President Trump signed the Tax Cuts and Jobs Act into law on December 22. The enactment of this legislation provides the first major tax reform in over 30 years and will have a far-reaching effect on both corporate and individual taxpayers. Many of the changes in the final bill are temporary and most are effective beginning on January 1, 2018 with a few exceptions. This article will highlight several of the key provisions that will have a significant impact on organizations in the construction industry.
The Tax Cuts and Jobs Act repealed the Domestic Production Activities Deduction (DPAD), effective for tax years beginning after December 31, 2017. Put in place in the early 2000s, the DPAD provided a 9% deduction on “qualifying production income,” which, for construction trades, was available for most, if not all, contractors, provided the work was performed in the United States. With tax rates as high as 39.6% for individuals, this deduction was roughly a 3.5% tax savings for individual taxpayers in the highest tax bracket. This deduction was applicable to several business sectors but was most applicable to construction and manufacturing.
The Tax Cuts and Jobs Act provides for a deduction that works similar to the DPAD, but allows for a more widely applicable and increased 20% deduction for Qualified Business Income (QBI) for pass-through entities including S Corporations, Partnerships and sole proprietorships. This can reduce the effective tax rate on QBI to 29.6%.
QBI includes income generated from a qualified trade or business, and does not include investment income such as long-term capital gains, interest, dividends, etc. A qualified trade or business is generally any trade or business unless it is a “specified service trade or business.” A specified service trade or business involves the performance of services in the fields of health, law, accounting, actuarial services, performing arts, consulting, athletics, financial services, brokerage services, investing or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.
Lawmakers specifically removed engineering and architecture from the list of non-qualifying services when writing the law so it looks like they are intended to be qualifying trades or business. Generally, it is expected that contractors will qualify for the deduction but more guidance is needed in this area. It is generally considered one of the more complicated areas of the new tax law.
Under the prior law taxpayers with average annual gross receipts over $10 million were required to use the percentage-of-completion method to report revenue on their non-exempt long-term contracts for tax purposes. Under the new law, that average annual gross receipts threshold was increased to $25 million. Now, taxpayers with average gross receipts under $25 million and contracts that are expected to be completed within two years can use an exempt contract method rather than percentage-of-completion, which generally results in a deferral of income. Permissible exempt contract methods include the completed contract method, the exempt-contract percentage-of-completion method, or any other permissible method-such as cash-as long as the contractor is otherwise eligible to use the cash method overall.
The Tax Cuts and Jobs Act also expanded the list of taxpayers that are eligible to use the cash method of accounting by allowing taxpayers that have average annual gross receipts of $25 million or less. Taxpayers that meet this will also not be required to account for inventories in the same manner as under prior law. Now, taxpayers are exempted from the uniform capitalization rules, which previously required an additional capitalization of costs as inventory for tax purposes and can treat their inventory as nonincidental materials and supplies.
These provisions to expand the application of these exceptions are effective for taxable years beginning after December 31, 2017. For long-term contracts, the change is applicable to contracts entered into after December 31, 2017.
Under prior law taxpayers were allowed an additional first-year bonus depreciation deduction equal to 50% of the cost of qualifying property, which included new equipment and certain heavy trucks. The 50% allowance was scheduled to phase down after December 31, 2017. Now, under The Tax Cuts and Jobs Act, taxpayers are allowed a deduction of 100% of the cost of qualifying property in the first year the property is placed in service by the taxpayer effective after September 27, 2017 and before January 1, 2023. Starting in 2023 the deduction is scheduled to phase down and be eliminated after December 31, 2026. The tax reform bill also expanded the definition of qualifying property to include used property.
The Tax Cuts and Jobs Act also expanded a taxpayers’ ability to expense qualifying property in the year placed in service under Code Section 179. Under the prior law a taxpayer could expense up to $500,000 of qualifying property placed in service each tax year. Now for property placed in service in tax years beginning after December 31, 2017 taxpayers may expense up to $1 million. This will be reduced for taxpayers whose total acquisitions of qualifying property in each tax year are over $2.5 million.
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