Commonsense CPA: The Inflation Reduction Act is Here

“The hardest thing in the world to understand is the Income Tax.” - Albert Einstein

As the summer winds to its inevitable close, Congress has bestowed upon us a slimmed down version of the Build Back Better legislation, repackaged as the Inflation Reduction Act.

This month’s Commonsense CPA gives an early digest of the legislation (spoiler alert: the IRS may finally have some funding, but you’re unlikely to have agents knocking on your door anytime soon), which we’ll follow with more substantive details once they’re released later this year.

Matt Hetrick, CPA

President & Founder of Harmony Group Inc.

The Inflation Reduction Act Arrives

The Inflation Reduction Act (“IRA”) is a sweeping piece of legislation that should be signed into law shortly. At Harmony Group we want to keep you apprised of how changes made at the legislative or agency levels affect you as individual or business taxpayers.

Despite the name, the IRA is primarily a bill to address climate change and government healthcare. Since the primary lever for federal action is through taxation, however, much of this bill actually makes changes to the tax code.
 

Corporate Taxes

The first section of the IRA focuses on raising revenue by raising corporate tax collection. The IRA includes a tweak to the corporate alternative minimum tax that would set the minimum tax at 15% of the reported financial statement income (subject to some deductions) of any company that reported more than $1B a year in financial statement profits over the last three years.  

Another fund-raising mechanism in the IRA is a 1% excise tax on stock buybacks. A stock buyback is when a corporation buys back its own publicly traded shares, most often to increase returns to investors. Buybacks have become controversial as they’ve risen in popularity, totaling $881.7B in the S&P 500 in 2021, up 70% from 2020 and 10% from the previous record. 

IRA Impact on Harmony Clients: None directly. Gallons of ink will be spilled writing about the second order effects on business of the proposed AMT and buyback tax but nothing is conclusive at this point. Opponents of the bill say that increased corporate taxes will lead to lower investments, reduced hiring and a drag on stock prices. Proponents of the bill say these concerns are overblown and the benefit outweighs any effects.
 

Funding the IRS

Part two of the IRA is directly applicable to our work at Harmony Group. The bill includes $80B in investments into the IRS to close the tax gap – the difference between what tax is owed and what people actually pay to the government. The majority of funds ($45.6B) are ear-marked for enforcement, signaling that the priority isn’t to modernize paleolithic agency practices but spur revenue generation. Nonetheless, we’re happy to see $3.1B in Taxpayer services, $25.3B for Operations Support and $4.75B earmarked for business system modernization.  

Also in the bill is a task force to allow for free direct e-file, something many low-income advocates have urged for years. It’s just a task force but a good step towards protecting lower income taxpayers, who generally receive refunds, from unscrupulous preparers. 

IRA Impact on Harmony Clients: You’re in good hands. The main enforcement mechanism of the IRS is auditing taxpayers and applying penalties and interest if the taxpayer has taken positions that are incorrect or made impermissible deductions. The audit rates have been falling dramatically over the past decade and that trend will change. Your audit risk is highly correlated with your income – especially for those people making over six figures. If you’re a Harmony Client you have an experienced tax team that has guided you in making correct choices and will be available if you’re audited. Selfishly, we’re just hoping that some of this money goes towards cutting down the telephone hold times when we call the agency on your behalf.
 

Health Care Provisions

The IRA accomplishes a major campaign promise by lowering prescription drug prices for people enrolled in Medicare. The bill allows Medicare to negotiate drug prices for certain high priced single source drugs by entering into manufacturer agreements. It also makes drug companies issue rebates to Medicare enrollees if they raise the prices of drugs faster than the rate of inflation, gives free vaccinations to people on social security, and caps Medicare out of pocket drug costs at $2,000 per year.

The other major health care related provision is extending the Affordable Care Act subsidies that were enacted in the 2021 American Rescue Plan. These subsidies work by capping the cost of a benchmark insurance plan at a certain income threshold for  people enrolled in the ACA, often covering a significant portion of their health insurance costs. Significantly, the American Rescue Plan did away with a portion of the means test, making the only means test whether the benchmark plan exceeds 8.5% of your income. 

