The Inflation Reduction Act of 2022 (IRA) was signed into law by President Joe Biden (D) today (August 16, 2022) and brings with it a wide variety of law changes relating to tax, climate change, energy, and health care. The headline of the tax provisions is the introduction of a 15% corporate alternative minimum tax (“Corporate AMT”). This new Corporate AMT represents a significant change to the tax code and will take some time to fully comprehend. Additionally, taxpayers will have to wait for what will likely be significant additional guidance from Treasury on how to implement the new regime.

Simply stated, Corporate AMT will apply to certain large taxpayers with an adjusted financial statement income (“AFSI”) greater than $1 billion. And these taxpayers will be required to pay an annual minimum tax of 15% of their AFSI. However, S Corps, regulated investment companies, and REITs are specifically excluded from the Corporate AMT and there are special provisions pertaining to foreign-parented multinational groups. Corporate AMT will be effective for taxable years beginning after December 31, 2022.

Generally, financial statement income is calculated using GAAP or other non-tax accounting principles. But the IRA provides for a number of adjustments to AFSI which would bring it more closely aligned with US federal income tax calculations. One such adjustment is for depreciation related to tangible property. The IRA states that AFSI “shall be reduced by depreciation deductions allowed under section 167 with respect to property to which section 168 applies to the extent of the amount allowed as deductions in computing taxable income for the taxable year, and appropriately adjusted to disregard any amount of depreciation expense that is taken into account on the taxpayer’s applicable financial statement with respect to such property…” In short, AFSI will be calculated based on tax depreciation instead of financial statement depreciation. This carve-out, which was introduced late in the process by Senator Kyrsten Sinema (D-AZ), could have a significant impact on certain manufacturers and other taxpayers with capital intensive businesses.

Because of bonus depreciation and the modified accelerated cost recovery system (“MACRS”), tax depreciation expense is generally recognized on an accelerated timeline when compared to financial statement depreciation expense. So this adjustment could turn out to be a significant benefit to many taxpayers. For example, assume a taxpayer placed into service a $10 million piece of machinery during its 2023 taxable year. The table below illustrates how the depreciation adjustment to AFSI could play out in year 1.

The adjustment for this specific piece of machinery will eventually reverse as the yearly financial statement depreciation expense begins to exceed the yearly tax depreciation expense. But if a taxpayer continues to make significant new capital investments each year and takes advantage of accelerated tax depreciation treatment via bonus depreciation and Cost Segregation studies, the yearly AFSI adjustment for depreciation will likely remain favorable (i.e., reducing the AFSI and thus reducing the Corporate AMT liability). This should provide manufacturers and other taxpayers with capital intensive businesses, who may be subject to the Corporate AMT, with a renewed focus on Cost Segregation and other proactive depreciation planning strategies.

A number of other complex considerations may arise as a result of the depreciation adjustment to AFSI. We may not know the full extend of these impacts until Treasury issues guidance on this provision of the IRA. But these considerations could include the following:

• Gain or loss on disposition of tangible property
• Depreciation recapture
• Differences in depreciable basis between financial statement and tax depreciation calculations (e.g., repairs & maintenance, UNICAP, tenant construction allowances, financial statement impairments, etc.)
• Catch up adjustments arising from accounting method changes (i.e., Section 481(a) adjustments)
• Timing of bonus and/or ADS elections
• Changes to fixed asset depreciation software configurations (i.e., taxpayers may need to create new “books” within their fixed asset system in order to track and properly calculate the yearly adjustment)

It will be interesting to see how this all plays out and the IRA is sure to have a significant impact on taxpayers and tax practitioners for years to come. If you have any questions regarding the application of these provisions of the IRA to your specific facts and circumstances, please reach out to Andrew Kohrs at [email protected].