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:
- 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.
- 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.
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:
