The Inflation Reduction Act of 2022, passed by the US Senate on August 7, 2022, will dramatically affect a range of climate change, healthcare, prescription drug pricing, and tax matters. With an investment of more than $400 billion in spending, the act is expected to bring in more than $700 billion in revenue.
Among its most significant features, the act includes $369 billion dedicated to climate action through a restructuring of the eligibility and applicability of many clean energy tax credits, which could prompt many companies to reevaluate their overall climate change plans. For example, under the act’s liberalized ability for monetization of existing and new green technology tax credits, more organizations could take a broader view of their net zero plans over the next several years.
Other significant elements of the legislation include a new corporate minimum tax of 15% and a new 1% excise tax on stock buybacks; a provision empowering the federal government to negotiate down prescription drug prices and extend Affordable Care Act (ACA) subsidies for three more years; and nearly $80 billion in new funding for the Internal Revenue Service (IRS).
Although the act still needs to be approved by the US House of Representatives, our tax partners will present a 30-minute webinar, The Inflation Reduction Act of 2022’s Tax Benefits for the Green Technology Industry, on Wednesday, August 10, to address the proposed expansion of federal income tax benefits to the green technology industry, including the potential impact of how eligible green technology projects are financed and the monetization of new and expanded tax credits under the act. Register for the webinar now.
CLIMATE CHANGE PROVISIONS
The Biden-Harris administration made a strong pledge in the Paris Agreement to cut greenhouse gas emissions in half by 2030, as compared to 2005 levels. In pursuing these goals, the act would expand federal income tax incentives for a full range of green technology (including renewable energy) projects.
Although very welcome by the green technology industry, the act’s green technology tax benefits provisions are complicated, entangling the current tax credit framework with newer provisions that will take time for the industry to digest and for the IRS to develop the necessary compliance protocols. These new provisions will also require Treasury and the IRS to develop implementation guidance on an accelerated timeline for many of the provisions to be workable from a practical perspective for most taxpayers. Moreover, certain features of these tax credits may fundamentally restructure the way these deals are done and the market will need time to adjust to these new structures.
The below addresses some of the key aspects of the act’s expansion of federal income tax benefits for the green technology industry.
The act provides a new annual production tax credit (PTC) under Section 45V of the Internal Revenue Code of 1986, as amended (Code), for “qualified clean hydrogen” produced and sold or used after December 31, 2022. This PTC would apply for the 10-year period beginning on the date that the eligible facility is placed in service. The act defines “qualified clean hydrogen” as hydrogen produced through a process that results in a lifecycle greenhouse gas emission rate of not greater than 4 kilograms of CO2e (generally, greenhouse gas emissions) per kilogram of hydrogen.
The amount of the Section 45V credit initially depends on the lifecycle greenhouse gas emissions rate of the facility. Generally, the credit amount equals an applicable percentage of $0.60 (adjusted for inflation):
- 20%, if the lifecycle greenhouse gas emissions rate is between 2.5 kilograms and 4 kilograms of CO2e per kilogram of hydrogen
- 25%, if the lifecycle greenhouse gas emissions rate is between 1.5 kilograms and 2.5 kilograms of CO2e per kilogram of hydrogen
- 33.4%, if the lifecycle greenhouse gas emissions rate is between 0.45 kilograms and 1.5 kilograms of CO2e per kilogram of hydrogen
- 100%, if the result is a lifecycle greenhouse gas emissions rate of less than 0.45 kilograms of CO2e per kilogram of hydrogen
Any such credit amount is increased by five times if the taxpayer satisfies certain US Department of Labor–based wage and apprenticeship standards. Thus, the maximum credit could be $3.00 per kilogram of hydrogen produced, which some experts believe is more than half the cost to produce clean hydrogen.
Taxpayers may also elect to claim a capital expenditure–based, frontloaded investment tax credit (ITC) in lieu of the Section 45V clean hydrogen PTC.
To promote the development of additional carbon capture, use, and sequestration (CCUS) projects, the legislation extends and broadens the existing Section 45Q tax credit applicable to such facilities. Notable aspects include the following:
- The act extends the Section 45Q tax credit so that it is available for projects beginning construction before January 1, 2033.
