The BKFI Inflation Reduction Act of 2022 Primer
By Katelyn Murray, CFP®, FBS®, CFT-1™
Well, folks, after much anticipation, debate, and a long, lingering, uncomfortable glance, the Inflation Reduction Act of 2022 was finally signed into law on Tuesday, August 16, 2022. New legislation goin’ up on a Tuesday, people. And since everyone loves a sequel, I’m back on the BKFI blog this week with our official primer on the Inflation Reduction Act of 2022 and what it means for you.
What this article is not is an exhaustive discussion of the many and varied provisions within this new piece of legislation. The reality is that many of the components of this over 700-page law are still being fully fleshed out, as we’ll see in our discussion of the various energy rebates contained therein. My goal here is simply to provide an apolitical, plain-English overview of the most relevant pieces of the Inflation Reduction Act of 2022 to help our clients and future clients (I see you there…) better understand how their tax situations might be impacted and how they can plan proactively for the future.
All good? Alrighty– seatbelts, everyone! Let’s dive into an abbreviated list of the most topical provisions in the Inflation Reduction Act of 2022.
Throwing the IRS a Bone
You’ve probably heard that one of the main provisions of the new legislation is to beef up the IRS’s budget. The law states that over $80 billion will be invested into the IRS over the next ten years with the explicit expectation of increasing tax enforcement and compliance. It’s no secret that the IRS has been tragically underfunded for years. Any of our tax managers can attest to the understaffing at the agency, which results in insane hold times for phone calls and subpar service in processing returns. While you may think that more $$ in the pockets of the IRS means more audits, it apparently depends on your level of income. In this recent letter from IRS Commissioner Rettig, the agency reinforced that no family making under $400,000 per year will see increased audits, stating, “These resources are absolutely not about increasing audit scrutiny on small businesses or middle-income Americans. As we've been planning, our investment of these enforcement resources is designed around the Department of the Treasury's directive that audit rates will not rise relative to recent years for households making under $400,000.” We’ll see if that holds true.
Tax credits
$7500 EV Tax Credit
This was an existing credit that the new legislation has tweaked and extended through 2032 for folks who are buying brand spankin’ new “clean” vehicles like electric cars, hybrids, and even “hydrogen fuel cell vehicles” (whatever that is). Am I taking this as implicit permission from the universe to buy a badass new 2022 Jeep Wrangler 4xe? Maybe. But don’t rush out and buy a Prius right away expecting 75 big ones from Uncle Sam come tax time. There are some pretty specific eligibility requirements for this credit:
Income requirement: Married Filing Jointly (MFJ) filers must have a Modified Adjusted Gross Income (MAGI) of $300,000 or below to qualify; Single filers must have a MAGI of $150,000 or below.
Price requirement: For vans, SUVs, and/or pickup trucks, the price of the vehicle may not exceed $80,000. For all other types of vehicles (sedans, coupes, etc.), the price limit is $55,000.
There are also requirements on where the car was assembled, where batteries were mined and assembled, etc. The aim of this requirement is to encourage the manufacturing of electric vehicles in the U.S., which even proponents of the law agree could take a few years to ramp up. Here’s a list of car models that are likely eligible for the credit – just don’t tell your financial planner I gave you any ideas.
To know for sure if a vehicle qualifies, I recommend you also check the car's Vehicle Identification Number (VIN) in the VIN decoder.
$4000 EV Tax Credit
In addition to expanding the existing “new” electric vehicle credit, the Inflation Reduction Act of 2022 also created an additional tax credit for taxpayers who purchase “used” vehicles that are energy efficient. This credit is technically either $4000 or 30% of the total sales price, whichever is less. It comes with a few requirements of its own which differ considerably from the “new” EV tax credit:
Income requirement: MFJ couples must have a MAGI of $150k or less; Single filers must have a MAGI of $75k or less.
Price requirement: The sale price of used vehicles cannot exceed $25,000.
You can only get the credit if this is the first sale of the used vehicle.
The model of the car must be at least 2 years old.
This credit is only available to be claimed every 3 years (as opposed to the “new” EV credit, which can apparently be claimed annually).
