How North Bay employers could be impacted by Inflation Reduction Act

When President Joe Biden on Aug. 16 signed the $739 billion Inflation Reduction Act of 2022, the administration touted it as the beginning of work to bring down 40-year-high record inflation and address climate change and the high costs of energy and health care.

Over the next decade, the legislation will include $433 billion in new spending and over $300 billion committed to reducing the deficit, according to the Congressional Budget Office. The bill would slightly increase inflation for the next two years, and then lead to lower prices, according to the Wharton School, a business research school of the University of Pennsylvania in Philadelphia.

The legislation allots $64 billion to a three-year extension of enhanced Affordable Care Act premium tax credits, according to the CBO. The Internal Revenue Service stands ready to gain $80 billion to make improvements.

The “pay-fors” to cover these investments include $313 billion from a 15% minimum corporate tax, $288 billion from prescription drug-pricing reforms, $124 billion from bolstering IRS tax enforcement, and $74 billion from a 1% excise on corporate stock buybacks, according to the CBO.

So what does this all mean for North Bay employers? The Business Journal checked in with a number of businesses to find out.

Taxes

Some of the North Bay’s publicly traded companies could be affected by the new law’s provision to levy a 1% excise tax on purchases of their own shares starting next year. One of the exclusions was buybacks totaling under $1 million annually.

Corte Madera-based luxury home goods retailer RH in June upped its common-stock repurchase plan by $2 billion, on top of the $450 million it had remaining from its previous buyback authorization. If fully used, that could result in an excise tax of $24.5 million.

But by the end of June, RH said it was revising its outlook for the second half of its fiscal year and noted that it hadn’t repurchased any more shares.

“The deteriorating macro-economic environment has resulted in lower than expected demand since our prior forecast...,” CEO Gary Friedman wrote in the shareholder letter.

Nationwide, buybacks this year are forecast to reach $1 trillion as businesses have “swelled with cash from sky-high profits,” according to the New York Times.

But at Novato-based Bank of Marin, a key reason for the stock buybacks is for the benefit of shareholders, namely the company’s employee stock ownership plan, or ESOP, according to Chief Financial Officer Tani Girton.

“We’ve had dependable and predictable growth,” Girton said. “Every one of our employees is a shareholder. This is with them in mind.”

When the company does its capital planning, it aims for a sustainable dividend over time, and the institution has been increasing them over time to be in line with comparable Standard & Poor’s capital yields.

The bank’s board in the middle of last year approved the repurchase of up to $25 million through mid-2023, then increased that authorization to $57 million. By June 30 of this year, the bank had bought back nearly 619,000 shares for $22.3 million, with the last round of repurchases including $877,000 in the first quarter.

In 2018, the bank repurchased $71 million in stock, and that was accelerated in 2019 but suspended in early 2020 amid the economic shock of the pandemic.

“We wanted to consolidate liquidity and capital to be ready for what comes,” Girton said.

The repurchases were restarted at the end of 2020.

But one challenge with planning for repurchases in the pandemic has come because of the flood of deposits from various government relief programs to the bank’s customers, Girton said. That tipped the percentage of total assets for capital down on the balance sheet.

The excise tax could affect further stock buybacks for the bank, because the capital planning is done based on a spectrum of company stock prices, all after tax costs are considered, Girton said. Higher after-tax stock prices could result in fewer shares purchased.

The Inflation Reduction Act of 2022 also will impose a 15% corporate alternative minimum tax on businesses with income of at least $1 billion a year for any consecutive three-year tax period, according to the Wharton School and Stoel Rives. The earnings metric in question is adjusted financial statement income, or net income, with adjustments specified in the law.

No North Bay public companies have crossed the billion-dollar annual earnings threshold yet, but some are nearing it.

For example, Santa Rosa-based Keysight Technologies reported net income of $894 million in fiscal 2021, up from $627 million and $621 million the previous two years. RH reported earnings of $688.5 million in fiscal 2021, a big jump from $271.8 million and $220.4 million in fiscal 2020 and 2019, respectively.

IRS

The agency’s own infrastructure is so antiquated and inadequate, it still uses fax machines.

