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How the Inflation Reduction Act May Impact Your Business

The Inflation Reduction Act (IRA) became law on Aug. 16, but some have criticized it as another round of spending in an already inflated economy. Still, others saw it as a necessity for the future of the country.

When asked about the implications of the IRA, Larry Summers, the former treasury secretary under both presidents Clinton and Obama and one of the key drafters of the Inflation Reduction Act said, “We will bring down prices, particularly of pharmaceutical goods, by using the government’s purchasing power more effectively to procure at low costs. So, the net effect of this bill is going to be to reduce inflation, while at the same time doing very, very important things for the environment, very important things for fairness and access to health care, doing very important things in terms of strengthening the tax system by assuring that all who should pay, do pay.”

The question many business owners are wondering, however, is how the IRA will impact their business. The answer is in the key items addressed in the IRA: taxes, audits, credits, and climate change.

READ — What Does a Recession Mean for Your Finances?

Taxes

The IRA imposes an Alternative Minimum Tax of 15% on “Applicable Corporations.” Applicable Corporations are corporations that average an annual Adjusted Financial Statement Income for three years greater than $1 billion, with some exceptions.

Some view the AMT as an additional complicating factor to the already intricate U.S. tax code in the form of the new AFSI test. However, Reuven Avi-Yonah, director of the International Tax LLM Program at the University of Michigan and a world-renowned tax expert, curbs the criticism by noting that this measure will only impact approximately 125 large corporations that “can afford the complexity in the sense that they can pay the best accountants and tax lawyers to deal with this.”

Other than the additional complexity of calculating a corporation’s tax liability, the new AMT could play a role in the M&A market. Large corporations would likely attempt to reduce AFSI by acquiring growth companies because such companies “often have large annual revenue growth rates but little or no net income for GAAP or IFRS purposes” or through “spinoffs and other corporate breakups (i.e., taxable or tax-free dispositions of noncore assets) [that] will also reduce AFSI.”

Thus, the new AMT could provide creative opportunities in the M&A world for large businesses looking to reduce their AFSI by acquiring small growth companies or by breaking existing business branches out of their corporate structure.

Audit Risk

One of the key items in the Inflation Reduction Act that received much media attention is the additional $80 billion in funding to the IRS, $46 billion of which is designated for enforcement that will result in an estimated 87,000 new IRS agents and staff members.

Increased funding for the IRS has been a long time coming. The IRS claims it has been underfunded and understaffed for decades and in desperate need of more personnel and updated technology. The new funding, however, heightened the concern among individuals and business owners of increased audit risk. Nevertheless, many of the bill’s authors and IRS Commissioner Charles Rettig promised the public that only households that earn over $400,000 would be subject to increased audit scrutiny.

To provide further assurance to the public, Treasury Secretary Janet Yellen, in a letter to Rettig, explicitly directed, “Any additional resources — including any new personnel or auditors that are hired — shall not be used to increase the share of households below the $400,000 threshold or any small businesses that are audited relative to historical levels.”

Yellen’s letter is a clear declaration of intent by the Treasury for its audit treatment of individual households. However, the letter leaves some unanswered questions regarding small businesses. Yellen does not determine what qualifies as a small business. Would the IRS auditors decide for themselves before reviewing businesses’ returns? Does the Treasury or the IRS have an unpublished threshold for auditing small businesses, and if so, what is it? Are we likely to see an increase in audits for smaller businesses, or is that, once again, a concern for only very large corporations?

These questions remain unanswered, but it is fair to say that we will likely find out within the next tax year or so.

READ — Conduct a Mid-Year Tax Strategy Audit

R&D Credit

The IRA doubled the refundable R&D credit for small businesses from $250,000 a year to $500,000. Section 41(h)(1) of the Internal Revenue Code defines a small business for purposes of the R&D credit as a business with gross receipts of less than $5 million during the current taxable year and the past five taxable years. This new measure appears to provide a large advantage for small businesses regarding their tax liability.