Residential Clean Energy Credit
This credit extends and enhances an existing tax break for homeowners looking to be a little more energy efficient. A 30% tax credit is being made available for the installation of solar panels or wind energy systems. For perspective, a standard solar electric system typically costs about $15,000 to $20,000 to install, according to the Center for Sustainable Energy. The credit would apply to costs incurred between January 2022 and December 2032. This credit has a phaseout– falling to 26% in 2033 and 22% in 2034. Unlike the prior credit, the residential clean energy credit set forth in the IRA of 2022 also extends the tax credit to battery storage technology. This lets homeowners more easily pair solar installations, for example, with battery systems that store excess renewable energy for later use.
Nonbusiness Energy Property Credit
This is another expansion of an existing credit– this time on the cost of installing efficient exterior windows, skylights, exterior doors, water heaters and other items. The prior incentive only allowed a 10% credit or up to $500 for a taxpayer’s lifetime, so the new 30% credit (no lifetime limitation) is a substantial expansion. This credit is available through 2032 and applies in the year a project was installed. Again, installations must meet certain efficiency criteria– think EnergyStar ratings and the like– and there are annual caps that apply to specific projects. Energy efficient doors have a cap of $500 per year, while windows and skylights have a $600 annual cap, for example. Homeowners can get up to $2,000 in a year for installations of certain electric or natural gas heat pumps, electric or natural gas water heaters, and biomass stoves or boilers. The bill also expands the tax credit to cover the cost of a home energy audit up to $150 and an electrical panel upgrade up to $600 - newer technologies often require a more modern home wiring system.
One last note about credits: tax credits and tax deductions are not the same. Deductions reduce the amount of your income before you calculate the tax you owe. Credits can reduce the amount of tax you owe after that tax has been calculated, and some “refundable” credits may give you a refund even if you don't owe any tax. None of the aforementioned tax credits are refundable, meaning that if you don’t owe taxes for the year, you won’t be able to get the value of the credit in that year. However, interestingly, taxpayers who claim a residential clean energy tax credit but have an insufficient tax liability to benefit from claiming the credit that year can carry forward any unused credits to future years to offset future taxes.
Rebates
The HOMES Rebate Program
This rebate program is designed to benefit homeowners who successfully make reductions in their home energy use via efficiency retrofits like insulation and HVAC installations. Homeowners would be eligible for 50% of the cost of these projects, up to a dollar cap. In order to qualify, the homeowners’ income must be 80% or less of an area’s median income.
The exact amount of the rebate is dependent on two factors: 1) how much homeowners reduce their energy usage, and 2) their household income. Generally, consumers who cut energy by 20% across their whole home would be eligible for a maximum rebate of $2,000 or half the cost of the retrofit project, whichever is less. That dollar threshold rises to $4,000 for those who cut energy by at least 35%. The rebates double — up to $4,000 and $8,000, respectively — for lower-income households.
The High-Efficiency Electric Home Rebate Program
This rebate program boasts up to $14,000 in total rebates per household. These rebates, which are supposed to be “upfront” rebates issued at point of sale, apply to homeowners’ purchases of a large variety of electric appliances. Homeowners can receive up to $1,750 for a heat pump water heater; $8,000 for a heat pump for space heating or cooling; and/or $840 for an electric stove or an electric heat pump clothes dryer. Rebates are also provided for non-appliance upgrades. For example, you can get $4,000 for an electric load service center upgrade; $1,600 for insulation, air sealing, and ventilation; and/or $2,500 for electric wiring.
Income limits do apply. These rebates aren’t available at all to households earning over 150% of an area’s median income. Consumers with income below 80% of the area median can claim a rebate for the full cost of their upgrades, up to a $14,000 cap. Households that fall between 80% and 150% of the area median income are eligible for rebates of 50% of their cost, up to $14,000.
No Double-Dipping Allowed
Both of these rebate programs will be administered by state energy offices according to parameters set by the U.S. Department of Energy. States will apply for federal grants to fund this program– there is purportedly $8.8 billion total available. Additionally, while one cannot claim both rebates for the same project, there is nothing in the legislation to say that a homeowner cannot receive both a tax credit and a rebate for the same energy efficiency project. So double-dip away.
To Be Continued… There are a lot of operational specifics with regard to these rebate programs that need to be worked out by states in conjunction with the Department of Energy before these rebate programs can be successfully implemented. Even though the Inflation Reduction Act of 2022 has been ratified, it will probably be a while before these rebates are available to homeowners.
But What About These New Corporate Taxes I’ve Heard So Much About?
