Let’s Make a Deal: Inflation Reduction Act of 2022
By John Owens CFP®, EA, ECA, CPWA®
While I’m too young to have watched Monte Hall, it is apparently time to make a deal in Washington. Sen. Chuck Schumer may have out-foxed the fox this week, getting his $280B US Chip making bill passed in the Senate while secretly negotiating with Sen. Joe Manchin on a reconciliation package designed to combat inflation, raise corporate taxes, reduce the deficit, enhance social programs like Medicare and Obamacare, and put money towards energy and climate change. You might be asking - what’s really in this bill and how does it affect me? Let’s nerd out and dive in!
Revenue and Tax Provisions
One of the largest tax provisions - estimated to raise over $300B is the imposition of a Corporate Minimum Tax of 15% on the largest 200 corporations. While many large corporations report profits to shareholders based on their financial statement income, write-offs in the tax code often afford many of them the ability to pay little to nothing in corporate taxes.
Next up is added funding for the IRS. The plan invests $80B in IRS Tax Enforcement aimed at closing the tax gap - the spread between what folks owe in taxes and what they actually pay - to raise about $204B over the next 10 years. This nets about $124B in revenue and means more audits and better technology for the IRS - let’s hope it also means they answer the phone a little quicker.
Hedge Funds get hit up next by starting to close the Carried Interest Loophole. If you’re not familiar (most of our clients don’t run hedge funds) - this basically means investment managers at hedge funds can pay the lower capital gains rates on some of their profits from running the fund - rather than ordinary income rates. This legislation would tax more of that income at ordinary income rates but not fully close the loophole.
Finally, the bill changes how Medicare can negotiate for prescription drugs, which is estimated to save nearly $300B over the next 10 years.
Spending Provisions
Energy Security and Climate Change action make up the bulk of the spending provisions in the bill at $370B over 10 years. The legislation includes funding for:
Consumer home energy rebate programs that can electrify home appliances for low-income households.
Tax credits for heat pumps, solar, HVAC, and water heaters.
Expanded tax credits to buy used-clean vehicles ($4,000) and new clean vehicles ($7,500) that are more targeted at lower/middle-income households - those making less than $150,000 a year (married) or $75,000 a year (single).
Grant programs for energy-efficient affordable housing.
Expanded manufacturing of renewables and batteries.
Encouraging the manufacturing of clean vehicles.
Takes aim at reducing the economy’s carbon footprint through energy storage, energy tech accelerators, and methane reduction.
Funds neighborhood grants and climate justice block grants.
Puts $1B to work for cleaner school and transit buses, and garbage trucks.
Invests in making farming and forests more climate friendly, reducing forest fires, etc.
The legislation also puts $64B to work towards Obamacare subsidies - these were set to expire at the end of the year but will now be extended for 3 more years through 2025.
Deficit Reduction
Since the bill raises over $700B and (only - LOL) spends about $400B, nearly $300B goes towards deficit reduction - a fairly uncommon theme in Washington these days.
What’s NOT currently in the bill?
We spent a lot of time last fall talking about tax hikes for individuals and the closing of loopholes for wealthier individuals - this bill currently doesn’t go that far. In particular, it does NOT:
Eliminate the Backdoor Roth IRA
Eliminate the Mega Backdoor Roth
Make changes to the estate tax
Create surtaxes on high-income earners
Increase the top tax bracket for ordinary income earners
Increase the top tax bracket for capital gains
Crackdown on large retirement accounts (i.e., Peter Thiel and Mitt Romney)
How to plan?
Prepare for more audits - Most of our clients fall in the category of high earnings who are likely to be subject to more scrutiny from the IRS if this passes. Ensuring your tax return is completed accurately and working with a firm that can represent you in IRS proceedings and audits can help make that a little less painful.
Review eligibility for clean energy tax perks - A huge focus of this bill is incentivizing people to invest in cleaner, renewable, and more sustainable energy - from choosing your home’s heating source, appliances, or next vehicle. When the legislative sausage gets made, it’ll be important to see which of these perks you may be eligible for and what tax benefits their are for lowering your carbon footprint.
Continued market volatility - Raising taxes on corporations in a slowing economy could send jitters through the market. The spectre of passing a reconciliation package was, until just now, thought to be pie in the sky. There will likely be bumps in the road, amendments to this deal, and political uncertainty. The market hates all those things and will react. The key to your financial plan is making sure you don’t overreact.
Inflation - The bill is dubbed the Inflation Reduction Act of 2022. Whether it will do that remains to be seen. Hiking corporate taxes certainly takes some slack out of the economy and can help slow down the pace of inflation. Ditto for the ability to negotiate the price of prescription drugs which have historically been out of whack with the rest of the developing world. After spending trillions more than the government brought in the last few years, paying down the debt (every so slightly) is a refreshing change of pace.
What happens now?
The Senate Parliamentarian needs to do the Byrd Bath - basically reviewing to make sure the legislative text doesn’t deviate from the rules of budget reconciliation. She can strike provisions that are out of line with the Senate’s rules from the bill.
A vote-o-rama is likely - that’s where Senators can offer an array of amendments to the bill - that can pass by majority vote. This is often where Republicans will try to squeeze vulnerable Democrats into including poison pills or at least make some tough votes ahead of the mid-term elections.
The Democrats need all their members to be healthy and present to get 50-votes plus Vice President Harris’ tie-breaker to get this passed. Easier said than done - Sen. Manchin had COVID recently. Senate President Pro Tempore Patrick Leahy - the longest tenured Senate Democrat is in his last term and recently had major surgery. And Sens. Chris Van Hollen and Ben Ray Lujan had strokes this year. And perhaps more importantly, Sen. Krysten Sinema needs to support it. They’ll really need to thread the needle to get this done.
The House will also need to pass the bill with their slim majority - and probably without amendment - there’s not much time left in the legislative calendar to get this passed before the end of September when the window for reconciliation closes.
There’s still a lot left to learn about this legislation in the days ahead, and plenty of uncertainty. As legislative text becomes law - our team will continue to review and better understand how clients and their tax situations are impacted, and how to plan proactively. Buckle up - it’s going to be an interesting couple of weeks.