The new presidential administration is poised to lead to a number of proposed tax and regulatory changes, many of which will impact the construction industry.
The best indication of what’s to come can be found in Trump’s “100 days plan” that was presented during his campaign. In the plan, Trump outlines several tax proposals he plans on immediately working on with Congress. If these proposals are successful, most taxpayers, including those in the construction industry, will be affected. Following are ways the construction industry could be impacted.
Business and Individual Tax Rates
One of the most significant tax proposals from the incoming administration is to overhaul business and individual tax rates. Individual tax brackets would go from the seven bracket setup (the highest of which is currently 39.6 percent) to a three bracket setup with the highest rate being 33 percent. Individual taxpayers also may see the elimination of Alternative Minimum Tax (AMT).
Trump’s pledge includes a reduction of the business tax on C Corporations from a 35 percent graduated rate to 15 percent rate and an elimination of the corporate AMT. This is undoubtedly good news for construction companies set up as C corporations, as this can significantly reduce their bottom line. To avoid penalizing small business pass-through entities (sole proprietors, S corporations and partnerships), the plan proposes a flat tax rate of 15 percent on their undistributed income.
Conventionally, the income from pass-through entities is passed on to their owners, who pay the income tax on their personal return, using their tax rates. Without this proposal, these owners could have potentially been paying a 33 percent tax on their business income while C corporations enjoy a 15 percent tax rate on their income. This also may mean that distributed earnings from pass-through entities, which previously were not taxable (generally), would see a second layer of tax imposed on them—similar to dividends from C corporations.
The reduced rates would be a beneficial change to businesses and business owners, as it will help increase their margins. It also would encourage foreign companies and investors to bring more jobs and capital back to the United States.
Corporate Tax Expenditures
Trump’s plans also suggest that unspecified “corporate tax expenditures,“ other than the credit for increasing research activities (R&D credit), would be eliminated to compensate for the lower rates. Corporate tax expenditures include accelerated depreciation on machinery and equipment (i.e., bonus depreciation) and the exclusion of interest income on state and local bonds. There has been very little information about what other expenses may be disallowed.
There are even some speculations that Trump may be moving toward a gross receipts tax, which allows for very few expenses to be deducted. This would be concerning to businesses with high amounts of gross revenues and expenses—such as the construction management industry. This may cause businesses to pay federal taxes, even when at a loss position. In addition, with the tax reduction and the potential introduction of foreign construction companies to the market, market share for domestic companies would invariably suffer in a new, more global and competitive landscape.
Trump’s tax proposition includes a “one-time” reduced tax rate on deemed repatriation of corporate profits held offshore, with the goal of boosting corporate investment and job creation in the United States. The proposed 10 percent tax on repatriated profits, which could lead to hundreds of billions of dollars in capital being brought back to the country, also would benefit the U.S. construction industry.
Section 179 Deduction
Although there may be a reduction in deductible corporate expenditures, Trump indicated he would not only keep the Section 179 deduction, but also would double the annual cap limitation of the deduction. The Section 179 deduction provision allows businesses to deduct 100 percent of the cost of qualified fixed assets that were placed in service during the year, as opposed to depreciating (expensing) the cost over several years.
Currently, the Section 179 deduction is limited to $500,000 if $2 million of total fixed assets acquisitions or less are placed in service during a profitable tax year. If more than $2 million of fixed assets were placed in service, the deduction is reduced by the dollar amount over the $2 million, making it more attractive to small businesses.
The incoming president’s plan calls for an increase of the $500,000 cap to $1 million. This means smaller construction companies can invest more dollars on items such as heavy machinery and equipment and enjoy the benefit of expensing the cost all in one year.
This proposal also will reduce the effect of the possible loss of “bonus” depreciation—which immediately expenses 50 percent of qualified fixed assets acquisitions. This will not necessarily be beneficial to larger construction companies with more than $2 million of fixed assets acquisitions during any given year. These larger businesses currently rely more on the “bonus” depreciation, which does not have a cap on the depreciation deduction nor requires the company to be profitable for the tax year.
The proposed American Energy & Infrastructure Act referred to during Trump’s campaign calls for leveraging public-private partnerships and private investments through tax incentives to spur $1 trillion in infrastructure investment during 10 years. If this holds true, it would mean more funding for renovation projects on highways, airports and railways.
Affordable Care Act
Trump had always been vocal about wanting to repeal the Affordable Care Act (ACA). Its repeal may be welcomed by construction companies, particularly those who hire seasonal employees, as its implementation imposed an enormous administrative burden on them.
During his campaign, Trump also vowed to eliminate all taxes associated with the ACA. These may include the additional 0.9 percent Medicare tax (for taxpayers with compensation higher than $200,000-$250,000) and the additional 3.8 percent tax on net investment income. However, his campaign materials only specifically address repealing the latter. This would allow construction business owners looking to sell their interest in the business possible savings of 3.8 percent on the gain of that sale.
Because there is no telling how long it will be until repeal actually happens, businesses should plan to be in compliance for this tax year or face hefty penalties—the heftiest since its inception. To comply with existing reporting requirements, employers with at least 50 full-time workers must distribute forms to employees detailing their 2016 health insurance coverage by Jan. 31. Coverage information also must be filed with the IRS by Feb. 28 if filing on paper, or March 31 if filing electronically.
AMT and the R&D Tax Credit
The elimination of the AMT, a flat rate paid on income, would be a positive change for those in the construction industry. Those in construction may have the additional advantage of being able to use the Research and Development (R&D) tax credit more freely once this tax is eliminated.
Under the R&D credit, qualified taxpayers in the construction industry may be entitled to a credit of 20 percent of the excess of their qualified expenses over a specific base amount calculated over four years.
The R&D credit is not a deduction of taxable income; rather, it is a dollar-for-dollar credit against taxes owed. To qualify for the credit, the expenses must have been used to create a new business component or to make improvements to an existing component. A business component is defined as a process, technique, invention, formula or software that the taxpayer intends to hold for sale, lease, license or use in the taxpayers trade.
If the AMT is eliminated, many in the construction industry would be able to take advantage of the R&D credit more freely. Prior to 2015, the R&D credit could not be used against AMT. For example, if AMT was $80,000, while regular tax was $100,000, and available R&D credit was $50,000, taxpayers could only use $20,000 of the R&D credit to offset their tax liability.
Beginning in 2016, only small businesses and their owners are allowed to use their R&D credit against their AMT. Eliminating AMT could open the door for large construction companies to take advantage of this credit as well.
It’s important to keep in mind that there are no definitive answers on what will happen with the new administration, as the above propositions are just that—propositions. The expectation is that more details will be coming out in the upcoming months, and some of the proposals may take months or even years to materialize.
Although, considering the Senate and Congress have a Republican majority, the likelihood of getting the proposals through is high. Business owners must plan according to the information currently available.