On December 22, 2017, the “Tax Cuts and Jobs Act” (“TCJA”) was signed by President Trump. This bill represents the most comprehensive amendment to the United States tax system since 1986 and presents changes that are likely to impact every American taxpayer including those firms in the construction industry. Because the TCJA bill is so expansive and many parts of the new law lack key details that must be dealt with through regulations, it is impossible to perform a complete analysis of the changes. For this article we will focus on those provisions that effect most construction related businesses.
C Corporation Rate Reduction—One of the hallmarks of the TCJA is the reduction of the corporate tax rate to 21% (from a tiered rate system with a maximum rate of 35%). For construction companies, the top effective rate was actually around 32% because of the effect of the Domesticated Production Activities Deduction. This deduction is eliminated under the TCJA. This change is effective for tax years beginning after December 31, 2017. However, Section 15 of the Internal Revenue Code (“Code”) provides that fiscal year taxpayers will be able to obtain the benefit of the reduced rate as of January 1, 2018 by computing a tentative tax under both rates and prorating the tentative tax based on the number of days in the fiscal year before and after January 1, 2018 to arrive at a blended income tax rate.
Partnership and S Corporations`—For years beginning after December 31, 2017, TCJA provides a new provision that allows an individual taxpayer (including a trust or estate) a deduction of up to 20% of the individual’s domestic “qualified business income” (QBI) from a partnership, S-corporation or sole proprietorship. Generally, income from construction, architecture, and engineering activities are considered QBI. This deduction would be subject to certain limits based on either (i) 50% of W-2 wages paid or (ii) a combination of 25% of W-2 wages paid plus 2.5% of the unadjusted (cost) basis of all qualified property. The TCJA also lowered the top individual rate from 39.6% to 37%.
Depreciation—TCJA provides for the full expensing (i.e. 100% “bonus depreciation”) for equipment placed in service after September 27, 2017 and before January 1, 2023. Starting on January 1, 2023, the bonus depreciation percentage would phase out through to 2026. Additionally, TCJA eliminates the requirement that property be “original use property” that was previously in the statute which effectively allows the bonus depreciation provisions to apply to used property that is acquired by a taxpayer. The Section 179 deduction threshold is increased to $1 million and so is the point at which the Section 179 deduction begins phasing out, now to $2.5 million. The definition of Section 179 property is also expanded to include certain components of nonresidential real property.
Small Taxpayer Accounting Methods—Historically, certain small contractors have been allowed to use other methods of accounting besides percentage-of-completion. This includes the permitted use of the cash and completed contract method of accounting. Historically, taxpayers with average annual gross receipts of $10 million or less were considered small taxpayers and afforded these benefits. Under TCJA, the gross receipts threshold is increased to $25 million.
Alternative Minimum Tax—C Corporate alternative minimum tax (AMT) is repealed effective for tax years beginning after December 31, 2017. Individuals are still subject to AMT so Partnerships and S Corporations will still have AMT adjustments.
Net Operating Loss Deductions—Under current law, corporate net operating losses (NOLs) can be carried back two years and carried forward for twenty years. TCJA provides that NOLs can no longer be carried back but can be carried forward indefinitely. Restrictions would be placed on NOLs created after December 31, 2017 and could only be used to offset up to 80% of taxable income in a given year. NOLs created before January 1, 2018 will not be subject to the 80% limitation.
Like-Kind Exchanges—TCJA restricts the applicability of the Section 1031 like-kind exchange rules to real property not held primarily for sale. Therefore, exchanges of personal property (e.g. machinery, equipment or vehicles) will no longer qualify for nonrecognition treatment and will be considered taxable sales. These rules apply for transactions entered into after December 31, 2017.
Meals and Entertainment—Under prior law, meals and entertainment expenses that had a business purpose were considered 50% non-deductible. TCJA delineates between meals and entertainment and provides different treatments for each. Food and beverage expense associated with the operation of a taxpayer’s business (e.g. meals consumed by employees while working out of town) as well as food or beverage provided at an employee provided eating facility will be considered 50% non-deductible. Entertainment, amusement or recreation expenses—even if directly related to a taxpayer’s trade or business—will become entirely non-deductible.
Fringe Benefits—TCJA disallows the deduction for employers’ expenses associated with providing employees with qualified transportation fringe benefits. A deduction may be claimed for providing transportation benefits if the value of the benefit is included in the employee’s income (i.e. it is not treated as a fringe benefit).
Loss Limitations—TCJA contains a significant change to the treatment of non-passive losses of taxpayers other than C-corporations. This bill creates a new concept of an “excess business loss.” An excess business loss is any net business loss in excess of $250,000 for a single taxpayer or $500,000 for married filers. Any excess business loss would be carried forward. This provision has the effect of limiting the net business losses of a taxpayer that can be utilized in a given year and is likely to have a major impact on taxpayers that have significant non-business or investment income because historically non-passive losses were allowed to offset other non-business income.
The preceding are big issues that effect contractors. There could be others that effect you, so each business must get with their tax advisor to see what they should do.
Please contact Barry Leasure if you have any questions.