According to the OECD R&D Tax Incentive analysis in 2021, between 2000 and 2018, the number of R&D tax relief recipients in the U.S. more than doubled from 10,500 recipients in 2000 to 26,000 in 2018. Companies with gross receipts of less than $50 million a year accounted for approximately 70% to 75% of the total recipients. However, despite the increase in R&D tax relief recipients in the past 20 years, the total use of the credit remains fairly low. From my personal experience working as a tax consultant for over two years and reviewing hundreds of transactions and tax returns, I can say that most of the R&D credits claimed by small businesses are in the tens of thousands. One of the reasons for the low threshold is that R&D credits are fairly difficult to claim and are often subject to audit. Claiming R&D credits require a business to go through at least an internal study or preferably hire an outside expert to do the same. This fact deters many businesses from claiming the credits.

Nonetheless, with the right knowledge and preparation, claiming R&D credits could still be possible and worthwhile. Small businesses should be aware of the new changes to the law and understand the rules and regulations for claiming R&D credit.

Climate Change

According to the White House, “The Inflation Reduction Act represents the most aggressive action to combat the climate crisis and improve American energy security in our nation’s history.” The assertion made by the executive branch is that the IRA would cut social costs related to climate change by up to $1.9 trillion by 2050, with the ambitious goal of reducing greenhouse gas emissions by 40% in 2030.

The Inflation Reduction Act allocates approximately $370 billion to climate change-related projects. Such projects may include, among others, air quality monitoring, assisting farmers in shifting to sustainable practices, research in climate impact on agricultural practice, endangered species recovery plans, and protection and restoration of coastal communities and ecosystems. It is important to note that businesses operating in the renewable energy environment may benefit from the additional IRA funding that authorizes billions in federal loans and loan guarantees “for energy and automotive projects and businesses.”[3] To emphasize the impact of the new federal funding on renewable energy projects, Dan Reicher, a former assistant energy secretary under President Clinton, said, “[This is a sleeping giant in the law and a real gold mine [emphasis added] in deploying these resources.”

Businesses should, therefore, be mindful of the new opportunities presented by the IRA and estimate whether they can benefit from a federal loan to fund a climate change-related project.

However, the same cannot be said for businesses operating in the oil and gas industry. The latter will see an increase in the Superfund Tax from 9.7 cents a barrel to 16.4. This might be regarded as a negligible amount but such that could have an aggregated impact on oil and gas producers.

Conclusion

The White House, along with the drafters of the IRA, made two important claims about the bill when introducing it to the American public. First, the IRA is an aggressive and ambitious act that will fight the climate change emergency; second, the investment the act provides will eventually reduce consumer prices and consequently bring inflation down.

Our analysis focused only on the key elements addressed by the IRA and what they mean to the everyday American business owner. Though the criticism of the bill may be valid, we can hope that the new investments, along with the additional tax measures and credits, would incentivize the market, encourage investors to increase M&A activity, and provide new opportunities and relief to businesses suffering from the high costs due to inflation.

However, appreciating the implications of the IRA would require business owners to give up a precious asset – time. It may take a few months or even more, and we can only hope that the legislators’ intent will indeed come to fruition in the near future.

 

Duekevysquare 1Evy Duek is a corporate attorney with Sherman & Howard LLC in Denver. Evy has extensive knowledge of M&A deals from a legal and tax perspective.

How Business Owners Can Access Their COVID-Related Tax Credit Refund  

A little-known government program is offering financial relief for business owners impacted by the COVID-19 pandemic. The Employee Retention Credit (ERC) is a tax credit from the Federal government and part of the Infrastructure Investment and Jobs Act. The ERC is open to businesses of all sizes that retained employees during the pandemic-related shutdowns and slowdowns in 2020 and 2021. Although the program was officially sunsetted in 2021, the credit is available retroactively, with businesses having up to three years from the end of the program to review wages paid after March 12, 2020 and file a claim. The ERC could give businesses up to $26,000 per full-time employee if eligible, and benefits can be larger than the amounts a company received in PPP funding.   

According to the IRS, the ERC is “a refundable tax credit against certain employment taxes equal to 50% of the qualified wages an eligible employer pays to employees after March 12, 2020, and before January 1, 2021. Eligible employers can get immediate access to the credit by reducing employment tax deposits they are otherwise required to make. Also, if the employer’s employment tax deposits are not sufficient to cover the credit, the employer may get an advance payment from the IRS. 

