Benefits of Tax Credit Investments Mostly Preserved in Inflation Reduction Act, But Significant Questions Remain
The Inflation Reduction Act of 2022 (H.R. 5376), which the House of Representatives passed today and will soon be signed into law by President Joe Biden, has substantial implications for the tax credit development community. While there are many welcome provisions, including those for renewable and clean energy, there remain questions that need to be answered to protect the important work being done because of community development tax incentives.
How We Got Here
After the surprise announcement in late July by Sen. Joe Manchin, D-West Virginia, that he and Senate Majority Leader Chuck Schumer, D-New York, reached an agreement on a budget reconciliation proposal, the Inflation Reduction Act of 2022 was introduced. After a long weekend following the bill’s introduction that included concessions made to obtain the support of Sen. Kyrsten Sinema, D-Arizona, and an amendment vote-a-rama, the Senate passed the reconciliation bill along party lines, with Vice President Kamala Harris casting the deciding vote, 51-50. The House then made a special return from its August recess Friday to vote in favor of the bill by a narrow margin.
What’s in the Final Bill
The enacted version of the act remains similar to the version released in late July and summarized in a July 29 Novogradac blogpost. Specifically, the final bill still includes:
- a 15% corporate minimum tax on book income,
- clean and renewable energy provisions, including extensions of the production tax credit (PTC) and investment tax credit (ITC),
- increased tax enforcement resources,
- an extension of the Affordable Care Act premium tax incentives, and
- prescription drug reform.
The major change made to ensure Sen. Sinema’s support was the removal of a carried interest provision that would have extended from three to five years the required holding period on investments needed to get preferential tax treatment for income that could otherwise be taxed as ordinary income.
Because the renewable energy provisions in the act are unchanged from the descriptions in a previous blogpost, this discussion will focus on the new 15% corporate minimum tax on book income and its potential impact on the tax credit equity markets.
What the 15% Minimum Tax on Book Income Could Mean for Tax Credit Equity Markets
The law establishes a 15% minimum tax on book income applicable to corporations with average adjusted financial statement income for a three-taxable-year period ending with the current taxable year of more than $1 billion. This is often referred to as a tax on book income, because it is applied to a corporation’s financial statement net income before taxes, rather than the taxable income calculation traditionally used for tax purposes. To determine the minimum tax, a corporation starts with its adjusted financial statement income (AFSI), as defined in Internal Revenue Code (IRC) Section 56A, which begins with “the net income or loss of the taxpayer set forth on the taxpayer’s applicable financial statement for such taxable year.” For most corporations, this will be the financial statement income or loss based on generally accepted accounting principles (GAAP), often referred to as “book” income. However, the corporation’s financial statement income is just the starting point, as the act provides for several notable adjustments.
Some of these adjustments–most notably adjustments allowed for accelerated depreciation and amortization–protect tax incentives Congress passed to encourage certain investment activity. In addition to providing an adjustment to allow accelerated depreciation to reduce financial statement income, the act also allows for general business credits–such as the low-income housing tax credit (LIHTC), new markets tax credit (NMTC), historic tax credit (HTC) and renewable energy tax credits (RETCs)–to be taken against this minimum tax. This general business credit provision helps preserve the value of tax credits that have successfully incentivized equity investments in affordable housing, community development, historic preservation and clean energy. This provision is certainly a welcome and important aspect of the new law, but there are important technical details to consider in the new law that could also significantly affect tax credit equity markets.
In addition to the adjustments noted above, there are other matters to consider. Of note is an adjustment to the income or loss included in book income flowing from an investment in a partnership. The Inflation Reduction Act states, “if the taxpayer is a partner in a partnership, adjusted financial statement income of the taxpayer with respect to such partnership shall be adjusted to only take into account the taxpayer’s distributive share of adjusted financial statement income [AFSI] of such partnership.” Thus, partnerships would be required to report to their partners the allocable share of the partnership’s AFSI. This will likely mean that accountants for those partnerships will need to perform a new analysis that includes certain adjustments, such as for accelerated tax depreciation, to calculate each partner’s share of the partnership’s AFSI as defined by the new law.
This language also appears to require the corporation to record the flow-through AFSI income and/or losses of the partnership to determine its own AFSI. For tax credit investments that are recorded using the proportional amortization method or other similar methods that account for income or losses “below the line,” this adjustment for investments in partnerships appears to require that income or loss be recorded “above the line” for purposes of determining the corporation’s AFSI. The new law would not require the corporation to change the method of reporting for its GAAP financial statements, allowing the corporation to continue using methods such as proportional amortization. This is important because the corporation’s financial statements provided to the public would still be eligible for the benefits that proportional amortization provides, mainly in the form of recording the impact below the line in the corporation’s tax item.
What’s Needed to Protect Tax Credits’ Value and Maintain the Investments they Support
It would be very helpful if the U.S. Department of Treasury provided guidance confirming the interpretations above, preferably with an example specifically related to tax credit investments accounted for under the proportional amortization method. Without such published guidance, the economic benefits of community development tax credits for some investors could be at risk and could lead investors that incur corporate minimum tax on book income to reconsider their appetite for such credits. Any resulting cooling off in appetite could have an immediate and dramatic negative effect on the pricing of tax credit equity and the amount of subsidy that would be provided to those developments it was intended to benefit.
Hear more about the implications for the tax credit community of the Inflation Reduction Act in the Aug. 23 episode of the Tax Credit Tuesday podcast. Additionally, Novogradac’s various working groups will work with their members to submit comments and requests for guidance as needed to address open questions; email [email protected] if you have questions about joining a working group. And sign up today to attend an upcoming Novogradac tax credit conference to hear more about what lies ahead related to this law and other legislation expected to be considered yet this year.