What Should You Know About the Inflation Reduction Act
Unless you've been hiding out underneath your weighted blanket rewatching Schitt’s Creek for the last month (honestly, fair), you’ve probably heard about the Inflation Reduction Act. And you’ve probably heard a lot of crazy, confusing things about it, too.
While the long-term effects of the Inflation Reduction remain to be seen (hence the phrase “long-term”), we can offer you at least a few details and answer a few questions about this major piece of legislation that addresses not only inflation and taxes, but (somehow) climate change and healthcare. And we’ll do it in four parts:
The Main Takeaways
Some Notable Details
The Nitty Gritty
What About Inflation?
Let’s get into iiiiiiiiit.
The Main Takeaways
It Expands Medicare Benefits
This Act expands Medicare benefits for those enrolled in Medicare plans, including:
Free critical vaccines beginning in 2023;
A $35/month cap on the cost of insulin beginning in 2023; and
A cap on out-of-pocket, annual drug costs to an estimated $4,000 or less, beginning in 2024. This cost is anticipated to settle at $2,000 in 2025.
2. It Lowers Healthcare Costs
This Act also lowers overall health care costs outside of Medicare coverage.
The Inflation Reduction Act is anticipated to save the average enrollee $800/year in the Affordable Care Act (ACA) marketplace, allows Medicare to negotiate the price of over 100 drugs over the next decade, and requires drug companies to rebate back price increases higher than the rate of inflation.
3. It Lowers Energy Costs
This Act lowers energy costs for American households.
The Inflation Reduction Act is anticipated to cut energy bills by $500 to $1,000 per year, per household.
4. It’s a Historic Climate Investment
This Act also makes a historic climate investment, marking one the single largest federal investment in combat climate change.
By utilizing various methods - including clean energy subsidies and tax credits - the Act hopes to reduce carbon emissions by roughly 40% by 2030.
5. It Creates Clean Energy Manufacturing Jobs
This Act also heavily focuses on creating clean energy manufacturing jobs.
A $60 billion invested will create millions of new domestic, clean manufacturing jobs.
6. It Promotes Environmental Justice for Disadvantaged Communities
The Act focuses on investments in disadvantaged communities, with specific focus on cleaning up pollution and taking steps to reduce environmental injustice.
This includes a $60 billion investment for environmental justice and sustainability.
7. It Closes Tax Loopholes
The Act takes specific focus on closing tax loopholes used by the mega-wealthy.
This includes a 15% corporate minimum tax, a 1% fee on stock buybacks and enhanced IRS enforcement (we’re sure you’ve heard a lot of rumors about this. Check below for more on this).
8. It Protects Lower Income Families
The Act will balance this effort to close tax loopholes by protecting families and small businesses making $400,000 or less.
The increased IRS scrutiny mentioned above will, hypothetically, apply only to high-earning taxpayers and will not be applied to households under the $400,000 yearly income threshold.
Some Notable Details
Tax Credits for Cleaner Energy
The bill offers a number of tax credits for people switching to cleaner energy sources, including electric vehicles and rooftop solar panels.
Those incentives will take effect in 2023, and according to Democrats, will mean a 40% cut in greenhouse emissions from 2005 levels by the end of the decade.
2. IRS Funding
The Internal Revenue Service will get a boost in funding, particularly to improve its customer service and tax enforcement.
This investment could help alleviate some of the challenges with long response times or getting tax refunds processed.
It could also increase collection of taxes that are currently owed but go unpaid.
3. Health Insurance Subsidies
Millions of Americans will continue to benefit from subsidies that help with rising health insurance premiums that were originally slated to expire next year.
4. Capping Out-of-Pocket Prescription Costs
The bill will put a $2,000 annual cap on out-of-pocket prescription drugs for individuals insured by Medicare. This will be most impactful for senior citizens with illnesses such as cancer and multiple sclerosis.
However, this provision won't materialize until 2025.
The Nitty Gritty
Ultimately, our clients will not be drastically affected by any of the new policy updates. But, just in case you needed some more in-depth answers to your burning questions:
Am I going to see an increase in my taxes?
It's unlikely that a vast majority of households will see a direct impact on their taxes, including the majority of our clients. Instead, the tax increases will largely fall on corporations.
That being said, consumers may feel that tax burden indirectly (specifically if you work for a C Corporation or Professional Corporation). When taxes on large corporations rise, the price of doing business for these large corporations rise… so they raise their prices. Of course, this is all hypothetical, but it's a hypothesis based on history.
What about the $80 billion dollars dedicated to the IRS?
The Inflation Reduction Act did, indeed, dedicate a staggering $80 billion to the Internal Revenue Service (IRS). $45.6 billion of that funding will go towards increased enforcement which, yes, means an increase in the number of IRS agents out there.