- Section 45Q tax credits are currently based on the amount of carbon oxide captured and sequestered, calculated by the metric ton, and the applicable method of sequestration employed (i.e., disposal, injection, or utilization). The act increases the tax credit rates that apply to all methods of sequestration.
- Separately, to foster the development of new carbon capture technologies, the act includes significantly increased tax credit rates for projects that utilize direct air capture (DAC) systems.
- The act decreases the amount of carbon oxide that a facility must capture for Section 45Q tax credit eligibility. These lower thresholds may provide new opportunities for fossil fuel–based power generation facilities to be eligible for Section 45Q tax credits by including CCUS equipment.
- Section 45Q tax credit amounts are subject to adjustment, including based on whether the applicable project satisfies the wage and apprenticeship standard mentioned above.
Wind and Solar Power
The act would remove the current ITC and PTC sunset and stepdown provisions for renewable energy facilities placed in service after 2021, and ITC and PTC eligibility would be extended for solar (with solar projects now eligible for the PTC) and onshore and offshore wind facilities that begin construction before 2034 (and possibly beyond).
Certain interconnection costs for smaller facilities (not more than 5 megawatts (MWs)) would also become eligible for the ITC. Eligibility for a full ITC or PTC and even an enhanced credit would be subject to several new requirements or standards, including the wage and apprenticeship standard.
The act would expand the ITC to apply to stand-alone energy storage facilities. The act would also provide an election out of the Section 50(d)(2) “public utility property” normalization method of accounting limitation for larger energy storage facilities (capacity in excess of 500 kilowatt hours (KWhs)).
These energy storage–related provisions have long been sought by the green energy industry, as the current rules are very cumbersome and a roadblock to incentivizing grid stabilization through storage build-out. This is due to the operation of the current ITC rules, which require storage to augment solar or wind ITC generation property and allow for only limited grid charging. The election out of public utility property status for larger energy storage projects should also enable larger regulated utilities to spearhead storage expansion as part of their infrastructure spending since such utilities may now be able to realize much greater value from the tax credits, making such projects much more cost competitive.
Clean Technology Manufacturing Facilities
The act would revive the now dormant Section 48C ITC for expenditures on advanced energy production facilities for government authorized manufacturing, recycling, and greenhouse gas–reducing equipment. The act would also add a new Section 45X advanced manufacturing PTC for applicable components produced in the United States and sold after 2022 to encourage US production of wind power, solar power, electricity inverter, and energy storage equipment, as well as of critical materials (including certain rare earth metals).
Monetization of Credits
The act would provide for refundable energy, carbon capture, manufacturing, and fuel PTCs and ITCs for tax years after 2022 for facilities placed in service after 2022. However, aside from limited exceptions for the Section 45Q carbon capture credit, the clean hydrogen PTC, and the advanced manufacturing PTC, only tax-exempt and US federal, state, local, or tribal governmental entities (including Alaska Native Corporations) and corporations operating on a cooperative basis engaged in furnishing electricity to persons in rural areas would be eligible for the refundable credit.
The act would also allow for taxable entity project owners (generally, those not eligible to claim refundable credits) to sell all or a portion of their tax credits with respect to a particular year for cash. This ability to directly sell all or a portion of the tax credits has the potential to fundamentally alter the market for renewable energy financing, which currently includes complex tax-driven structures (partnership flips, sale-leaseback, and inverted leases) to monetize tax credits that may become much less prevalent once credits can be directly sold.
For more detailed information on these and other tax benefits under the act, please read our LawFlash, Inflation Reduction Act Would Significantly Expand Federal Income Tax Benefits for Green Technology Industry.
As the administration has a stated goal of 50% electric vehicle (EV) adoption by 2030 and individual states are taking an even more aggressive stance, this legislation aims to spur increased development and deployment of clean fuel vehicles in US markets. In so doing, the legislation takes direct aim at some of the more prominent obstacles raised against EV deployment, including obstacles relating to affordability and dependence on foreign sources for battery materials.
The legislation codifies a continuation of the current $7,500 federal tax credit made available for purchases of new clean fuel vehicles. For the first time, Congress is also making available a tax credit for the purchase of used clean fuel vehicles—up to $4,000.
