By Evy Duek
SHERMAN & HOWARD
The Inflation Reduction Act became law on Aug. 16. As the name entails, the bill was enacted with the goal of reducing inflation. Some criticized it as another round of spending in an already inflated economy, while others saw it as a necessity for the future of the country.
When asked about the implications of the IRA, Larry Summers, the former treasury secretary under both former Presidents Bill Clinton and Barack Obama and one of the key drafters of the IRA, said, “We will bring down prices, particularly of pharmaceutical goods, by using the government’s purchasing power more effectively to procure at low costs. So, the net effect of this bill is going to be to reduce inflation, while at the same time doing very, very important things for the environment, very important things for fairness and access to health care, doing very important things in terms of strengthening the tax system by assuring that all who should pay, do pay.”
The question many business owners are wondering, however, is how the IRA will impact their business. The answer is in the key items addressed in the IRA: taxes, audits, credits, and climate change.
Taxes
The IRA imposes an alternative minimum tax, or AMT, of 15% on “Applicable Corporations.” Applicable corporations average an annual adjusted financial statement income, or AFSI, for three years greater than $1 billion, with some exceptions.
Reuven Avi-Yonah, director of the International Tax LLM Program at the University of Michigan and a world-renowned tax expert, curbs criticism over the AMT by noting this measure will only impact approximately 125 large corporations that “can afford the complexity in the sense that they can pay the best accountants and tax lawyers to deal with this.”
Other than the additional complexity of calculating a corporation’s tax liability, the new AMT could play a role in the M&A market. Large corporations would likely attempt to reduce AFSI by acquiring growth companies because such companies “often have large annual revenue growth rates but little or no net income for GAAP or IFRS purposes” or through “spinoffs and other corporate breakups (i.e., taxable or tax-free dispositions of noncore assets) [that] will also reduce AFSI.”
Audit Risk
One of the key items in the IRA that received much media attention is the additional $80 billion in funding to the IRS, $46 billion of which is designated for enforcement that will result in an estimated 87,000 new IRS agents and staff members.
Increased funding for the IRS has been a long time coming. The IRS claims it’s been underfunded and understaffed for decades and in desperate need of more personnel and updated technology. The new funding, however, heightened concerns among individuals and business owners of increased audit risk. Many of the bill’s authors and IRS Commissioner Charles Rettig promised the public that only households that earn over $400,000 would be subject to increased audit scrutiny.
Treasury Secretary Janet Yellen in a letter to Rettig said, “Any additional resources — including any new personnel or auditors that are hired — shall not be used to increase the share of households below the $400,000 threshold or any small businesses that are audited relative to historical levels.”
But there are still some unanswered questions regarding small businesses. Yellen doesn’t determine what qualifies as a small business. Would the IRS auditors decide for themselves before reviewing businesses’ returns? Does the Treasury or the IRS have an unpublished threshold for auditing small businesses, and if so, what is it? Are we likely to see an increase in audits for smaller businesses, or is that only a concern for very large corporations?
These questions remain unanswered, but it is fair to say that we will likely find out within the next tax year or so.
R&D Credit
The IRA doubled the refundable R&D credit for small businesses from $250,000 a year to $500,000. Section 41(h)(1) of the Internal Revenue Code defines a small business for purposes of the R&D credit as a business with gross receipts of less than $5 million during the current taxable year and the past five taxable years.
According to the OECD R&D Tax Incentive analysis in 2021 between 2000 and 2018, the number of R&D tax relief recipients in the U.S. more than doubled from 10,500 recipients in 2000 to 26,000 in 2018. Companies with gross receipts of less than $50 million a year accounted for approximately 70% to 75% of the total recipients.
Despite the increase in R&D tax relief recipients in the past 20 years, the total use of the credit remains fairly low. But with the right knowledge and preparation, claiming R&D credits could still be possible and worthwhile.
Climate Change
According to the White House, “The Inflation Reduction Act represents the most aggressive action to combat the climate crisis and improve American energy security in our nation’s history.” The assertion made by the executive branch is that the IRA would cut social costs related to climate change by up to $1.9 trillion by 2050, with the ambitious goal of reducing greenhouse gas emissions by 40% in 2030.
The IRA allocates approximately $370 billion to climate change-related projects. Businesses operating in the renewable energy environment may benefit from the additional IRA funding that authorizes billions in federal loans and loan guarantees “for energy and automotive projects and businesses.”
Businesses should be mindful of the new opportunities presented by the IRA and estimate whether they can benefit from a federal loan to fund a climate change-related project.
But the same can’t be said for businesses operating in the oil and gas industry. The latter will see an increase in the Superfund Tax from 9.7 cents a barrel to 16.4. This may be a negligible amount but it could have an aggregated impact on oil and gas producers.
Conclusion
The White House, along with the drafters of the IRA, made two important claims about the bill when introducing it to the American public. First, the IRA is an aggressive and ambitious act that will fight the climate change emergency; second, the investment the act provides will eventually reduce consumer prices and consequently bring inflation down.
This analysis focused only on the key elements addressed by the IRA and what it may mean for business owners. Though the criticism of the bill may be valid, the hope is that the new investments, along with the additional tax measures and credits, will incentivize the market, encourage investors to increase M&A activity and provide new opportunities and relief to businesses suffering from the high costs due to inflation.
– Evy Duek is a corporate and M&A associate at Sherman & Howard. He served as an officer and captain in the Israeli Defense Forces and gained his Master of Law from the UCLA School of Law. His law practice is focused on M&A deals from a corporate and tax perspective.