Tax Law Updates, Including the Inflation Reduction Act

This article will highlight only some of the key items affecting income taxes, including scheduled changes in selected tax rules as well as new laws passed in the Inflation Reduction Act (IRA). It will not address the very detailed and numerous changes in alternative energy production (solar and production tax credits) or refueling 
facilities at this time. 

Scheduled and Highlighted Changes 

Section 45W Credit for Qualified Commercial Clean Vehicles – The IRA introduced a tax credit for “Commercial Clean Vehicles.” The credit is more targeted to commercial vehicles as opposed to personal use vehicles, which are covered under IRS Sec 30D and Sec 25E. IRS Sec 30D has numerous limitations and requirements pertaining to the source of the materials as well as where the asset is manufactured, whereas Sec 45W does not. 

The Sec 45W credit is the lesser of (a) 15% of the taxpayer’s basis in the vehicle and appears to be mostly targeted at hybrid vehicles, and (b) 30% for vehicles powered by other than gasoline or diesel, such as electricity, natural-gas or fuel cells. The credits are capped at $7,500 for vehicles with a weight rating of less than 14,000 pounds (mostly cars and light trucks) and the lesser of $40,000 or the incremental cost of the vehicle compared to a gas/diesel powered vehicle. The larger Sec 45W credit is aimed at larger alternative clean fuel, fuel cell and electric vehicles, such as heavier general-purpose trucks and Class 8 tractors. 

The credit casts a wider net however and is expected to also include other “mobile machinery” such as forklifts and even commercial lawn mowers, so it opens a wider range of asset classes. 

The Sec 45W credit has less restrictions than the Sec 30D credit pertaining to critical mineral or battery components. This may mean that cars which otherwise might have limited credits under Sec 30D may have larger credits when leased to consumers, because they are being depreciated for tax purposes. This should be resolved when the Regulations are issued; initial experience has indicated that a fair amount of confusion exists in the application of the credits. 

Interest expense deduction limitation – IRS Sec 163j - Commencing Jan. 1, 2022, the limitation of net interest expense deductibility for entities with a three-year average annual gross receipt over $25 million switched to a Tax Earnings Before Interest & Taxes (“Tax EBIT”) benchmark. In general, a taxpayer that has interest expense (net of interest income) greater than 30% of Tax EBIT would be unable to currently deduct the interest expense above the 30% threshold. The non-deductible interest is carried forward to be utilized if or when the reverse situation occurs. Many capital-intensive entities such as manufacturers and operating lessors are often leveraged such that they will inevitably have currently non-deductible net interest expenses and may be carrying a non-deductible amount for either an extended period or perhaps indefinitely. 

A taxpayer can either (i) change their capital structure, for instance by leveraging at a lower level, (ii) explore the effect their bonus depreciation election has on the calculation and/or (iii) use tax lease financing to finance some of their assets as a lessee, thus converting interest expense to rental expense. Each of these actions has an inherent counter effect which must be considered. 

This situation may provide lessors with a new opportunity to provide tax-oriented leasing to address this tax situation. 

Bonus depreciation phase down – Bonus depreciation phases down to 80% for most assets placed in-service after Dec. 31, 2022 (exceptions apply). Initial analysis indicates that this decrease in bonus depreciation has little economic impact, but the change should be incorporated into all pricing and analyses. 

Introduction of Book Alternative Minimum Tax – The IRA introduced the “book” Alternative Minimum Tax (“BAMT”). This applies to U.S. taxpayers with a consecutive three-year-average book income exceeding $1 billion for U.S. companies or $100 million for U.S. subsidiaries of multi-nationals. Morgan Stanley estimates between 70-100 entities fit these definitions. 

These entities would be required to calculate their taxes using both the statutory approach with a 21% rate and the BAMT approach using 15%. BAMT disallows certain items but not bonus depreciation. The taxpayer then pays the higher of the two calculations and if they must pay the BAMT, the excess paid over the statutory tax amount is carried forward for potential future application when the opposite scenario occurs. Effectively it is a pre-payment of taxes. 

Note that if a taxpayer is subject to BAMT, its accelerated tax depreciation is only deducted at 15%; if one identifies a candidate subject to BAMT, they may be a potential lessee if the time value of the 6% difference is large enough. Further, if a taxpayer has tax-exempt income, it is unclear at this point if that income will then become taxed; the final regulations are being released shortly. 
 

Conclusion

The equipment finance industry is presented with great opportunities to invest in these alternative energy opportunities. This article described only a fraction of the tax incentives now in the Tax Code. The challenge continues to pertain to understanding the complex economic nature of the tax incentives and incenting marketing staff to make those investments.  

Disclaimer - The views expressed here are that of the author and not of the organizations or entity that the author works with or for. The author is not providing tax, accounting, legal or business advice herein. Any discussion of U.S. tax matters is not intended or written to be used by any taxpayer for the purpose of avoiding U.S. tax-related penalties. Each taxpayer should seek advice from their own independent tax, accounting or business adviser.