While the legislative process of reforming the federal tax code is underway, the ultimate changes that will result are far from certain. Republicans in Congress and President Trump are both determined to make the process a speedy one – start to finish in less than three months. Given this extremely short timeline, it is imperative for businesses, individuals and their advisors to stay up to date on the proposed provisions, to advocate for their interests and plan for the potential impact of the changes.
Both the House and Senate have issued their proposals—the House via the Tax Cuts and Jobs Act (H.R. 1) on November 2 and the Senate through the conceptual Chairman’s Mark on November 9. Many provisions included in both proposals will impact all types of industries, including construction. Changes in tax rates, elimination of the alternative minimum tax, interest deduction limitations for larger companies, exclusion of like-kind exchange tax deferral benefits on assets other than real property, and elimination of certain entertainment expense deductions will have widespread effect.
Several provisions, however, will impact construction contractors in a direct and significant way.
One such provision is the increased availability of the completed contract method of accounting to small and medium-sized construction contractors. For many years, the use of this accounting method has only been an option for contractors with average gross receipts of $10 million or less in the prior three years. The House bill would increase the threshold from $10 million to $25 million, while the Senate proposes increasing the threshold from $10 million to $15 million. The completed contract method allows the contractor to postpone taxation of income on contracts until they are completed. Contractors not permitted use of the completed contract method must generally use the percentage of completion method of accounting. This methodology requires recognition of taxable income on contracts based on the completion percentage of the job.
Other provisions expand the ability of businesses to quickly deduct the cost of property and equipment additions. These will be attractive to construction contractors who have a need or desire to make significant investments in expensive equipment such as heavy trucks, earthmovers and cranes. Under both proposals, as an alternative to the current “bonus depreciation” provisions which are phasing out, businesses could fully and immediately expense 100% of the cost of qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023. Both the House and Senate recommend increases to Section 179 depreciation limits. The 2017 rules permit $510,000 to be expensed, with a phase-out beginning at $2,030,000 for total acquisitions. The House suggests increasing these to $5 million/$20 million, respectively, while the Senate’s increases are only to $1 million/$2.5 million. Both increases would be effective through 2023.
Virtually every domestic construction contractor would be affected by another House proposal—repeal of the Domestic Production Activities Deduction. Under current law, contractors are allowed a deduction for 9% of their Qualified Production Activities Income (QPAI). Generally, QPAI is the amount of taxable income from a contractor’s construction activities in the United States.
Although it is very early in the process of tax reform, we wanted to keep our friends and clients in the construction industry informed about the potential impact. Some of the provisions mentioned above may change or be eliminated in the course of the legislative process, as the House, Senate and President must all agree to arrive at a final law. If you have any questions about the tax reform process, please feel free to reach out to your Clark Schaefer Hackett professional.