“For each employee, wages (including certain health plan costs) up to $10,000 can be counted to determine the amount of the 50% credit. Because this credit can apply to wages already paid after March 12, 2020, many struggling employers can get access to this credit by reducing upcoming deposits or requesting an advance credit on Form 7200, Advance of Employer Credits Due To COVID-19.” 

Below we break down the ERC tax credit process, including eligibility requirements, necessary documentation and steps to apply. 

Who is eligible? 

The ERC is available to all types of small businesses—LLCs, LLPs, C-Corps, S-Corps, B-Corps, sole proprietors and non-profits with W2 employees. Three criteria govern who can receive the credit, with businesses having to meet only one to qualify. While eligibility details should always be reviewed with the IRS or a tax professional, generally, below are the ERC eligibility requirements: 

  1. Reduced year-over-year revenue in 2020 or 2021 
  2. Reduced revenue in those years due to government mandates, such as forced business shutdowns; or if the business was started after February 15, 2020 
  3. Less than $1 million in gross annual receipts 

What you’ll need  

After reviewing the eligibility requirements, business owners can begin the application process by preparing the following paperwork: 

  • Employer’s Quarterly Federal Tax Return, Form 941 
  • Advance Payment of Employer Credits Due to Covid-19, Form 7200 
  • Reporting Agent Authorization, Form 8655 
  • PPP Application and Forgiveness, when applicable 

Additional forms and supporting materials may be required, depending on your unique circumstances, which can include 2019, 2020 and part of 2021 financials, along with any official government-ordered shutdown or suspend operations notices.  

How to apply  

Business owners can apply online at https://www.irs.gov/forms-instructions after gathering the necessary forms. For third-party assistance with the application process, business owners can visit https://www.LendioDenver.com. If you go the “do-it-yourself” route, be prepared for a potentially long process if you select to complete the application on your own. While business owners can file for the credit themselves, the process for getting a full tax credit can be challenging with the application running to over 170 pages of IRS-required documentation with ongoing amendments to the program since inception. It is recommended that business owners seek the expertise of an experienced professional or third party to maximize the odds of a successful application.   

Per the IRS, “eligible employers will report their total qualified wages and the related health insurance costs for each quarter on their quarterly employment tax returns, which will be Form 941 for most employers, beginning with the second quarter.” The IRS website indicates a six-week to six-month timeline to receive credits, yet we are seeing the process take six to eight months, with some applications taking more than 12 months to receive a credit. 

If using a third party, such as Lendio, business owners may be asked to complete a pre-qualification application to begin the ERC process. In this instance, the local Lendio team performs internal prechecks after the pre-qual application is complete and works with the business owner to identify the documents needed to submit their application. 

While the ERC program remains overlooked by many small businesses, it is a tremendous opportunity for businesses that have been negatively affected by the COVID-19 pandemic.  If your business experienced a substantial decline in gross receipts but has since recovered and you didn’t claim the tax credit, it is possible to apply for the credit for retaining employees and persevering through the economic challenges resulting from the COVID-19 pandemic.  

Bill Airy 2Bill and Leanne Airy are president and owner of Lendio Denver.  Lendio Denver and its partners have secured over $5.7 million in tax credits for Denver-area small business owners. Bill is a Colorado native and experienced entrepreneur who founded his first small business in 2007 and sold several businesses before founding Lendio Denver. Contact him at 303-747-3538 or [email protected]. 

Selling your business in 2021? There’s still time to save estate taxes

Tax Law Changes on the Horizon

Odds seem increasingly likely that Congress will succeed, using the budget reconciliation process, in passing a tax bill between October 1 and the end of the year.

Income and capital gains tax rate increases are anticipated, along with a reduction in the estate tax exemption amount from the current $11.7 million to possibly $5.0 million or even $3.5 million per person.

If you’re a business owner, current market optimism, coupled with looming tax law changes, present a unique climate of urgency in deciding whether to sell your business. 