Institution of a minimum corporate tax of 15% In his most recent State of the Union address, President Joe Biden cited a report by the Institute on Taxation and Economic Policy that found that "at least 55 of the largest corporations in America paid no federal corporate income taxes in their most recent fiscal year despite enjoying substantial pretax profits in the United States." In a self-stated effort to crack down on billionaire corporations that evade their tax obligations and make sure the largest corporations pay their “fair share”, the Inflation Reduction Act of 2022 contains a provision that will require companies with at least $1 billion in income to calculate their annual tax liability in two different ways. Companies will continue to use the longstanding tax accounting calculation of 21% of profits less deductions and credits, but they will also have to apply a 15% tax rate to the earnings they report to shareholders on their financial statements, commonly known as book income. Whichever amount is greater between the two would be their tax liability for the fiscal year. The tax aficionados among us miiiiight be getting a little deja vu right about now. Some have accused the new legislation of essentially resurrecting the Corporate Alternative Minimum Tax (AMT) by another name, which was repealed by the Tax Cuts and Jobs Act of 2017. Many economists argue that it would be much simpler to raise the corporate tax rate or eliminate corporate tax breaks that many consider to be too generous. Regardless, it’s unlikely that the 15% minimum corporate tax will have any direct impact on your tax situation. Now, will increasing taxes on corporations at a time of high inflation, high interest rates, and economic uncertainty be a good move for the market? Some argue that this move could contribute to further market volatility, while others claim the impact could be hardly noticeable.
Excise tax of 1% on corporate stock buybacks The new law imposes a 1% surcharge on corporate stock buybacks for all publicly-traded U.S. corporations. This provision is reportedly aimed at encouraging businesses to invest instead of enriching CEOs and funneling profits tax-free to shareholders.
First of all, let’s get the tea on how a stock buyback even works: When a profitable public company has excess cash, it can purchase shares of its own stock on the public market or make an offer to shareholders, known as a stock buyback. This practice returns cash to shareholders and can boost earnings per share as the overall number of shares available in the market is decreased, thus increasing demand. In 2021, when interest rates were low, profits were high, and the livin’ was easy, S&P 500 companies bought back a record $881.7 billion of their own stock in 2021, up from $519.8 billion in 2020, according to S&P Global data, resulting in a (temporary) increase in share prices. Now, legislators are now seeking to de-incentivize this practice.
So. What does this mean for you? The answer is: probably not much. It’s estimated that the 1% surcharge on share repurchases may trigger a minimal 1.5% increase in corporate dividend payouts, according to the Tax Policy Center. While increased dividends in a taxable investment account can have the effect of increasing your taxes owed– since dividend income is taxed as ordinary income– the effect isn’t likely to wreak havoc for most people. The additional taxes that might be generated by increased dividend income could be easily compensated for by utilizing asset location and tax-loss harvesting strategies, both of which the BKFI team uses in our investment management clients’ portfolios.
One last caveat on the stock buyback surcharge: since the new law won’t kick in until Jan. 1, 2023, some experts predict companies will accelerate “tax-free” stock buybacks through 2022, especially with stock prices still well below previous values. So be on the lookout for potential buybacks through the end of the year.
So– how do we plan?
Okay, okay. So we’ve talked through a lot of the most relevant portions of the new legislation and hopefully made the Big Scary New Tax Bill a little less intimidating. But what does all of this mean for you? Here’s the TLDR for how to plan for the tax changes the Inflation Reduction Act of 2022 will bring.
Better service might well mean more audits - First of all, understand that more funding for the IRS will likely result in improved customer service and better problem resolution. The agency has been understaffed and underfunded for a long time. If this law is successful in addressing those issues, taxpayers will likely benefit. That said, most of our clients do fall into the category of high income earners (over $400,000 in income per year) who are likely to be subject to increased scrutiny from the IRS. 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 - As we’ve seen in our investigation of the various credits and rebates provided by the law, a huge focus of this piece of legislation is incentivizing people to invest in cleaner, renewable, and more sustainable energy - from choosing your home’s heating source, appliances, or your next vehicle. Don’t let the tax tail wag the dog on big decisions like installing solar or buying a new car; however, if these are things you’ve been considering, review the discussion above to see what tax benefits there might be for lowering your carbon footprint.
Expect 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 and political uncertainty as this new legislation is integrated. The market hates both those things and will react. The key to your financial plan is making sure you don’t overreact. If you need help with that, consider giving us a call.