“I think they have needed to make improvements on the technology side. Just trying to call them is a huge problem,” said Andre Shevchuck, a partner and accountant working in the Specialized Tax Services division of BPM. The San Francisco-based accounting firm has offices in the North Bay.

Shevchuck noted throwing money at an agency that enforces tax collections appears like a “careful-what-you-ask-for" approach.

“It seems counterintuitive because we don’t necessarily want more audits,” he said. But that’s precisely where the tax specialist estimated the money would go because audits raise revenue for the U.S. government. About half the funding is earmarked for enforcement, according to a Kiplinger report on Aug. 22.

Declining to make someone available for an interview, the agency provided a statement from IRS Commissioner Chuck Rettig, who called the pot of cash a “historic reconciliation package” marking a “transformational moment for our agency.”

And as most have discovered, the majority of IRS business does not occur fast. Wherever the funding goes, changes in the mechanics of the agency will not be immediate as it beats back challenges that have created a backlog of thousands upon thousands of delayed transactions to be processed.

Speaking about reports of a backlog of thousands and thousands of returns, he stated, “We have a lot of hard work in front of us to deliver on the high expectation this historic funding will provide.”

But David Brown, financial adviser at Encore Wealth Management in Santa Rosa, said in a job climate already taxed with getting people to come back to their original pre-pandemic positions, adding on to the staff of a maligned agency could prove difficult.

“But who wants to work for the IRS?” Brown said sarcastically.

Kiplinger reported the last time the agency received a windfall of funding to hire about 40,000 agents, it took so long that it barely compensated for those who were retiring. The U.S. Treasury Department has estimated the agency needs double that number to get operations up to par.

“The service level has been really poor,” Santa Rosa accountant Jon Dal Poggetto said, adding more and newer equipment to the wish list the IRS may consider working on.

And what if the agency gets more people and better equipment? Does it mean more audits?

“Then, maybe it could get them back to a normal auditing process,” he said. “But we’d rather have the IRS provide service to the taxpayer.”

Health care

On the health care front, the Inflation Reduction Act of 2022 focuses on two areas: lowering the cost of prescription medications for Medicare beneficiaries, and changes to the Affordable Care Act; the latter in the state known as Covered California.

There are three main components of the law that address lowering the cost of certain prescription drugs under Medicare: price negotiation, inflation rebates and caps on out-of-pocket spending.

The first piece requires lowering prices for branded prescription drugs that aren’t yet available in generic form. The law does not identify the eligible medications, but starting in 2026, and over time, the Centers for Medicare and Medicaid Services must negotiate with drug manufacturers 10 prescription medications under Medicare.

That number jumps to 15 drugs in 2027 and 2028; then to 20 drugs in 2029 and every year after. Drug companies that don’t comply with the law’s negotiation requirements will face civil penalties and excise taxes, according to the legislation.

The second part, starting next year, requires drug manufacturers to give rebates to CMS for medications that annually cost Medicare recipients at least $100 per year and whose prices increase faster than inflation. Again, this applies to branded drugs without generic versions and brings penalties to manufacturers for noncompliance.

The law also caps at $2,000 a year out-of-pocket drug costs for individuals with Medicare Part D prescription drug plans. That law starts in 2024.

“The Medicare part will not have a huge impact for employers,” said Victor McKnight, vice president of Petaluma-based InterWest Insurance Services, Inc., which services more than 500 employers. “There are some people that are concerned with a transfer of costs, which happens a lot in health care, but I don't think we'll see a ton of that.”

In addition, workers who qualify for Medicare generally stay on their employer’s group plan until they retire, McKnight noted.

Jordan Shields, senior partner at Petaluma-based Arrow Benefits, which currently has 1,700 group clients, agreed the Medicare changes should not keep employers up at night.

“It does open the door for additional changes, of course, but their impact cannot yet be determined,” Shields said, referencing the potential for future government action.

Looking at the Affordable Care Act, the new law extends the enhanced federal premium subsidies through 2025 — adding another three years. Those subsidies were expanded through the American Rescue Plan, which passed in March 2021.

Once again, it would be rare to see any impact on employers, Shields said.