Fortunately, closing a sale  before year-end  is still feasible. Good businesses brought to market now may sell more quickly and at higher than normal multiples because of historically low interest rates, readily available debt financing, and high levels of “cash on the sidelines” to invest—all of which are driving buyer interest. 

Tax changes alone shouldn’t dictate your decision to sell. That said, specific proposals under President Biden’s American Families Plan are impacting exit planning. Most salient include the proposal to nearly double the top long-term capital gains tax rate to 39.6% (43.4% if you include the net investment income tax), and taxing the appreciated value of unsold assets at the owner’s death. Long-embraced strategies for tax planning efficiencies are being upended by these proposals. 

Consider, for example, a business owner planning to make a bequest of family business interests to his or her children at death. The owner could see that bequest treated as if it were a sale for income tax purposes, taxable at the 43.4% capital gains rate (subject to certain exemptions and payment deferrals); in effect, the owner could see a loss of the basis step-up tax benefit for gifts from holding those assets until death. Moreover, this tax would be independent of the gift and estate tax, currently assessed at 40% on amounts gifted or transferred at death in excess of $11.7 million per person.  An increased estate tax rate and a lower exemption amount under the Biden plan would exacerbate the tax hit. 

Often you as an owner don’t have the luxury of scripting the precise timing and path between formation and exit.  If external forces (e.g., market conditions or tax law changes) are driving the sale of your business before year-end, there’s still time for effective estate planning measures. 

3 Proactive Steps You Can Take To Mitigate Estate Taxes: 

1. Put governing documents in order

Be sure your Operating Agreement, Voting Agreements, Shareholders’ Rights Agreements, Buy-Sell Agreements, and the like are current and complete, and consistent with your overall estate and business succession plan. Consider whether any provisions are stale and in need of an update (such as a valuation formula in a buy-sell agreement). Confirm all necessary signatures are on file and ownership information is up-to-date. Because time kills deals, eliminating potential hiccups in the due diligence phase is even more critical now if you’re seeking to close before year-end and mitigate the impact of higher taxes. 

2. Leverage Generational Gifting

If the sale of your business will create a taxable estate, there is powerful leverage pre-sale to gift and sell interests in your business, prior to a market value being set by an outside buyer. You can take advantage of lack of marketability and lack of control discounts for minority, non-voting interests ranging from 25-35% or more, depending on the circumstances.

Ideally, you should complete any gifting of business interests long before signing the Letter of Intent with the buyer. The IRS has taken the unofficial position that the execution of an LOI sets a price.

Pre-LOI, you can maximize lifetime gifting planning by removing business interests from your estate at the discounted value. Any increase in value at the time of sale, along with future appreciation on the business interests, would occur outside of your estate. 

If you simply don’t have time to focus on estate planning before signing the LOI, all is not lost. You may still be eligible for discounts “before the deal is done” based on uncertainties inherent in any deal. 

Discounts for the time value of money held in escrow, probabilities of hitting earnout targets, and risk arbitrage regarding whether a deal will happen at all provide a basis for taking discounts on pre-sale gifts of business interests, potentially in a range of 12-13%.  

3. Leverage Charitable Gifting

If you’re charitably inclined, charitable gifting pre- sale can help you achieve your goals and at the same time yield tax efficient results. For highly appreciated assets, pre-sale is a perfect time to consider a contribution to a charitable remainder trust (CRT).  You can gift an interest in your business to a charity and retain an interest in a periodic payment (such as an annuity) for a specified term.

At the end of the term the remaining assets would pass to the charity.  Tax benefits are three-fold: [1] there would be no gift tax on the gift to the charity; [2] as a tax-exempt entity the charity would pay no income tax on the sale of the interests (notwithstanding the gain on the appreciation of the company’s assets at the time of sale), and [3] you as the business owner would receive an income tax deduction for the value of the assets given to charity in the year of transfer.

IRS Section 7520 interest rates, used to calculate the annuity amount that is paid to the owner, remain low, making this a good time to consider a CRT. 

If your goal is to close on the sale of your business before year-end, it’s not too late to implement certain business succession and estate planning techniques. Acting now could have a meaningful impact. 

Photo Maribeth Younger Maribeth Younger, Counsel, Williams Weese Pepple & Ferguson.