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Inflation Reduction Act: What You Should Know

The Inflation Reduction Act, signed into law on August 16, 2022, includes health-care and energy-related provisions, a new corporate alternative minimum tax, and an excise tax on certain corporate stock buybacks. Additional funding is also provided to the IRS. Some significant provisions in the Act are discussed below.

Medicare

The legislation authorizes the Department of Health and Human Services to negotiate Medicare prices for certain high-priced, single-source drugs. However, only 10 of the most expensive drugs will be chosen initially, and the negotiated prices will not take effect until 2026. For each of the following years, more negotiated drugs will be added.

Starting in 2025, a $2,000 annual cap (adjusted for inflation) will apply to out-of-pocket costs for Medicare Part D prescription drugs.

Starting in 2023, deductibles will not apply to covered insulin products under Medicare Part D or under Part B for insulin furnished through durable medical equipment. Also, the applicable copayment amount for covered insulin products will be capped at $35 for a one-month supply.

Health Insurance

Starting in 2023, a high-deductible health plan can provide that the deductible does not apply to selected insulin products.

Affordable Care Act subsidies (scheduled to expire at the end of 2022) that improved affordability and reduced health insurance premiums have been extended through 2025. Indexing of percentage contribution rates used in determining a taxpayer’s required share of premiums is delayed until after 2025, preventing more significant premium increases. Additionally, those with household incomes higher than 400% of the federal poverty line remain eligible for the premium tax credit through 2025.

Energy-Related Tax Credits

Many current energy-related tax credits have been modified and extended, and a few new credits have been added. Many of the credits are available to businesses, and others are available to individuals. The following two credits are substantial revisions and extensions of an existing tax credit for electric vehicles.

Starting in 2023, a tax credit of up to $7,500 is available for the purchase of new clean electric vehicles meeting certain requirements. The credit is not available for vehicles with a manufacturer’s suggested retail price higher than $80,000 for sports utility vehicles and pickups, $55,000 for other vehicles. The credit is not available if the modified adjusted gross income (MAGI) of the purchaser exceeds $150,000 ($300,000 for joint filers and surviving spouses, $225,000 for heads of household). Starting in 2024, an individual can elect to transfer the credit to the dealer as payment for the vehicle.

Similarly, a tax credit of up to $4,000 is available for the purchase of certain previously owned clean electric vehicles from a dealer. The credit is not available for vehicles with a sales price exceeding $25,000. The credit is not available if the purchaser’s MAGI exceeds $75,000 ($150,000 for joint filers and surviving spouses, $75,000 for heads of household). An individual can elect to transfer the credit to the dealer as payment for the vehicle.

Corporate Alternative Minimum Tax

For taxable years beginning after December 31, 2022, a new 15% alternative minimum tax (AMT) will apply to corporations (other than an S corporation, regulated investment company, or a real estate investment trust) with an average annual adjusted financial statement income in excess of $1 billion.

Adjusted financial statement income means the net income or loss of the taxpayer set forth in the corporation’s financial statement (often referred to as book income), with certain adjustments. If regular tax exceeds the tentative AMT, the excess amount can be carried forward as a credit against the AMT in future years.

Excise Tax on Repurchase of Stock

For corporate stock repurchases after December 31, 2022, a new 1% excise tax will be imposed on the value of a covered corporation’s stock repurchases during the taxable year.

A covered corporation means any domestic corporation whose stock is traded on an established securities market. However, the excise tax does not apply: (1) to a repurchase that is part of a nontaxable reorganization, (2) with respect to certain contributions of stock to an employer-sponsored retirement plan or employee stock ownership plan, (3) if the total value of stock repurchased during the year does not exceed $1 million, (4) to a repurchase by a securities dealer in the ordinary course of business, (5) to repurchases by a regulated investment company or a real estate investment trust, or (6) to the extent the repurchase is treated as a dividend for income tax purposes.

Increased Funding for the IRS

Substantial additional funds are provided to the IRS to help fund operations and business systems modernization and to improve enforcement of tax laws.

If you like to further discuss the provisions of the Inflation Reduction Act, contact an advisor at CapSouth Wealth Management.

To learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com or https://capsouthwm.com/what-we-do/ or call 800.929.1001. Click to Schedule a Discovery Call.

CapSouth Partners, Inc, dba CapSouth Wealth Management, is an independent registered Investment Advisory firm. This material is from an unaffiliated, third-party and is used by permission. Any opinions expressed in the material are those of the author and/or contributors to the material; they are not necessarily the opinions of CapSouth. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice. Any performance data quoted represents past performance; past performance is no guarantee of future results.

How Inflation Affects Social Security Benefits

With inflation a top concern among Americans these days, you may be wondering how Social Security’s cost-of-living adjustment is calculated.

With inflation dominating the news, you may be developing more than a passing interest in how the Social Security cost-of-living adjustment (COLA) is figured. Whether it’s a matter of simple curiosity or an effort to maximize benefits through strategic claiming, you should know how Social Security benefits are adjusted for inflation—both before and after retirement.

Social Security is one of the few sources of predictable, inflation-adjusted lifetime income available to retirees. This, by itself, is a reason to maximize benefits through strategic claiming. Compared to the task of repositioning investment portfolios for an inflationary environment, maximizing one’s inflation-adjusted Social Security benefit is easy—just claim at the optimal age and let Social Security’s automatic inflation adjustments raise the income each year at a rate that approximates rising prices (though on a lagging basis and not necessarily matching a recipient’s own spending experience).

Before I get into how it all works, we must acknowledge that some clients have a misguided notion of the optimal claiming strategy about the COLA. More than a few people have asked if they should claim their benefit early to get the COLA. The answer is a resounding, “No!”

All PIAs (Primary Insurance Amounts) are raised with the COLA, whether benefits have been claimed or not. In fact, the optimal claiming strategy regarding the COLA is to claim at an age that will provide the highest possible benefit—age 70 for retirement benefits and FRA (Full Retirement Age) for spousal benefits—because that will maximize the dollar amount of the COLA.

It’s simple math: A client with a PIA of $3,000 and FRA of 67 will receive $2,100 if he claims at 62 versus $3,720 if he claims at 70. This year’s COLA of 5.9% would have given the early claimant a monthly increase of $123.90, versus $219.48 for the later claimant.

The COLA is based on the Consumer Price Index (CPI), which measures price increases of goods and services from year to year. The CPI usually makes the headlines when it’s announced each month, especially this year, when inflation is running higher than normal due to a myriad of factors.

Some argue that the CPI-W is not a good index for the Social Security COLA because it measures spending by urban wage earners, not retirees. It also doesn’t consider changes in buying habits when inflation is high—substituting chicken for steak, for example, when there’s a spike in beef prices. At various times people have claimed that the CPI-E, which measures spending by the elderly, or the “chained” C-CPI-U, which takes buying substitutions into account, should be used instead. But in the end, it doesn’t make much of a difference. There have been years where the CPI-E would have provided a lower COLA than the CPI-W and the C-CPI-U would have provided a higher COLA. So, it all likely evens out over the longer term.

If you want to know exactly how the COLA is applied to your Social Security benefit, you can go to the web page of SSA Office of the Chief Actuary. Here it explains that the COLA for 2022 equals the percentage increase in the CPI-W from the third quarter of 2020 through the third quarter of 2021. In figuring the COLA, SSA uses the raw index, which stood at 100 in 1982–84. It averages the index for July, August, and September of 2020 and 2021 respectively, subtracts the 2020 average from the 2021 average, and figures the percentage gain. That difference was 5.9%.

So, in December 2021, SSA’s automated system raised the PIA of everyone age 62 or older by 5.9%. For those who had already claimed their benefit, the system then applied the appropriate reductions or credits for early or delayed claiming and adjusted January checks accordingly. (This has the effect of simply raising everyone’s checks by 5.9%, but the fact that the COLA was applied to the PIA, after which reductions or credits are applied, is important for understanding that all PIAs are raised by the COLA, whether benefits have started.) For those who had not yet claimed, the PIA was raised by 5.9%; the reductions or credits will be applied at the time of claiming. Auxiliary benefits such as spousal, survivor or dependent benefits are also adjusted as the PIA on which they are based is adjusted.

