There’s no way to sugarcoat this: Small and midsize businesses should be scared to death about the consequences of the Inflation Reduction Act. Unless they provide goods and services to the green energy industry, the law’s unforeseen consequences could increase their operating expenses in two ways. Here’s what to expect — and how to prepare.
The Inflation Reduction Act is essentially a climate change law with some health care benefits. While the new legislation doesn’t include any direct tax increases on small and midsize businesses, some of its provisions have the potential to raise costs for these companies significantly.
First Reason Why Cost of Business Could Be Going Up
For one, your chances of being audited may be going up. The new bill substantially expands the Internal Revenue Service’s budget: More than half of the $80 billion increase in the IRS budget over 10 years will be used to beef up enforcement through new technology and new hires. That means more audits for companies that are the least able to financially manage them. I worry for businesses that gross $5 million or less since they usually don’t have excess funds to pay a lawyer $50,000 to fight the IRS if their matter proceeds to court.
In a letter to the Senate, the agency’s commissioner said, “These resources are absolutely not about increasing audit scrutiny on small businesses or middle-income Americans.” Even so, with the hire of new auditors, it’s likely that people with little or no experience will be leading audits. Resulting errors could force businesses to take disputes to tax court or feel compelled to settle. Either way, the costs in time and money could be substantial.
Here’s just one example of what I think will happen with more frequency: I currently represent a real estate developer who borrowed $6 million from a bank to help fund a new development. A young auditor, who majored in history in college and had no accounting or business background, recharacterized the loan as income, even though we had a 300-page loan binder from the bank and a letter from the bank president saying the loan was being repaid.
My client received a $2 million tax bill because the auditor re-classified the loan to income. I’m now in tax court on behalf of the client to prove that the loan isn’t income. I expect many more stories like these as the IRS expands and exercises its enforcement power.
A Second Way Businesses’ Costs Could Rise
Counterintuitively, the new law could also increase the costs of fuel and electricity. Green energy isn’t presently able to replace the stability of fossil fuel energy — the technology to store wind and solar power simply isn’t there yet.
To be fair, the act earmarks $386 billion for climate and energy spending and tax breaks to expand the use of green technology, but that technology still isn’t entirely dependable. Just look at France and Germany, where green energy initiatives haven’t provided enough power to make up for reduced electricity supply caused by nuclear reactor fixes and reduced Russian gas imports.
I also worry the new law will cut investment in fossil fuels and increase the tax rate on certain crude and petroleum products 16.4 cents per barrel. This could increase power and electricity costs, which are already rising. That, too, can hurt small and midsize businesses.
5 Things Businesses Should Do to Prepare
Companies must prepare now for potential negative consequences of the Inflation Reduction Act. Here’s how:
- Assume you’ll be audited. If the IRS audits your whole return, what will they find? If there’s something there, address it now so you’ve at least mitigated the risk going forward. Be honest with yourself.
- Commit more resources to record-keeping. Keep original receipts to document the business purposes of all your spending. If you go on a trip and expense a business dinner or sponsor an event, document it. Don’t just record the expense: You must be able to prove it with receipts and demonstrate how it benefits the business. Don’t fudge the numbers. The worst thing you can do is send your tax adviser into an audit with nothing to verify the accuracy of the deduction.
- Beware of certain tax credits and tax deductions. If you declare certain tax reductions of any substance, the IRS will be interested in auditing the heck out of it. Every year the IRS publishes its Dirty Dozen list of “potentially abusive arrangements that taxpayers should avoid.” This year’s list includes two arrangements on which the IRS is currently hammering small and midsize businesses and their owners — syndicated land conservation easements and captive insurance. While these strategies are legal, be sure you are doing them with reputable vendors who execute the strategies properly.
- Be open and honest with your tax preparers and expect the same of them. Demand that your tax preparer answer your questions and knows what they’re doing. If they fail at either, find a new tax preparer.
- Be mindful about costs and profitability. If energy prices rise as I expect, we’ll be in this inflation cycle for a while. Scrutinize the pricing of your services and products. Be ready to strategize smart ways you can pass those higher costs on to clients and customers.
The United States is a strong, resilient country, supported in great part by the integrity of its small and midsize businesses. It’s up to us to understand the unforeseen consequences of this new law and protect ourselves as much as possible.
Learn More About the Inflation Reduction Act
The Inflation Reduction Act was signed into law on August 16, 2022. For more information from Kiplinger about this climate, healthcare and tax legislation, see:
- The Inflation Reduction Act and Taxes: What You Should Know;
- Save More on Green Home Improvements Under the Inflation Reduction Act;
- EV Tax Credits Are Changing: What's Ahead;
- Is an Army of New IRS Agents Coming for Your Tax Dollars?;
- Inflation Reduction Act Boosts Obamacare Tax Credit;
- Biden's Inflation Reduction Act: Investing Winners and Losers;
- Inflation Reduction Act a Blessing in Disguise for Drug Stocks?; and
- How Senate Breakthrough on Climate Could Benefit ESG Investors.
Bruce Willey has been working with small to midsize businesses across the country for more than a decade, helping them navigate business and tax law in a variety of situations. His services include assisting with business start-ups, operations, growth, asset protection, exit planning and estate planning.
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