On July 27, 2022, Senators Joe Manchin and Chuck Schumer announced an agreement on H.R. 5376, now known as the Inflation Reduction Act. The Inflation Reduction Act is yet to receive a vote in the House or the Senate, and it is unclear if it will ultimately become law. However, this bill raises several issues that taxpayers should consider and plan for in anticipation of future IRS compliance efforts.
While the Inflation Reduction Act bill reflects aspects of the Build Back Better Act that we wrote about here, key changes were made to the tax controversy provisions.
Additional Funding for the IRS
The Inflation Reduction Act would earmark approximately $45.6 billion towards enforcement and compliance over the next ten years. This amount represents an increase of approximately $700 million from the amount proposed in the Build Back Better Act. This funding is intended to function as one of the revenue-raising aspects of the Inflation Reduction Act by funding IRS compliance efforts to close the “tax gap” between taxes owed and taxes collected. Taxpayers should therefore anticipate an increase in the number of audits and other compliance efforts if the Inflation Reduction Act becomes law in its current form.
Baker Botts Note: As we observed in our prior updates here, here, and here, based on the administration’s focus on high net worth taxpayers and companies that reported to shareholders an annual average of $1 billion in annual profit over the past three years, those groups can expect increased enforcement actions by the IRS.
Corporate Minimum Tax
As we discussed here, the Inflation Reduction Act would generally impose a corporate alternative minimum tax (AMT) of 15 percent on the adjusted financial statement income of a corporation with average adjusted financial statement income in any prior post-2021 tax year in excess of $1 billion. This corporate minimum tax raises a number of issues for future IRS compliance efforts.
Baker Botts Note: On the one hand, the use of adjusted financial statement income in the corporate AMT could create an incentive to report lower financial statement income to reduce tax. On the other hand, companies typically want to report profits on their financial statements that are provided to investors. There could also be incentives for taxpayers to avoid exceeding the $1 billion average adjusted financial statement income threshold, for example, through corporate spinoffs. In any event, these proposals would increase the complexity of tax compliance for taxpayers subject to the tax.
Baker Botts Note: Another issue raised by the proposed corporate AMT is whether the IRS would seek to audit a corporation’s financial statement income. Under proposed new section 56A(a), the corporate AMT would be imposed on the taxpayer’s “adjusted financial statement income,” which is defined as “the net income or loss of the taxpayer set forth on the taxpayer’s applicable financial statement for such taxable year, adjusted as provided in this section.” However, if the IRS were to audit whether a corporation correctly reported its financial statement income under GAAP, this would require the IRS to consider the financial reporting standards that apply to a corporation’s financial statements. The IRS typically does not deal with GAAP, and this could significantly add to the complexity of an audit.
Baker Botts Note: The corporate minimum tax can be offset by many tax credits. Therefore, these tax credits may be subject to increased scrutiny because the IRS could obtain two levels of tax revenue if they make any adjustments (one to the corporate minimum tax, and the second to income tax).
Comparison to the Build Back Better Act
The Inflation Reduction Act does not include several relevant tax-controversy provisions from the Build Back Better Act, such as:
- the elimination of written supervisory approval of certain penalties;
- increased information reporting and back-up withholding requirements for third party settlement organizations;
- a surcharge on high income individuals; or
- modification of the wash sale and constructive sale rules with respect to cryptocurrency transactions.
Baker Botts Note: While the Inflation Reduction Act no longer modifies the wash sale and constructive sale rules with respect to cryptocurrency transactions, taxpayers should still anticipate increased IRS scrutiny of those transactions – the language earmarking $45.6 billion for enforcement (mentioned above) highlights “digital asset monitoring and compliance activities” as a purpose of the funding.
We will continue to monitor developments and will provide further updates as more details are released. In the meantime, Baker Botts would be pleased to assist you in your analysis of these proposals.
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