The Inflation Reduction Act that Congress passed Friday includes a new minimum tax of 15% on the book income of corporations that earn over $1 billion in revenue, along with a 1% tax on stock buybacks, and those provisions are likely to change the tax planning used by the largest companies and their accounting firms.
The new "book tax" applies to the earnings recorded on the business' financial statements, as opposed to the income that's usually recorded for tax purposes and reported to the Internal Revenue Service.
The new tax isn't the same as the global minimum tax of 15% that Treasury Secretary Janet Yellen negotiated with other countries involved with the Organization of Economic Cooperation and Development. That deal is still being held up in the Senate (
"I think it will be more pronounced for specific industries and business models, business models where it's capital intensive and where there's an incentive in the Tax Code to accelerate depreciation expense," said Wes Bricker, vice chair and U.S. Trust Solutions co-leader at Big Four firm PricewaterhouseCoopers. "That arises whenever your book minimum tax is higher than your Tax Code tax. That arises because when you add a big capital project which is consumed or depreciated over a long period of time in your investor report, you might be depreciating that over 30 years. For tax, you might be accelerating the depreciation over, say, seven years. In that case, you're allocating the same cost over a much shorter period of time, so your expense for calculating taxable income is much higher, your taxable income is much lower, and your tax is much lower. For book, your tax is lower because it's spread over a longer period of time. Therefore, your net income is higher. That's the disparity that legislators have focused on, where they've said, 'Let's use the book numbers, because that's more reflective of the economic realities. Let's apply a 15% tax on book income.'"
"When you do that it really represents a second look at all of the tax policies that were grounded on incenting investments in capital projects," he continued. "That's the tax policy justification for accelerating depreciation. You get more renewal and more investment in the economy and it spurs growth, so it can have a dampening effect over time."
Sen. Kyrsten Sinema, D-Arizona, insisted on creating an exemption for accelerating depreciation deductions as one condition for agreeing to support the legislation, so companies such as manufacturers will still be able to take advantage of the accelerated bonus depreciation to buy equipment, for example, and it will be exempted from the corporate minimum tax (
Bricker believes the law may be refined further depending on the outcome, and accounting standard-setters may need to get involved as well. "It will be interesting to see whether a later Congress pulls back on this dampener because we'd like to see more capital investment," he said. "But there's another side to this: What is the role of general purpose financial statements? Right now, they're primarily designed for investors, contractual counterparties like suppliers, employees, or other capital providers like a lessor. It's designed for commercial purposes generally. But there are places where the government, as a policymaker, is also a consumer of general purpose financial statements. It's regulatory capital. This is the latest [area] where the government, as a user of general purpose financial statements, staked a claim. They've said, 'We're going to be a user of general purpose financial statements. Now, that has implications as the [Financial Accounting Foundation] looks at its oversight role, the standard-setters look at their role. Even corporate preparers, as they select accounting policies and apply those accounting policies, do so with an eye toward unbiased reporting, which really reinforces financial reporting as the gold standard."
Another compromise that Sinema insisted on before she would give her crucial 50th vote in the Senate was preserving the carried interest tax break that allows hedge fund managers and private equity firm partners to be taxed at the lower capital gains tax rate of 20%, rather than the ordinary income tax rate of up to 37% on their share of a fund's profits. To help make up for the potential revenue lost from preserving this and the accelerated depreciation tax break, another new tax will be a 1% excise tax on share buybacks. That could have the effect of prompting some companies to offer more dividends to shareholders, instead of using excess profits on buybacks to pump up stock prices and options for executives.
"It's hard to say, but I would anticipate that the application of a tax does change the overall incentives," said Bricker. "Stock buybacks are generally viewed as a return of capital to the shareholders who are remaining. There are many other ways to return capital. You can spin off a segment of the business. You can dividend out. You can fund that dividend with debt. You can recapitalize the entity. I do think it changes the assessment of individual alternatives on how to return capital to investors. Ideally we want companies to invest the capital they have in productive purposes, and if they don't have productive purposes, to return it. We want that evaluation to be done in a way that is optimizing the allocation of capital in our system."
Bricker was formerly chief accountant at the Securities and Exchange Commission before rejoining PwC. "I come at this from my experience as a regulator," he said. "That's the fairness and the efficiency of our markets. If there's too much capital trapped in a business that they can't deploy, it's better to be returned so that it can be invested in some other company and some other project. I tend to favor the allocation and reallocation of capital across business models. That reinforces the obligation of all of us to build confidence in the quality of disclosures, which enables the board, management and investors to make decisions about the optimal allocation of capital. Can it be deployed in a way that really produces a return that's greater than the cost of that capital? That's fundamentally the decision. An excise tax certainly changes the balance of those scenarios."
Ultimately, corporations will need to decide what tax strategies they should pursue on behalf of themselves and their investors. "The corporation is going to have to make a decision," said Kevin Matthews, a CPA and accounting professor at George Mason University's School of Business who also has his own tax practice. "Do we want to do dividends or do we want to do stock buybacks in order to get cash out to investors? This is going to be one data point that's going to cause them to make a decision whether they want to do it one way or the other. But I don't think 1% is going to cause that much of a decision factor to say, 'Because of 1% we're definitely not doing it.' It's one factor of many."
He is more concerned about the corporate minimum tax on book income. "We finally got rid of the [Alternative Minimum Tax] on the corporate side and now it seems like they're bringing it back," said Matthews. "But the biggest issue that I've seen with this is that it's based on financial income. Financial income, of course, plays under different rules than taxable income does. I was looking at some of the modifications that they're asking us to do. For depreciation, you have to use IRS rules. For goodwill intangibles, you have to use IRS rules. There are a lot of things that they're putting into these modifications to do the adjustments. I just think it's going to be that a lot of extra compliance is going to have to be done in order to figure it out. Now, the good news is you have to have over $1 billion in revenue for three years. Let's be honest, if you're making a billion dollars in revenues, you're probably able to afford to hire somebody to do the calculations."