To encourage increased purchases from US entities while also ensuring EVs will be available to all potential consumers, the legislation overhauls the tax credit mechanism in two important ways. First, the legislation removes the 200,000-vehicle cap that previously existed, which precluded purchasers of brands that were already in excess of the cap from tax credit eligibility. In its place, the legislation is imposing a cost and income mechanism whereby tax credit eligibility turns on the MSRP cost of the purchased vehicle (less than $55,000 for new cars and $80,000 for pickups, SUVs, and vans) and the income of the purchaser ($150,000 for a single filing taxpayer and $300,000 for joint filers). Second, the legislation’s tax credit mechanism is able to be made available to manufacturer dealers, thereby allowing the credit to operate as a point-of-sale rebate for consumers rather than a credit for which a taxpayer must wait to claim on a tax return filed post-purchase.
One of the largest obstacles to credit eligibility that currently exists is that the cars must be assembled in North America and that materials and “critical minerals” in the battery must come from the United States or a select group of approved trade partners. Currently, this requirement may be difficult (or impossible) for many manufacturers to satisfy because the potential nations from whom manufacturers are able to source critical minerals and battery components are limited.
OTHER TAX PROVISIONS
Corporate Alternative Minimum Tax
The act creates a new corporate minimum tax regime based on financial statement income for companies with profits in excess of $1 billion. Subject corporations must pay the greater of their regular income tax liability, based on taxable income as determined under the Code, and their liability under the new “alternative” minimum tax (AMT), equal to 15% of “adjusted financial statement income” (AFSI). The use of financial statement income marks a significant departure from existing tax rules.
The new corporate AMT generally applies only to a corporation or group of corporations treated as a single employer (applicable corporation) whose average AFSI for any three‑year period ending prior to the current taxable year and after December 31, 2021, exceeds $1 billion. That threshold, however, is only at least $100 million for a foreign-owned domestic corporation if it is a member of a “foreign-parented multinational group” with AFSI exceeding $1 billion. A corporation ceases to be subject to the AMT only when, along with a change in ownership or several years with average AFSI below $1 billion, the US Treasury secretary determines that it is no longer appropriate to treat the corporation as an applicable corporation.
Key rules governing the calculation of AFSI and tax under the AMT include those allowing for 1) the use of tax rather than financial statement depreciation, 2) the use of accumulated financial statement losses to reduce AFSI, 3) the inclusion of income but not losses from foreign subsidiaries in current AFSI, and 4) the application of general business credits against liability under the AMT to the same extent as against regular tax. Finally, a credit against regular tax liability is available to taxpayers with an AMT liability for prior years beginning after 2022 and is applied up to the excess of regular tax liability over AMT liability. This credit effectively makes the new corporate AMT a prepayment of regular tax liability.
Increased IRS Funding
Included within the other tax-focused provisions, the act allocated $76.6 billion in funding for the IRS over the next 10 years. More than half of that amount, $46.6 billion, is earmarked for “tax enforcement activities,” with the remainder spread across IRS operations, taxpayer services, and systems modernization.
This funding boost has long been sought by the agency, which has lately struggled with staffing shortages and funding cuts, and was operating with a budget in 2021 that was nearly 20% percent below the 2010 level, as adjusted for inflation. In fact, actual expenditures by the IRS in 2021, including the supplemental funding to support the IRS’s COVID-19 pandemic-related activities, only totaled $13.7 billion for overall operations.
Citing these resource constraints, the IRS’s ability to audit large corporations; complex business structures, including large partnerships; and high-net-worth individuals has been impacted and audit rates for these taxpayers have continued to decline. The Congressional Budget Office estimates that these increases in funding for enforcement activities will bring in nearly $204 billion over the next 10 years.
The IRS commissioner stated that the additional funding would not increase the audits of households making less than $400,000 a year or of small businesses, and that the IRS plans to use the increase to focus its efforts on large corporations and global high-net-worth taxpayers. The IRS recently announced additional hiring, and with the additional funding the act would provide, the increase in the number of IRS agents and others focused on enforcement, including legal and litigation support, will certainly continue.
New Excise Tax on Certain Stock Repurchase Transactions
The act introduces a new 1% excise tax on certain corporate stock repurchase transactions. The provision is generally applicable to domestic corporations, the stock of which is traded on established securities markets. The tax is applicable to corporate stock redemptions, transactions determined by the IRS to be “economically similar” to redemptions, and acquisitions by a limited class of affiliates (including certain partnerships).