Climate change

The Inflation Reduction Act of 2022 aims to address climate change in several ways, including with incentives for companies that make far-reaching investments in solar energy and shift from gas cars to electric vehicles, for example. These incentives are set to take effect next year.

According to the Congressional Budget Office, $369 billion of spending is for tax credits and other funding to address climate and energy security, which would cut the country’s carbon emissions by about 40% by 2030, according to the legislation.

While it’s called the Inflation Reduction Act of 2022, many of the components are environmental in nature.

“The Inflation Reduction Act is going to be a major boost to the solar industry and electric vehicles. One of the most important things it does is restore the 30% tax credit, which is really excellent for promoting solar,” said Geof Syphers, CEO of Sonoma Clean Power. “It also clarifies that nearly all electric vehicles will qualify for the tax credit.”

Sonoma Clean Power (SCP) provides residential and commercial power service to Sonoma and Mendocino counties.

Under the Act, people who purchase certain new electric vehicles would receive $7,500 in tax credits, as well as $4,000 in tax credits on some used EVs.

Scott Silveira, who owns Silveira Chevrolet in Sonoma and Silveira Buick GMC in Healdsburg, said the bill is good news for General Motors, Tesla and Toyota because it removed a ceiling on a maximum number of vehicles sold that can qualify for the tax break.

He believes the new regulations will give a “good bump” to car sales at his lots.

“We are just starting to come back into selling them. We had to stop selling our electrics for almost a year because we had to wait for a new battery pack,” Silveira said. “Now it’s hard to keep them in stock.”

As with most legislation, there is a lot of fine print. Minimum percentages are set for how much of the vehicle has to be manufactured and assembled in the United States or in a country with which the U.S. has a free-trade agreement. Battery manufacturing is a criterion, as is the income level of the purchaser and the price point of vehicles. Those percentages increase annually.

“In the long run, it will bring more jobs and more manufacturing to the United States,” said Justin Hansel, co-owner and vice president of Santa Rosa’s Hansel Auto Group.

It’s the short-term concern of manufacturers being able to get enough materials to build enough cars to meet the demand that worries him.

Vince Compagno, general manager of Napa Nissan, expects it will take about three years for manufacturers to be able to comply with the new rules.

Also, there’s the matter of all of the people who ordered EVs expecting to qualify for tax credits that were on the books at the time they placed their deposit. The legislation eliminates them, and most of the vehicles don't fit the new criteria of being mostly manufactured in the U.S.

Victor Amerson, who works in sales at Marin County Ford in Novato, is concerned about manufacturing computer chips, so necessary in today’s vehicles. China dominates that market. Fast tracking this country’s chip production capabilities is the focus of a recently approved $52.7 billion federal legislation package.

“I think the public should be more concerned about the chips used for weapons. It will affect every manufacturer with chips stuck in China,” Amerson said. “All the trouble is with Taiwan. World War III could happen tonight.”

Chips are also necessary in the solar industry.

Prior to the passage of the Inflation Reduction Act, Danny Koelzer was worried about the future of the solar industry as the federal Investment Tax Credit was to have expired at the end of 2023.

“I was very concerned how the solar industry would carry on after that and with PG&E also making it less attractive to go solar by next year some time,” said Koelzer, president of Mirador Energy in Fairfield in Solano County.

Raising the credit back to 30% (it’s currently at 26% and was to drop to 22% on Jan. 1 and locking it in for 10 years is a significant saving for people installing solar. This means if a solar project costs $20,000, a 30% tax credit cuts that total by $6,000.

Of course, to take full advantage of any tax credit the person needs to have a tax liability of that same amount or more.

“Even if they eliminate the tax credit, the solar industry would carry on,” Koelzer said. This largely has to do with California mandating all new home construction come with solar.

Phil Alwitt, CEO of Novato-based SolarCraft, is excited about the Inflation Reduction Act of 2022. Beyond the tax credit for panels, he applauds the incentives for people who install battery systems on existing systems.

Another bonus he pointed out is that now nonprofits and non-taxpaying entities like churches and schools can apply for the tax credits.

“(The law) is great for everybody financially, but the bottom line is it is going to help the world get cleaned-up and save the planet,” Alwitt said.

Correspondent Kathryn Reed contributed solar industry reporting to this story.