Some people are trying to get a jump on the 2023 COLA by checking the inflation rate over the past 12 months and extrapolating it out. According to the latest release, the CPI-W in May was 9.3% higher than a year ago, suggesting a rather large COLA for 2023. Those who want to be a bit more precise can compare the raw index in May (288.022) to the third quarter average in 2021 (268.421) which would result in a possible COLA of 7.3%. But there are four months to go before the COLA will be calculated, and a lot can happen between now and then—even a possible decline from May’s index if prices revert to more normal levels.

Inflation adjustments for current workers

To understand how Social Security benefits keep up with inflation for people who are still working, it is necessary to understand how the benefit is calculated and how some of the components in the formula are adjusted for inflation.

The PIA is calculated for each person the year they turn 62. In calculating the PIA, SSA tallies up all earnings through age 61, indexes each year’s earnings for inflation (except earnings for ages 60 and 61, which are recorded at nominal value), averages the highest 35 years of earnings to get the AIME (Average Indexed Monthly Earnings), segments the AIME into three tiers based on that year’s bend points, multiplies each tier by a set percentage—.90, .32 and .15—and then totals these dollar amounts to get the PIA.

The PIA is the benefit the person will receive if it is claimed at full retirement age (FRA). If claimed before or after FRA, the benefit will be reduced or increased as shown in this table. https://www.ssa.gov/oact/ProgData/ar_drc.html Once the PIA is calculated, it is adjusted each year for the COLA as described above.

A maximum earner born in 1960, whose PIA is calculated in 2022, has a PIA of $3,357.50. The PIA is the amount they’ll receive if they claim benefits at their FRA. But by the time they get to FRA, in five years, the PIA will have been adjusted for inflation, so the amount they receive will be higher. If they wait until age 70 to claim, they’ll get three additional years of COLAs (compounded) plus delayed credits of 8% a year (not compounded), giving them the highest possible benefit.

Inflation adjustments for current workers happen in the indexing factors and bend points, which rise each year based on increases in the national average wage index (AWI). Workers under 62 can be assured that by the time their PIA is calculated, the indexing factors and bend points will be higher than they are today, resulting in a higher Social Security benefit. To put it simply, benefits rise with wages while people are earning (before age 60) and with prices while they are spending (after age 62).

The wage index is a lagging indicator. Whereas the COLA is based on the prior year’s CPI (third quarter to third quarter), the indexing factors and bend points are based on the AWI two years prior. This can cause a bit of a disconnect. Usually the AWI exceeds the CPI, but in 2020—the index used in calculating PIAs for 62-year-olds in 2022—it didn’t. The 2020 AWI rose just 2.83% over the 2019 index, compared to the 5.9% COLA.

This can cause some inequities among cohorts. This year’s 62-year-olds (the 1960 cohort) didn’t get the COLA because their PIAs were only just calculated this year—and their indexing factors and bend points were based on a lower-than-usual increase in the AWI. Next year, the 1960 cohort will get the (presumably high) COLA along with everyone else over age 62, but the 1961 cohort, who will be having their PIA calculated in 2023, will not. Their increase will depend on the amount by which the 2021 AWI exceeds the 2020 AWI of $55,628.60. Wage statistics are not as easy to track as the CPI, so there’s really no telling what the 2021 AWI increase will be or what those indexing factors and bend points will turn out to be.

As you can see, adjusting Social Security for inflation is exceedingly complex. It may not be perfect, but it’s not bad. Social Security does a better job than most sources of retirement income in helping retirees keep up with the rising cost of living.

If you have any questions about Social Security Benefits, please send your question(s) and contact information to LRobinson@CapSouthPartners.com.

P. Lewis Robinson, CPA – Managing Director/Senior Wealth Advisor

1.Source: How Social Security Benefits Keep Up With Inflation, July 8, 2022, By Elaine Floyd, CFP®

To discuss this article further or to learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com or call 800.929.1001 to schedule an appointment to speak with an advisor.

Investment advisory services are offered through CapSouth Partners, Inc, dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting, or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice. Any performance data quoted represents past performance; past performance is no guarantee of future results.

