manufacturers.
For example, one of the qualifications to claim the credit for new EV is that the final assembly of the clean vehicle must occur in North America. This has greatly limited many current EV manufacturers as China is still the dominant player in the factory world. Another requirement is that the taxpayers Adjusted Gross Income (AGI) is limited at $150,000 if they filed single, $225,000 if filed as head of household and $300,000 for joint filers to claim for new EV tax credit. AGI is limited at $75,000 if they filed single, $112,500 if filed as head of household and $150,000 for joint filers to claim the used EV tax credit.
Tax credit for households to offset energy costs
Energy Efficient Home Improvement Credit: From January 2023, a $1,200 annual tax credit will be applied to all eligible home improvements made during the year. It covers things such as biomass stoves and boilers, electric panels, and home energy audits. There is an addition tax credit of $2,000 for heat pumps and heat pump hot water heaters for homeowners who don’t qualify for the rebate due to higher household income.
The credits are claimed on the purchaser’s individual income tax return. Household income cannot exceed 150% of the area median income as calculated by the Department of Housing and Urban Development to qualify. These tax credits will be equal to approximately 30% of the annual costs.
The IRA’s $4.28 billion High-Efficiency Electric Home Rebate Program will provide an upfront rebate of up to $8,000 to install heat pumps that can both heat and cool homes. It also provides a rebate of up to $1,750 for heat pump water heaters. There’s also a rebate of up to $840 to offset the cost of a heat-pump clothes dryer or an electric stove, including induction ranges. If a home needs an electrical panel upgrade to support new electrical appliances, then there’s up to a $4,000 rebate to help with that. There’s also a rebate of up to $2,500 for electrical wiring improvements. And for one of the most cost-efficient and quickest ways to make a home more energy-efficient – insulation and sealing – there’s a rebate of up to $1,600. Homeowners will be able to collect a maximum of $14,000 total in rebates.
Lower Health Care Costs
This law mainly affects those who hold a health insurance plan through the Affordable Care Act and those using Medicare. It lowers cost of prescription drugs for Medicare recipients and allows Medicare to negotiate the price of certain prescription drugs starting in 2026. Medicare recipients will have a $2,000 cap on annual out-of-pocket prescription drug costs, starting in 2025, as well as a $35 cap for a month’s supply of insulin.
Revitalize American Manufacturing
This is reflected in the requirements of the other aspects in IRA. For instance, starting in 2024, vehicles cannot have any battery components sources from a foreign entity of concern, which includes China. In addition, starting in 2025, EV batteries cannot have any critical minerals sources from a foreign entity of concern, which includes China. These changes will have a ripple effect in reminding the companies to promote domestic sourcing and therefore increasing American jobs by touching upon their sensitive profits.
Overall, the law will raise $737 billion and authorize $369 billion in spending on energy and climate change, $300 billion in deficit reduction, three years of Affordable Care Act subsidies, prescription drug reform to lower prices, and tax reform.
Source: Congressional Budget Office
After knowing the details of IRA, are you confused in what you can do or what you cannot do? No worries, here is a clean summary of how you should be aware of this IRA and what actions you can take:
- One of the most important impacts to almost all our clients is: the increased auditing for anyone who earns more than $400,000 as a household. If you have a financial advisor or a CPA who has been working closely with you for your tax reports, you don’t have to worry too much; on the contrary, if you have been filing your taxes using Turbo Tax only, or had a recent income increase as a business owner, or received a good amount of stock compensation, there is a high possibility that an auditor might contact you soon in an unpleasant way. Anyone should retain documentation as part of their tax records so they can prove in the event of an IRS audit. We suggest a tax planning session with us if you are not sure about whether you are affected!
- Be prepared to have a different utility bill based on your preferences of installing different energy saving appliances or home improvements. Again, to be eligible for the rebate program when you do your tax return, remember to save the receipts for the home improvements and the appliances installation in case of an IRS auditing.
- Big corporation’s job stability might not be as bright as you think anymore. Based on the research of Tax Foundation, the proposed 15 percent minimum tax on corporate book income will reducing GDP by 0.1 percent and costing about 20,000 jobs. While it now exempts accelerated depreciation, tax credits, and certain other items, the book tax remains a substantial tax increase on corporate income as it hits several other book-tax differences and limits the ability to carry forward losses. The excise tax on stock buybacks also eliminates about 7,000 jobs. As most of our clients are immigrants or H1-B owners who are not U.S citizens yet, with the extra 15% tax and 1% excise tax to big corporations, the hiring and the operating budget will be decreased significantly, not to mention the recent talks on coming recessions. If you have been through the hiring freeze, offer withdrawals, or the layoffs in March 2020, then an ugly truth must be laid out – the big corporation will get rid of the non-citizen workers first.
- Are you a wealthy real estate owner? If your answer is yes, then you could feel the impact of “pass-through” tax limit the most, because it is difficult for you to offset a large depreciation value in your books. However, one method is that you can postpone the offsetting procedure as the loss stays throughout the times. For more details and methods, you are welcomed again to book a tax planning session with us!
Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
The content is developed from sources believed to be providing accurate information.