The act introduces a netting rule, by which the amount subject to the excise tax is reduced by the fair market value of any stock issued by the corporation during the taxable year of the applicable repurchase transaction. The current draft contains a prospective effective date, applying the new excise tax to repurchases made after December 31, 2022.
Prescription Drug Pricing Reform
One of the pillars of the act, Title I, Subtitle B, amends Title XI of the Social Security Act to establish a new Drug Price Negotiation Program (the program) under the authority of the secretary of the Department of Health and Human Services. As part of the program, the secretary shall compile and publish a list of selected drugs, enter into agreements with manufacturers of those selected drugs, negotiate (and renegotiate as appropriate) maximum fair prices, and provide compliance monitoring.
For the initial price applicability year, 2026, the secretary must select 10 negotiation-eligible Medicare Part D drugs, which includes high-priced drugs that don’t have a publicly available generic or biosimilar equivalent and, in many cases, have been on the market for nine or more years. For 2027, the secretary must select 15 eligible Part D drugs. In 2028, the criteria expand to a total of 15 eligible drugs for either Part B or Part D. Finally, in 2029 and all subsequent years, the secretary will be required to select a total of 20 eligible drugs for either Part B or Part D.
To accomplish this, the secretary shall rank 50 Part B and 50 Part D negotiation-eligible drugs, according to relevant total expenditures during the preceding 12 months. The list for the initial price applicability year must be published by September 1, 2023.
Once negotiated, and with a maximum fair price established and published, an agreement will remain in place until the drug is no longer considered a “selected drug.” The selection of a drug, the determination of a maximum fair price, and the determination of renegotiation-eligible drugs, such as those that have been approved for a new indication, are not subject to administrative or judicial review. Pharmaceutical companies that don’t comply with the costs set by the negotiation could face excise taxes and potential civil fines. The new law provides direction for determining a range into which the maximum fair price will fall, which takes into considerations various price calculations for prior government purchases under Medicare, as well as factors to be considered such as comparative effectiveness, whether the product represents a therapeutic advance, and unmet medical need. The law also provides a timeline for the negotiation process, compliance requirements, and civil money penalties for various manufacturer violations.
In addition to the new Drug Price Negotiation Program, the act will do the following:
- Establish Medicare Part B and Medicare Part D inflation rebates. Drug manufacturers would have to pay rebates to the Medicare trust fund if they increase drug prices faster than the rate of inflation, with a few exceptions for low-cost drugs. Civil monetary penalties for those that don’t pay the rebates could be as high as 125% of the applicable rebate.
- Cap out-of-pocket Medicare Part D costs at $2,000 per beneficiary per year beginning in 2025.
- Require coverage of certain adult vaccinations under Medicaid for plan years beginning after January 1, 2023, while eliminating some cost sharing.
Several provisions initially proposed by Senate Democrats were removed prior to passage. Democrats had to remove a provision that penalized pharmaceutical manufacturers for increasing drug costs above inflation in the commercial market, not just with respect to Medicare, after the parliamentarian ruled that it couldn’t be considered under the rules governing reconciliation.
Democrats also sought to cap the cost of insulin on the commercial market. That too was struck down by the parliamentarian. The insulin price cap provision nevertheless was brought to the Senate floor for a vote, but ultimately failed, falling three votes shy of the enhanced 60-vote threshold.
Affordable Care Act
Title I, Subtitle C of the act (Section 12001), as passed by the Senate, amends the Code to extend ACA premium tax credits through 2025. The bill extends eligibility and calculation changes to the premium tax credit made under the American Rescue Plan Act, P.L. 117-2 (ARPA), through 2025.
This legislation marks one of the largest investments for climate change in US history and includes substantial measures for healthcare and tax proposals. When totaled, the full package is anticipated to include more than $400 billion in spending and to bring in more than $700 billion in revenue.
Up next, the House is expected to vote on the bill later this week before it goes to President Biden’s desk to be signed into law. A multidisciplinary team of Morgan Lewis lawyers will monitor this legislation as it progresses. We are available to discuss the implications for participants in the clean green technology, healthcare, and other affected industries, as well as those that are impacted by the broader proposed tax provisions.
 The excise tax is extended to a limited class of publicly traded foreign corporations.