August 23, 2022
Inflation Reduction Act has implications for tax-exempt entities
The Inflation Reduction Act (H.R. 5376) (the Act), signed into law on August 16, 2022, contains provisions affecting tax-exempt entities, including: a 15% corporate alternative minimum tax (CAMT) based on adjusted financial statement income (AFSI) for corporations with profits exceeding $1 billion ($1 billion of unrelated business taxable income (UBTI) for tax-exempt corporations); tax credit opportunities under new IRC Section 6417 to encourage investment in clean energy; expanded incentives for energy-efficient construction by tax-exempt entities; and increased IRS funding to improve IRS enforcement and taxpayer compliance.
CAMT applicable to unrelated business income
The CAMT, a new 15% minimum tax, will apply to a domestic corporation's (or group of corporations treated as a single employer under IRC Section 52(a) or (b)) average AFSI exceeding $1 billion for any three consecutive tax years preceding the tax year at issue. (See, HR 5376, section 10101, Corporate Alternative Minimum Tax.) The 15% CAMT will be effective for tax years beginning after December 31, 2022, and will not apply to S corporations, regulated investment companies or real estate investment trusts.
For tax-exempt corporations subject to unrelated business income tax (UBIT), new IRC Section 56A(c)(12) adjusts AFSI to take into account solely AFSI attributable to (1) an unrelated trade or business; and (2) debt financed property, to the extent the income is treated as UBTI.
The new CAMT underscores the importance of scrutinizing the reporting on a tax-exempt corporation's financial statements and carefully determining and reporting its UBTI. Tax-exempt corporations should also carefully review IRC Sections 52(a) and (b) to determine which of their affiliate entities must be treated as a controlled group of corporations, the UBTI of which must be aggregated when determining if the group has met the $1-billion threshold.
Energy tax credit opportunities
By adding IRC Section 6417 to the Code, the Act will make tax-exempt entities eligible for a direct-pay option for certain tax credits that encourage investment in clean energy. (See HR 5376, section 13801, Elective Payment for Energy Property and Electricity Produced from Certain Renewable Resources, Etc.) Specifically, IRC Section 6417 will allow "applicable entities," defined as tax-exempt entities, government entities, state and local governments, the Tennessee Valley Authority, Indian Tribal governments or an Alaska Native Corporation, to make a direct-pay election to have energy tax credits determined without regard to the IRC Section 50(b) limitations. The newly available credits generated by a renewable energy project would be treated as a direct payment against tax, enabling a tax-exempt entity to receive a refund, regardless of whether it has UBTI.
The tax credit under IRC Section 6417 provides new incentives for a broader range of tax-exempt entities to invest in clean energy. For organizations previously incapable of claiming such credits, the new law will serve as another way for organizations to lower their UBIT liability or receive refunds. Tax-exempt entities should spend adequate time understanding the benefits of these credits, especially when considering investing in renewable energy projects.
Incentives for energy-efficient design
The Act provides funding for loans and grants for projects addressing affordable housing and climate change. (See HR 5376, section 13303, Energy Efficient Commercial Buildings Deduction.) Funding for these projects would, for example, provide incentives to improve the efficiency of water and energy usage in affordable housing.
The Act expands the tax deduction for energy-efficient commercial buildings under IRC Section 179D to allow the deduction to be allocated to "the person primarily responsible for designing" energy-efficient commercial-building property that is installed on or in property owned by a tax-exempt entity. For purposes of the IRC Section 179D tax deduction, the designer will be considered the taxpayer. Tax-exempt entities, for this purpose, include entities exempt from taxation under federal law, governmental entities, Indian tribal governments and the Alaska Native Corporation.
These new incentives may be particularly attractive to tax-exempt hospitals, universities and other tax-exempt entities that invest in energy-efficient buildings, as they may now be eligible for financial benefits under the expanded tax deduction.
Enhanced IRS resources
The Act provides significant increased funding to help the IRS improve taxpayer services and compliance. (See HR 5376, section 10301, Enhancement of Internal Revenue Service Resources.) Focus areas for the funding include business systems modernization, e-file systems, enforcement and customer service.
The Act provides an influx of funding to strengthen the IRS's enforcement and outreach efforts to taxpayers, enable a much-needed upgrade to its business and e-file systems (which should enable the IRS Tax Exempt and Government Entities division to more efficiently and effectively process e-filed Forms 990, 990-PF, 990-T and 4720) and provide better support to those attempting to contact IRS Customer Account Services. Tax-exempt entities will likely see an uptick in IRS examinations and other enforcement activity as a result of this increased funding, further behooving exempt organizations to maintain proper tax compliance, reporting and supporting documentation.