Reconciliation bill advances; carried interest changes removed

Editor's note: The developments discussed in this piece were part of the legislative process leading to enactment of the Inflation Reduction of 2022. Please see our capstone article about that legislation for details about the final changes included in that bill.

The Inflation Reduction Act of 2022 (IRA) has taken a step forward, as the Senate completed its deliberation and passed the bill on August 7. While in the Senate, a few alterations were made to the tax provisions, including the removal of any changes to the taxation of carried interests. The IRA now heads to the House for consideration, with passage likely later this week.

Senate negotiations and final vote

The IRA was previously announced on July 27 as result of negotiations completed by Senators Manchin and Schumer. However, the bill was subsequently modified during further negotiations. Those included discussions with Senator Sinema during the past week and negotiations on the Senate floor prior to the final vote. Here are the key takeaways following a review of the updated bill:

• Removal of carried interest changes — The prior version of the bill would have tightened the existing rules under Section 1061. However, that section has been removed altogether. This means that those receiving carried interests, such as principals of private equity and other investment funds, will continue to apply the tax rules that were made effective in 2018 as part of the Tax Cuts and Jobs Act (TCJA).
• Insertion of stock buyback tax — An excise tax on stock buybacks that was previously proposed as part of the Build Back Better Act has been reintroduced as a revenue-raising substitute for the carried interest changes. This would apply a 1% excise tax on the fair market value of any stock that a publicly traded corporation repurchases. Certain transactions would be excluded, including: repurchases occurring as part of a tax-free reorganization; repurchased stock contributed to employee pension or similar plans; transactions where the total value of the stock repurchased in a single year is less than $1 million; repurchases where the purchaser is a dealer in securities; repurchases made by a real estate investment trust or a regulated investment company; and repurchases taxed as a dividend.
• Modification to book minimum tax — The new 15% minimum tax on the financial statement income of large corporations with an average annual financial statement income exceeding $1 billion over a three-year period has been retained in the bill, albeit with several technical changes. Those include: (1) an adjustment to permit financial statement income to be reduced by tax depreciation instead of book depreciation; and (2) modification of the multinational group rules for defining which corporations are subject to the tax. A change was proposed to controlled group rules that could have caused businesses owned by an investment fund or similar pool of investors to be combined for this purpose, but that expansion was stripped from the bill.
• Extension of excess business loss rule — A rule first enacted as part of the TCJA limits the ability of pass-through business entities owners to deduct losses from those entities against nonbusiness income. That rule, pursuant to Section 461(l), is currently set to expire at the end of 2026, but would now be extended for an additional two years through 2028.
• Tax treatment of farmer assistance — A new provision addresses the taxability of assistance provided to farmers as a result of the American Rescue Plan Act, which was enacted in March 2021. In general, this provision would make such assistance tax-free while preserving tax deductions for expenses funded with such assistance.

All other tax provisions remain largely unchanged from the version of the IRA released on July 27. This includes the $80 billion increase in IRS funding over the next 10 years, the increase in the payroll tax credit for research and development by $250,000 per year (total of $500,000), and the many energy tax provisions.

What’s next for the Inflation Reduction Act?

The IRA now heads to the House for consideration this week. If any changes are made to the bill, a conference committee would be required to reconcile the differences. However, initial reporting suggests that Democratic leadership in the House intends to move swiftly toward passage of the bill later this week without any further changes.