Tax Implications of the Inflation Reduction Act

Financial advisors have long been awaiting the Inflation Reduction Act of 2022, which was signed into law by President Joe Biden on Aug. 16, 2022. According to the Congressional Budget Office and the Penn Wharton Budget Model, the Inflation Reduction Act is not expected to have much impact on inflation, despite its name.

There are also no meaningful changes in terms of personal income taxes. So why should financial advisors be familiar with it? Financial advisors can still provide great value to their clients by being familiarized with some of the Inflation Reduction Act’s biggest provisions as follows:

— Energy-efficient home improvement tax credits.

Electric vehicle tax credits.

— Premium tax credit eligibility expansion.

— Pass-through tax break limits.

— Understanding what’s not in the Inflation Reduction Act.

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Energy-Efficient Home Improvement Tax Credits

One of the Inflation Reduction Act’s main goals is to address climate change. As such, there are incentives for homeowners to make energy-efficient improvements to their homes. The non-business energy property credit, which expired in 2021, has been extended and renamed the energy-efficient home improvement credit. Starting in 2023, homeowners can claim up to 30% of the cost of all eligible home improvements made during the year, and the $500 lifetime limit under the old credit has been replaced with a $1,200 annual limit. Some specific home improvements have had their limits modified, allowing them to exceed the $1,200 annual limit. For example, there’s an up to $2,000 credit for an electric or natural gas heat pump water heater under this credit.

For families whose annual income is less than 150% of the median income where they live, the high-efficiency electric home rebate program can be of great benefit. For example, there’s a credit of up to $8,000 for a heat pump used for space heating or cooling, $840 for a stove, $2,500 for electrical wiring and $1,600 for insulation. Under the rebate program, the maximum total rebate can be up to $14,000.

This can present a planning opportunity when working with a client that is mapping out home improvements in the future and has the ability to control their income.

Electric Vehicle Tax Credit

The Inflation Reduction Act also make some major changes to the EV tax credit, in order to help combat climate change. For qualifying electric vehicles placed into service in 2023, the Inflation Reduction Act extends the EV tax credit up to $7,500 until December 2032. Used vehicles that are at least two years old will have a separate tax credit, up to 30% of the price of the vehicle, or as much as $4,000 as long as they are not purchased for resale.

Premium Tax Credit Eligibility Expansion

Another major goal of the Inflation Reduction Act is to reduce the cost of health care. The premium tax credit will now be available to more individuals and for a longer period of time. The premium tax credit was originally included in the Affordable Care Act, and was designed to help lower-income individuals pay for health insurance obtained through the health care marketplace or state exchange by subsidizing the cost of health insurance. This was accomplished by providing advanced payments to the insurance company, which in turn lowered the out-of-pocket costs for consumers. In its original form, individuals and families could only claim the credit if their income level was between 100% and 400% of the federal poverty level. However, in 2021 and 2022 people with income levels above this threshold were allowed to claim the credit as a result of the American Rescue Plan Act. The Inflation Reduction Act has extended the temporary exception to the 400% cap through 2025.

This allows financial advisors to help their clients plan for health care costs in the future as they incorporate their out-of-pocket insurance and other costs into their financial plans.

Pass-Through Tax Break Limits

The Inflation Reduction Act also extended a tax limitation on pass-through entities for two more years. This can provide a planning opportunity for financial advisors who work with self-employed individuals. Pass-through businesses include sole proprietorships, S-Corps, some LLCs, and partnerships. There currently is a limit called the “limitation on excess business losses” in place, which was scheduled to end in 2027. The Inflation Reduction Act extends this another two years. This law disallows pass-through owners from using business losses exceeding $250,000 to offset non-business income. The threshold is $500,000 for married couples filing jointly. These numbers adjust for inflation and in 2022 are $270,000 and $540,000, respectively.

Understanding What’s Not in the Inflation Reduction Act

Financial advisors should also be familiar with what’s not included in the Inflation Reduction Act, as it can help ease some of the concerns clients may have had. The Inflation Reduction Act is not designed to raise taxes on families making less than $400,000 or small business owners. Instead, it’s focus is on larger corporations. The Inflation Reduction Act includes a 1% excise tax on corporate stock buybacks and businesses with $1 billion or more in reported income will pay a minimum corporate tax of 15%. The Inflation Reduction Act also includes $80 billion of additional IRS funding, mainly geared toward improving their processing systems, hiring more staff to provide for a better customer service experience, improving technology and an estimated $45 billion to improve enforcement, although not geared toward the average American family.

There were also no changes to backdoor Roth IRA rules. This was a major concern that financial advisors were worried about, since it may have impacted a lot of the work done to help higher earners contribute to Roth IRAs.

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