President Biden signed the Inflation Reduction Act of 2022 (P.L. 117-169) into law on August 16, 2022. The legislation includes a new corporate minimum tax, a stock repurchase excise tax, numerous green energy credits, other tax provisions, and significantly increased enforcement resources. For an in-depth analysis of the federal tax provisions in the legislation see Checkpoint’s Executive Summary of the Inflation Reduction Act. The law makes changes to the Internal Revenue Code (Code) that could impact state taxation to varying degrees depending on the provision, the state, and the tax year at issue.
Rolling vs. static conformity.
Most states incorporate federal tax provisions by using federal gross, net, or taxable income as the starting point for calculating state taxable income and then applying state-specific modifications. “Rolling conformity” states generally incorporate the Code as amended and in effect for the applicable tax year. In these states, the state legislature will not need to take any action for federal tax law changes to take effect for state purposes. “Static conformity” states adopt the Code as of a specified date and the legislature must pass a law to advance that date (many update the date each year while some, such as California, advance the date less frequently). States may also conform to specific provisions only, carve out provisions for nonconformity, or use a different conformity date for certain Code sections.
Corporate alternative minimum tax.
The Inflation Reduction Act imposes a new 15% corporate alternative minimum tax (AMT) on the adjusted financial statement income of applicable corporations. (IRC §55(b)(2), as amended by Act Sec. 10101(a)(1)). This “book minimum tax” is a departure from the previous calculation of the corporate AMT rules, in place prior to the Tax Cuts and Jobs Act (TCJA) of 2017, where the starting point was taxable income. Some states, like Alaska and California, impose a corporate AMT and reference federal AMT provisions in their calculation. However, it is unclear whether states that had previously conformed to the pre-TCJA AMT rules based on taxable income will continue conforming to the new AMT based on adjusted financial statement income, given this shift in base. States considering conformity with the new AMT may analyze how taxpayers would apportion a tax based on adjusted financial statement income as opposed to taxable income.
New and extended federal excise taxes.
The Act includes several new or extended excise taxes, including a 1% excise tax on certain stock repurchases (buybacks) (IRC §4501(a), as added by Act Sec. 10201(a)). Federal excise taxes can play a significant part in a business’s overall tax liability, but generally they do not have a direct impact on state taxation.
Deductibility of excess business losses.
The Inflation Reduction Act also extends the limitation on deductibility of excess business losses in IRC §461(l)(1) from January 1, 2027, to January 1, 2029. States conform to this Code provision to varying degrees and the state’s conformity date will influence whether this change automatically flows through to the state level.
Observation:
The federal amendment will impact tax years starting in 2027 and 2028 and a state’s conformity date and method may change in the interim.
Cost recovery.
The Act modifies the calculation of the maximum accelerated cost recovery deduction under IRC §179D for green building property. Some states conform to IRC §179D, often due to using federal taxable income or federal adjusted gross income as the starting point for state income. The Act also adds three categories of green energy property to the MACRS 5-year property classification, applicable to facilities and properties placed in service after December 31, 2024: (1) “qualified facility” (defined under IRC §45Y(b)(1)(A) for the new Clean Electricity Production Credit); (2) “qualified property” (defined under IRC §48E(b)(2) for the new Clean Electricity Investment Credit which is a “qualified investment” defined under IRC §48E(b)(1)); and (3) “energy storage technology” (defined under IRC §48(c)(6) for the energy credit, but without application of the termination date for that provision).
In states that use static conformity, the federal changes will apply at the state level only with state legislative action. In rolling conformity states, legislative action would be needed for the state to opt-out of incorporating these provisions of the Inflation Reduction Act, unless the state already excludes the applicable Code sections from their conformity provisions. New Jersey, for example, conforms to depreciation and expensing provisions in the Code as of December 31, 2001 (depreciation) and December 31, 2002 (expensing). For the changes that are effective for property placed into service in a future year, states have several years to act.
Observation:
Cost recovery is a common area for state nonconformity, and states may take different approaches in different years. It is important to review each state’s rules carefully. States may also opt out of, for example, bonus depreciation under IRC §168(k) while conforming to federal depreciation provisions regarding property classification.
Green energy tax credits.
The federal legislation includes over 20 new, extended, and expanded federal tax credits to boost green energy production and use. The legislation further encourages use of certain environmental-related credits by allowing applicable entities (mostly, tax-exempt entities and certain government entities) to elect to be treated as making a payment against income tax equal to the credit amount or by allowing eligible taxpayers (those that are not applicable entities) to transfer certain environmental-related credits to other taxpayers.
Generally, tax credits are applied after calculating federal tax liability and thus do not flow directly into the calculation of state income in the same manner as federal income and deductions. However, states with credits tied to a federal credit amount or that reference federal calculations and definitions could be affected by the new law.
Conclusion.
The Inflation Reduction Act provides additional resources for federal tax enforcement and makes significant tax policy changes. It may be several years before it can be determined whether increased federal enforcement leads to increased federal and state taxable income. Further, since many of the federal tax law changes apply to excise taxes and credits rather than to parts of the Code to which states generally conform on a widespread basis, many changes do not have an immediate state tax impact. Nearly every state has ended their legislative sessions this year and will have the opportunity to consider the conformity issues raised by the Inflation Reduction Act when the legislatures return (in most states) in early 2023.
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