The House is about to consider the final adoption of the Inflation Reduction Act (IRA) later this week, after months of negotiations over President Biden’s Build Back Better program. To help fund the clean energy provisions, the IRA includes two major new corporate taxes: a 15% alternative minimum tax and a 1% excise tax on share buybacks.
The new alternative corporate minimum tax resembles that proposed under the Build Back Better Act (BBBA), but with a few key differences. The tax applies to adjusted book income from the financial statements of U.S. corporations with a 3-year average adjusted book revenue greater than $1 billion, as well as foreign corporations with an average U.S. revenue greater than $100 million .
About 470 US companies currently meet this threshold, although many would not be affected because they already pay more taxes than the minimum amount. The Joint Committee on Taxation has indicated that about 150 companies will be subject to minimum tax. The new version will affect fewer businesses due to the exclusions added to the version passed by the Senate. The new minimum tax is expected to increase by approximately $222 billion over 10 years.
How is the new minimum tax different?
The main difference in this updated accounting minimum tax is the treatment of depreciation schedules, which determines over what period a company can deduct the full cost of a new investment. In their financial statements, companies typically deduct the cost of the investment based on economic depreciation, that is, the actual decline in asset productivity over time. However, the tax depreciation of investments in equipment is accelerated to provide an incentive for investment.
Businesses can currently fully and immediately deduct most equipment purchases for tax purposes less than 100%. depreciation premiumwhich should disappear between 2023 and 2026. Standard tax depreciation, the Modified Accelerated Cost Recovery System (MACRS), is also accelerated in relation to book depreciation.
While the previous version of accounting income tax required amortization of accounting income, the new version allows corporations to use bonuses and accelerated depreciation in calculating their minimum tax.
The exclusion of depreciation will therefore significantly reduce the minimum tax bill of companies with high levels of investment over the next few years, but will have less impact later, after the phasing out of bonus depreciation.
The new bill also removed the minimum tax from private equity subsidiaries that control multiple companies whose total profits exceed the $1 billion threshold.
How will the minimum tax on books increase income?
Cost recovery is one of the main sources of accounting and taxable income differences. Even with this exclusion, the minimum book tax will generate substantial revenue. Other major differences between accounting income and taxable income would still apply, such as the treatment of stock-based compensation and certain interest income.
Companies deduct larger amounts for stock-based compensation, such as employee stock options, under financial accounting than under tax accounting. Companies with substantial equity compensation will therefore be more likely to be subject to the accounting minimum tax.
Returns from certain types of investments are tax-exempt but reported on accounting income. Municipal bonds make up the bulk of this category.
The minimum book tax also applies to worldwide income, allowing credits for most foreign taxes paid. The Global Low-Tax Intangible Income (GILTI) regime enacted in 2017 already imposes a minimum tax of 10.5% on a share of the foreign income of U.S. multinationals. However, the higher rate and wider base of accounting minimum tax means that some companies paying low overseas taxes may be subject to an additional liability under accounting minimum tax.
What other tax preferences remain under this proposal?
Along with the depreciation exclusion, the minimum tax allows businesses to use general business credits – such as credits for research and experimentation – and investment tax credits to offset up to at 75% of combined regular and minimum tax. Companies can also use green credits against minimum tax.
As in the previous version of the bill, companies that have suffered operating losses in previous years will be able to carry forward the losses to reduce their adjusted financial result by up to 80%. And businesses can claim a minimum tax credit on accounting income to offset their regular tax liability in future years when their regular tax is greater than 15% of accounting income.
Although minimum tax is an important source of income for the IRA, it comes with complexities. This will prevent some businesses from paying a low effective rate on their business returns. But policymakers are already grappling with exemptions for this new minimum tax, a debate that could continue if and when the tax is put in place.
