On Aug. 16, 2022, President Joe Biden signed the Inflation Reduction Act of 2022 (I.R.A.) into law, finalizing amendments that were made to the budget reconciliation bill in the Senate. The bill was previously release by Senate Majority Leader Chuck Schumer (D-NY) and Sen. Joe Manchin (D-WV).

One of the key changes to the bill between its initial draft and its current, enacted form was the removal of changes to carried interest provisions during negotiations in the Senate. The I.R.A. saw no further changes in the House, where it passed on Aug. 12 before being sent to the President. This article summarizes changes made to the bill during negotiations and before it was signed into law, which are especially relevant in industries such as the private equity and venture capital industry.

Expansion of Carried Interest Tax Regime Removed

In the final version of the I.R.A., as signed into law by the President, all changes that had been proposed to further restrict the long-term capital gain treatment of carried interests in partnerships were removed. Initial proposals sought to change the required holding period by investment fund managers from three years to five years in order to claim long-term capital gains tax treatment on the eventual sale of a carried interest in a partnership. It had also significantly altered the holding period start date. These proposals were removed during Senate negotiations.

1% Stock Buyback Excise Tax Added

Also during Senate negotiations, a 1% excise tax on corporate stock buybacks was created to replace the revenue anticipated from expanding the carried interest rules. This excise tax will be imposed on the fair market value of any stock of a covered corporation, which is repurchased by such corporation during the taxable year. A covered corporation is one whose stock is traded on an established securities market. Exceptions from the excise tax apply in the circumstances below:

• The repurchase occurs as part of a tax-free reorganization under Section 368(a) of the Code and no gain or loss is recognized.
• The repurchased stock is contributed to an employer-sponsored retirement plan, employee stock ownership plan, or a similar plan.
• The total value of the repurchased stock in any taxable year does not exceed $1,000,000.
• Pursuant to regulations to be issued, the repurchase is made by a dealer in securities in the ordinary course of business.
• The repurchase is by a real estate investment trust or regulated investment company.
• The repurchase is treated as a dividend for federal income tax purposes.

This tax will apply to taxable years beginning after Dec. 31, 2022.

Establishing a Corporate Alternative Minimum Tax

Large C corporations also saw changes in the Alternative Minimum Tax between the initial and final forms of the I.R.A. The new corporate alternative minimum tax of 15% is based on a corporation’s average adjusted financial statement income (AFSI); the tax would apply to all corporations with $1 billion or more of average AFSI in the previous three years. If the U.S. corporation has a foreign parent, it will apply only to U.S. subsidiary corporations that have a three-year average AFSI of $100 million or more earned in the U.S. (assuming the international financial reporting group has average AFSI of $1 billion or more).

An amendment was made during Senate negotiations to remove aggregation rules that would have grouped portfolio companies of PE/VC funds together to determine if the $1 billion threshold was satisfied. Depreciation benefits were also retained in the minimum tax calculation in the final legislation.

Please note, this provision excludes Subchapter S Corporations, regulated investment companies, and real estate investment trusts.

This tax will apply to taxable years beginning after Dec. 31, 2022.

Excess Business Loss Limitation Rule Extended

The I.R.A extends by two years (through 2028) the provision that caps an individual’s deductions for excess business losses. During 2022, the deduction for excess business losses cannot exceed $270,000 (for single filers) or $540,000 (for married spouses filing jointly). Excess business losses typically are generated from sources such as sole proprietorships, ownership interests in partnerships and S corporations and rental operations that rise to the level of a trade or business. Amounts in excess of the limitation are carried forward by individuals as net operating losses.

Outlook

CBIZ will continue to monitor impacts in this area as regulations are written to implement these new laws.  If you have any questions in the meantime, please contact us. You may also want to explore our more in-depth coverage of the I.R.A. so far.

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