Refunds to the Highly Compensated

Refunds to the highly compensated employees (HCE) in a qualified retirement plan can be frustrating to the participants and a challenge to the plan administrator.  Various options exist to improve this situation.  These include:

  • More effectively manage the deferral and refund process
  • Eliminate the issue of refunds caused by testing
  • Allow the participant to continue to individual retirement accounts

This article will discuss these options.

  1. More Effective Management 

If a plan is using the “current year” testing method, consideration could be given to using “prior year” testing.  Under the “current year” option, the data is not finalized until after the end of the year and the HCEs do not know the amount they can contribute until after the testing is completed.

Under the “prior year” option, the data from the previous year is used to provide the maximum deferral amount for each HCE.  This should eliminate excess deferrals that require refunds.

Another option is to notify the HCE at the beginning of the year regarding the estimated maximum deferral.  This is based on the prior year average deferral of the non-highly compensated employees (NHCE) and a review of the current deferrals of each of the HCE.  Of course, this amount may change during the year due to changes in the deferrals of either group.

  1. Consider a Safe Harbor Plan

A safe harbor plan allows the HCE to contribute the maximum allowable deferrals without regard to the average deferrals of the NHCE. There are various safe harbor options that a plan could consider.  These include:

  • Basic Safe Harbor Match (equal to 100% of amount contributed up to 3% of pay, plus 50% of amount contributed, up to the next 2% of pay);
  • Enhanced Safe Harbor Match (must be at least as generous as the basic formula, normally equal to 100% of amount contributed up to 4% of pay);
  • 3% Non-Elective Contribution (NEC); and
  • Qualified Automatic Contribution Arrangement (QACA):
    • QACA Match (equal to 100% of amount contributed up to 1% of pay, plus 50% of amount contributed, up to the next 5% of pay) or
    • QACA 3% NEC.
  1. Options for the Participant

Each HCE has several options to contribute to retirement accounts outside of the qualified plan.  These include:

  • IRA Deductible Contributions:  In most cases, HCEs do not qualify to make deductible IRA contributions.
  • Non-Deductible IRA Contributions:  Most HCEs qualify to make non-deductible IRA contributions.  The maximum contributions to IRA accounts for 2022 is $6,000 plus $1,000 for employees 50 and older. 
  • IRA to Roth IRA Conversions:  Each HCE should carefully consider the strategy of making non-deductible IRA contributions followed by a Roth conversion.  This works extremely well with participants who do not have an existing IRA account.  The non-deductible contribution is made, and the account is immediately converted to a Roth IRA.  The result of this process is that the money ends up in a Roth IRA growing income tax free just as it would have if the HCE elected to defer to the Roth 401(k) account inside the qualified plan.  If the participant has existing IRA accounts with zero basis, this option does not work as well.  In this case, the conversion would create additional taxable income.  This may or may not be an issue based on the current tax bracket and the projected future tax brackets. 
  • Some HCEs have outside businesses that generate taxable income.  In some cases, the HCE has the option of opening a SEP plan and deferring money to the SEP account.
  • Annuity contracts often allow investors to contribute unlimited amounts.  These contributions are after tax and form the basis in the annuity contract.  All the accumulated growth and earnings in the contract grow tax deferred.  Caution should be taken to avoid buying an annuity that has high internal fees and pays high commissions to the salesperson.  Always inquire as to the commissions to be paid, total expenses of the plan, and withdrawal options and penalties. 

Plan administrators should carefully consider the plan design to determine if changes could be made to manage this process more effectively.  HCE should seek guidance from qualified advisors to examine the various options available to assist them in making the critical long-term decisions regarding their retirement planning. 

by: Anthony McCallister, AIF®, J.D.

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To discuss this article further or to learn more about CapSouth Wealth Management, visit our website at www.capsouthwm.com or call 800.929.1001 to schedule an appointment to speak with an advisor.

Investment advisory services are offered through CapSouth Partners, Inc, dba CapSouth Wealth Management, an independent registered Investment Advisory firm. Information provided by sources deemed to be reliable. CapSouth does not guarantee the accuracy or completeness of the information. CapSouth does not offer tax, accounting, or legal advice. Consult your tax or legal advisors for all issues that may have tax or legal consequences. This information has been prepared solely for informational purposes, is general in nature and is not intended as specific advice.

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