The IRS has estimated that 87,000 new agents will be hired and trained within the next few years, but that’s exactly that - an estimate. The precise number of IRS agents needed will most likely shift as needs arise.
Keep in mind that “enforcement” doesn’t just mean auditors. Most likely this number will include legal counsel and assistance, as well as technological assistance and advancements that will aid in IRS investigations.
Will this increase the number of IRS audits?
With increased hiring and training of new agents and legal support, there will inevitably be an increased level of audits overall. This, combined with studies showing that in the past, lower-income taxpayers have seen higher-than-average IRS audits rates than higher-income taxpayers, naturally causes concern.
However, the IRS has been very clear that these audits will heavily focus on high-income earners making more than $400,000 per year, rather than lower- and middle-class Americans.
That being said, we at The Freelance CFO have some… reservations about the validity of this promise. With the IRS, it’s always best to proceed with caution.
What is the IRS after?
The ultimate priority of the IRS and Treasury Department with this $80 billion investment is to close the $600,000,000 “tax gap” (the difference in what high-earners owe in taxes versus what they inevitably end up paying). This will be accomplished by focusing heavily on:
High-earners;
Large corporations; and
Complex partnerships
Will this affect my tax returns?
If you didn’t know, the IRS’s systems currently rely on COBOL - a more than 50-year old computer programming language and system. That’s right - your iPhone has more processing power than all of the IRS computer systems, combined.
The good news here is that a large part of this funding is directed towards completely modernizing IRS systems and hiring customer support to make tax services, returns and refunds more efficient.
How exactly does the Inflation Reduction Act help small businesses?
In theory, the Inflation Reduction Act will not only scrutinize high earners, but directly benefit small businesses (or, at least, their owners). While Wall Street analysts generally agree that the Inflation Reduction won’t hurt most U.S. companies, the Act actually includes four major positives for small businesses owners and their money.
Specifically for the businesses themselves:
The qualified business income deduction (aka,” the pass-through deduction”) will be extended from 2025 through 2027.
Remember that “pass-through” companies are S-Corps, partnerships and other entities where the business income “passes through” to the business owner’s individual return.
This deduction, therefore, allows these entities a 20% deduction on their business income.
The increasingly popular research and development tax credit has been significantly expanded.
This tax credit gives businesses of all sizes the opportunity to reduce the taxes they owe, based on the amount of money spent developing new products (there’s also a crazy formula involved, but you get the picture).
Previously, if business owners wanted to apply this tax credit against their income or payroll taxes, the limit was $250,000. This has now increased to $500,000.
Specifically for business owners:
Business owners may be able to take advantage of the tax credit given on the use of electric vehicles (see more on that above), thus lowering their taxes.
Business owners may also be able to take advantage of the separate - yet still climate-related - tax credit addressing taxpayers who are investing in energy-efficient improvements to their personal homes (see above again), thus lowering their taxes.
What About Inflation?
Despite its name, there have been serious and valid criticisms to the Inflation Reduction Act. Many economists and legislators have questions whether or not this Act will actually reduce inflation, which stubbornly remains at 8.2% after the bill’s passage (remember - inflation should typically hover around 2% - or even a bit lower - in a stable economy). The bad news?
The Inflation Reduction Act won’t lower your gas or grocery bill anytime soon.
Most of the policies put forth in the Inflation Reduction Act to actually reduce the price of inflation are directed towards long-term legislative policy and tax strategy, such as the tax credits. There is very little policymakers can do to impact inflation overnight. The ultimate responsibility of curtailing current rising costs falls upon the Federal Reserve, but even the Fed has its limitations. Any decision that the central bank makes regarding fiscal policy needs time to make its way across the country and into the financial system itself.
In conclusion?
This thing is a behemoth of policy, a lot of which will, hopefully, be directed towards positive economic change over the long-term… but again. With the IRS, it’s always best to proceed with caution. The Inflation Reduction Act may eventually do what it’s named for and, ya know, reduce inflation. But the effects won’t be immediately seen for a few months, possibly longer. A recession may still be looming, after all (if we aren’t already in one, that is). And while we’re hoping increased audits won’t negatively impact small businesses, we have our doubts.
So, what to do?
Be prepared for anything.
And if you’re worried about an audit? Get in touch with us.
Yes, yes, yes, a shameless plug this may be. However, we wouldn’t be offering up our services if we weren’t serious about 1) Everything that we’ve just discussed in this blog; and 2) our ability to handle your books with the care, confidence and consideration it deserves.
Make sure your tax strategy is up to speed, and set up a one-on-one Tax Strategy Call with our resident Tax Strategist, Brock Ramaglia
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Disclaimer: The information provided in this blog is for educational purposes only and does not constitute financial or tax advice. Reach out to The Freelance CFO team with any questions regarding specific financial concerns, or seek the services of a fiduciary.
