Sen. Joe Manchin, D-W.V., and Senate Majority Leader Chuck Schumer, D-N.Y., on July 27 announced a breakthrough on a significant tax package that would raise approximately $450 billion in tax revenue to pay for a generous package of energy tax incentives.
The deal is a far cry from the massive tax bill originally envisioned by Democrats, but it would resurrect a few key pieces of an ambitious agenda that had appeared all but dead. Just days ago, Manchin allegedly walked away from negotiations on a broader bill, telling Schumer that he was prepared only to accept a narrow bill that would use money from drug pricing reform to extend Affordable Care Act (ACA) subsidies. The surprise agreement adds a new tax and spending title to the overall package — now dubbed the “Inflation Reduction Act of 2022” — though the legislation includes a only handful of major Democratic tax proposals:
- The 15% minimum tax on financial statement income
- Increased spending on IRS enforcement
- Increasing the holding period from three to five years for carried interest to qualify for long-term capital gains treatment
- A package of new, expanded and extended energy incentives with some changes from earlier versions
- An increased cap on R&D credits refundable against payroll taxes for qualified small businesses
The Joint Committee on Taxation has not yet provided an official score, but the entire reconciliation bill is projected to raise $739 billion, with $288 billion coming from drug pricing reform and the remaining $451 billion coming from new tax revenue. The bill would spend $433 billion on ACA extensions and energy and climate change proposals, with more than $300 billion going to deficit reduction. Schumer submitted the text to the Senate Parliamentarian for review on July 27 and said he plans to bring the bill to the Senate floor the week of August 1.
Enactment is not a foregone conclusion. Manchin’s support is key, but with only 50 Democrats in the Senate, any other Democratic senator could effectively block the bill. Earlier agreements ran into trouble even after Schumer stated they were locked down. Just weeks ago, Schumer submitted a net investment income tax proposal to the Parliamentarian claiming he had the support of all 50 Senate Democrats, but several quickly backtracked — including Manchin — and the provision was ultimately discarded.
Sen. Kyrsten Sinema, D-Ariz., may be the biggest Senate wild card, and she has yet to comment on the new agreement. She previously supported the 15% minimum tax but has reportedly been growing more averse to tax increases. She also has been reluctant to support changing the tax treatment of carried interest.
The bill also could run into problems in the House, where Democrats can only lose three votes and still pass legislation without Republican support. The omission of any relief from the $10,000 cap on state and local tax (SALT) deductions may be a major sticking point. Rep. Josh Gottheimer, D-N.J., and several other Democratic members have repeatedly insisted they will block any deal without SALT cap relief. Manchin, however, appears strongly opposed to such relief, characterizing the SALT deduction in a statement as a “loophole.”
President Joe Biden has issued a statement in support of the agreement, and his administration will be pushing the bill hard. Tweaks to the bill may be needed for the legislation to gain enough support for passage, but Manchin seems unlikely to renegotiate major pieces now that he has finally reached an agreement with Schumer.
The tax provisions in the bill are discussed in more detail below.
Corporate minimum tax
The bill would impose a 15% minimum “book” tax on corporations that report three-year average annual adjusted financial statement income exceeding $1 billion (with a $100 million threshold for certain foreign-parented corporations if the international reporting group has $1 billion in income). The tax would be imposed on both public and private C corporations, but not S corporations, real estate investment trusts, or regulated investment companies. Democrats claimed in summaries that only about 200 companies would meet this threshold.
The 15% rate would apply against “net income” from an applicable financial statement (AFSI), defined under Section 451(b)(3), with many significant adjustments, including:
- For foreign corporations, only U.S. effectively connected income would be considered
- Domestic corporations would add a pro rata share of financial statement income of each controlled foreign corporation where the domestic corporation is a U.S. shareholder
- Both foreign and domestic tax would be added back
- AFSI from disregarded entities owned by the taxpayer would be included
- Pension plan treatment would be aligned to tax principles rather than book principles
General business credits would be subject to the same limit applied under the old corporate alternative minimum tax. Newly defined “financial statement” net operating losses could offset up to 80% of AFSI. Any tax paid would be creditable against regular tax in future years. The proposal would be effective for tax years beginning after Dec. 31, 2022.