It’s worth noting that the efforts to impose these drug pricing restrictions on dealings with private insurers was sought in the bill but ultimately ruled to be unable to be included due to arcane parliamentary procedure rules. 

IRA Impact on Harmony Clients: If you are enrolled in Medicare you will see some savings on drug costs – but most will take effect after 2026. If you get your Health Insurance through the Affordable Care Act exchanges and think your health insurance costs are close to 10% of your income you should talk to your Harmony Advisor to see if you might be eligible for subsidies.  There is some concern that the disqualification of private insurers might raise costs for small business health care plans but we have to wait and see if those costs materialize.
 

Climate Change Provisions

The Inflation Reduction Act has grabbed headlines as the biggest climate change bill in American history. The headline grabbing piece is a $280B investment in clean energy credits for renewable energy sources designed to spur investment in this sector by bringing the costs below fossil fuel investments. 

On the personal and small business level, there are tax credits of up to $1,200 for energy efficient home improvement such as solar roofs, heat pumps, improved insulation in windows/doors and $20B to “Green Banks” that offer low-cost financing for energy efficient products.  

The most significant tax credit for most consumers revolves around the purchase of Electric Vehicles. The IRA removed the production caps that eliminated the credit after 200,000 vehicles; primarily affecting Tesla and GM. The tax credit, implemented at the point of sale, applies to cars priced at less than $55,000 (sedans) and $80,000 (SUVs/trucks) and can be claimed by taxpayers with adjustable gross incomes of less than $150,000 ($300,000 for joint filers).  Used EVs are eligible for a $4,000 credit. The credit is broken into two $3,750 credits dealing with the sourcing of the battery components and minerals requiring that 50% of each come from the United States or countries with a free trade agreement. 

There are also competitive grants for private landowners for fighting fires which could be useful for private land holders.

IRA Impact on Harmony Clients: If you’re planning on purchasing an EV we definitely recommend that you wait until implementation of the law and determination of which cars are eligible for the credit. Additionally we would wait and see about installing energy efficient hardware in our house until there is more clarity around implementation of the IRA.

R&D Tax Credit

The IRA also doubles the Research and Development Tax Credit from $250,000 to $500,000. Similar to the Employee Retention Tax Credit, it’s refundable and can be applied against payroll taxes. Eligible expenditures include the improvement or development of products, business processes and other items related to improving systems and infrastructure. Research needs to be for a permitted purpose, have some level of uncertainty, involve a process of experimentation and be technological in nature.

IRA Impact on Harmony Clients: If you think you are involved in research and development and have expenses that meet this definition talk to Harmony advisors about claiming this credit.

Clocking in at 775 pages, the IRA is guaranteed to keep lawyers, accountants, and financiers busy for years to come. We will be tracking the changes and having more in-depth conversations with our specific clients during tax time but wanted to circulate our first impressions on the bill.

Journal Entries

Free Money Attracts Scammers – Who Knew?

The Payroll Protection Program, which gave businesses aid in paying workers during the early stages of the COVID-19 pandemic was designed to be disbursed quickly over the objections of many who said the program was ripe for fraud. Now that the accounting is in it seems those concerns were well-founded with some people estimating that up to 15% of the $780B went to ineligible businesses. Hundreds of borrowers have been prosecuted and it appears the Federal government is turning their attention to lenders responsible for egregious conduct. 

The ____ is Too Damn High

Things are getting more expensive and inflation is running rampant but that’s not the only reason that costs are rising for urban millennials. If you woke up on a Casper mattress, took an Uber, ordered Doordash, worked at a WeWork or ordered meal delivery kits from Blue Apron you were benefiting from the ocean of investor capital that allowed these companies to operate unprofitably.  That appears to be changing as companies shift their focus from growth to profitability.

Women in the Workforce

Wondering how you can narrow the gender wage gap? A recent study from economists at Stanford and Princeton found that even in a work environment where union-negotiated contracts left no room for managerial gender bias or employee negotiation, the differences in how men and women respond to unpredictable schedules created a take-home pay variance of as much as 11% between men and women.The upside? Simple managerial steps such as scheduling shifts as far out as possible, allowing employees to swap shifts, having float employees for emergencies, and encouraging teamwork to allow for better coverage of responsibilities all improve pay equity and increase productivity.