{{Article.Title}}

By {{Article.AuthorName}} | {{Article.PublicationDate.slice(6, -2) | date:'EEEE, MMMM d, y'}}
{{TotalFavorites}} Favorite{{TotalFavorites>1? 's' : ''}}

The initial reception for the Tax Cuts and Jobs Act has been strong, with scores of companies of virtually every size and sector crediting tax reform for significant investments in their workers. But what does the new law mean for the construction industry?

First, the topline feature that has driven most of the conversation to date is across-the-board rate cuts for individuals and businesses. Construction has historically faced one of the highest effective tax burdens of any sector, meaning the industry stands to realize among the most significant gains.

The corporate rate reduction is as simple as it is dramatic: As of Jan. 1, the rate for C corps stands at 21 percent, slashed from the previous 35 percent. C corporations make up about a quarter of the industry, mostly on the larger side, but this new low rate might lead some firms to give the structure a second look.

For pass-through entities—companies whose owners pay taxes at the individual level—the benefits of the law are similarly significant, albeit less straightforward. While Republican lawmakers had long targeted a 25 percent top rate for pass-through income, a figure that carried through from the original House Blueprint to the joint Unified Framework, Congress ultimately settled on a 20 percent deduction for qualified business income (QBI). Together with a cut in the top individual rate from 39.6 percent to 37 percent, the Section 199A deduction reduces the top effective rate for pass-through income to 29.6 percent.

Mechanically, this new provision is modeled after the erstwhile Section 199 domestic production activities deduction. Qualified income is permitted a deduction of up to 20 percent, an amount limited to 50 percent of the company’s W-2 wages, or, in a new twist, 25 percent of payroll plus 2.5 percent of adjusted basis in depreciable capital. An additional guardrail to prevent abuse of this deduction carves out certain specified personal service trades, ranging from the legal, accounting and medical professions to finance and investment, entertainment or any other business whose principal asset is the reputation or skill of its employees.

While these guardrails introduce significant complexity, and will certainly need further clarification from the IRS, an exception applies to smaller businesses: The deduction applies fully to the QBI of all taxpayers with less than $157,000 in taxable income ($315,000 married filing jointly). Above these levels, the limitations kick in, with the benefit fully phasing out for personal service firms by $207,000 ($415,000 married filing jointly).

Incentivizing Capital Investment

The Tax Cuts and Jobs Act also creates a tremendous incentive for capital investment. By increasing first-year bonus depreciation from 50 percent to 100 percent, while expanding eligibility to used property, Congress has unleashed a powerful inducement for companies of all sizes to buy the equipment they need to grow. And by permanently doubling Section 179 levels to $1 million, while boosting the phase-out threshold to $2.5 million, small businesses have the certainty of a robust expensing allowance even after the accelerated depreciation sunsets.

Finally, the law does a great deal for small business. It permanently quintuples the gross receipts test for the use of cash accounting to $25 million, indexes it to inflation, and applies it to other provisions throughout the code. For instance, the new limitation on interest deductibility does not apply below this threshold. The percentage of completion method requirement for long-term construction contracts under Section 460(e) is likewise excepted. This marks the first reform to the small contractor exception threshold since it was established at $10 million in 1986, where it had remained for more than three decades. 

By increasing the definition of a small contractor by 150 percent for Section 460 purposes and indexing it to inflation, Congress has enacted the main prong of Associated Builders and Contractors’ proposed tax bill (the American Job Builders Tax Reform Act). And in doubling the estate, gift and generation-   skipping tax exemption to $11 million ($22 million married filing jointly), the law protects a broader swath of family businesses from the ominous shadow of the death tax.

Broad, Imperfect Reform

To be sure, the Tax Cuts and Jobs Act isn’t perfect. While partially offset by adding to the deficit, the cuts had to be made up for somewhere. Detractors focused on high earners and homeowners from high-tax states, while the paltry $10,000 annual deduction limit on pass-through business flew under the radar. Although the law affords pass-through business owners and wage earners temporary relief from the alternative minimum tax (AMT), it ultimately failed to repeal AMT altogether as promised. 

Larger contractors of all tax structures may be faced with limits on their interest deductions, or be forced to choose between full expensing and full deductibility. And as a result of budget gamesmanship to keep the bill within the allotted $1.5 trillion reconciliation instruction, the entire individual title of the bill—including the pass-through deduction and estate tax relief—is set to expire in 2026.

But whatever its faults, there’s no denying that the Tax Cuts and Jobs Act is a boon to the economy in the near term, lowering taxes for the overwhelming majority of Americans and offering a significant shot in the arm for many contractors. Much has been made in the media about whom the tax bill helps—which industries are the big winners and losers—but in some ways the debate misses the point. This was a broad reform bill that benefits most everyone, and the dramatic rate cuts and generous expensing provisions mean that it particularly helps capital-intensive industries and those who face high effective tax rates to begin with. 

Construction fits the bill in both respects, putting the industry among the bigger winners of tax reform. While there is still work to do, particularly with the law’s implementation, contractors should be pleased with the direction it’s headed. 

Print

 Comments ({{Comments.length}})

  • {{comment.Name}}

    {{comment.Text}}

    {{comment.DateCreated.slice(6, -2) | date: 'MMM d, y h:mm:ss a'}}

Leave a comment

Required!
Required! Not valid email!
Required!