Updated: Dec 3, 2018
Congress recently passed the most significant tax reform legislation since 1986. The Tax Cuts and Jobs Act, approved in late 2017, should have a positive impact on design and construction companies, as key provisions of the legislation will converge to drive business investment, employment and wages.
Fundamental aspects of the law include:
It cuts the corporate tax rate from 35 percent to 21 percent. The new 21 percent flat tax rate will benefit construction companies set up as C corporations.
Construction companies that are pass-through entities (meaning they can include business profits on their personal tax returns, with examples including sole proprietorships, partnerships and S corporations) will get a 20 percent deduction on that income.
Businesses with less than $25 million of gross receipts for the preceding three tax periods can now use the cash method of accounting. Many contractors also can now use the completed contract (instead of the percentage-of-completion) method for construction contracts.
Private activity bond financing will retain its tax-free status, which will keep more funds flowing to the public construction sector.
After Congress passed the legislation, Associated Builders and Contractors (ABC) President and CEO Michael D. Bellaman released the statement, “The vast majority of construction companies will benefit from the new 20 percent deduction for qualified pass-through income, bringing the top effective rate to 29.6 percent, down a full 10 points. The rest will feel a boost from the largest corporate rate cut in U.S. history. Changes to various accounting methods will ease burdens for many small contractors and the doubling of the estate tax exemption to $11 million is a big win for our industry’s family businesses.”
The construction industry has been paying a higher effective tax than any other sector of the nation’s economy, according to ABC reporting on a U.S. Department of Treasury analysis.
Changes brought about by the tax overhaul, in conjunction with President Trump's proposal for a $1.5 trillion infrastructure plan as outlined in “Legislative Outline for Rebuilding Infrastructure in America,” should stimulate significant growth and activity in the construction sector. Construction firms will enjoy more capital to invest, greater flexibility and less regulation.
DRIVING CONSUMER DEMAND
By the end of 2017, economic momentum was solid and business and consumer confidence were on the rise. The Brookings Institute reported that 81 percent of taxpayers will see a tax cut from the tax reform legislation, averaging more than $2,000 per year, and that only 4.8 percent of taxpayers (primarily very high earners) will see a modest increase. Having better availability of funds should correlate to increased demand on the part of consumers, both for goods and services, as well as for design and construction services.
FREEING UP COMPANY CASH
Keeping more capital in a business allows that business to reinvest. Near-term investment on the part of construction companies will likely take several forms. Some public companies will use the extra cash to buy back stock. Others will invest in their businesses via capital expenditures (CAPEX), new hires, and increased salaries and benefits for their employees. Capital-intensive businesses such as manufacturing companies can utilize the additional capital to fund the cost of facilities and equipment.
The construction industry overall is a “capital-intensive, cash-flow challenged, domestically oriented industry comprised mostly of small, family-owned and closely held merit shop construction companies employing hardworking Americans,” Bellaman said. “[ABC] members have waited for Washington to let them keep more money in their paychecks, which would enable them to invest back in their businesses, create new jobs in their communities and grow the economy. The wait is finally over.”
The new legislation will have a significant positive impact for small to mid-size businesses. These companies, which traditionally relied on bank loans for additional capital, will be able to take an immediate tax deduction to use as equity for their investment, thus encouraging further growth and expansion.
Another potential plus for design and construction firms is the tax advantages for smaller firms. “Gaining tax relief for architects who organize as pass-through companies—which includes the majority of U.S. architecture firms—is a significant improvement over earlier drafts," said Carl Elefante, National AIA 2018 President, in a December 2017 statement. “So is preserving at least in part the Historic Tax Credit, which was totally abolished by the original House tax reform bill.”
INVESTMENT IN PEOPLE
According to the Tax Foundation, the tax legislation will lead to the creation of nearly 339,000 full-time equivalent jobs. In addition to more new jobs and capital investment, legislation is expected to result in higher salaries and better benefits. In the recent National Association of Manufacturer’s survey, almost 54 percent of CEOs in the survey said they would hire more workers, and nearly half (48.8 percent) said they would increase employee wages and benefits.
Survey results from ABC's December 2017 Construction Confidence Index showed that 55 percent of contractors expect their profit margins to expand in the first half of 2018. In a news release announcing the survey results, ABC Chief Economist Anirban Basu said, “There are many reasons for confidence among the nation’s construction firm leaders. American wealth has never been greater in absolute terms as the economy experiences faster wage growth, surging equity markets and rising home values. Consumer confidence is at a 17-year high, while unemployment is at a 17-year low.”
A recent Goldman Sachs study reported that U.S. firms have more than $3.1 trillion invested overseas. The Tax Cuts and Jobs Act will serve as a strong incentive for these firms to bring their investment back home. The investment will be in the form of property, plants and equipment for facilities.
Prior to the legislation, the United States had one of the highest corporate tax rates in the world. According to the Tax Foundation, the average tax rate amongst developed countries was 22 percent. As already noted, the Tax Cuts and Jobs Act will reduce the U.S. corporate tax rate from 35 percent to 21 percent. By aligning U.S. corporate tax policy with other industrialized countries, Americans stand to gain as companies bring cash back. Design and construction firms will see an uptick in work as companies re-shore.
Construction firms will keep a close eye on the industry’s response to tax and infrastructure changes in 2018…and they’ll be working closely with their tax accountants to reap the benefits now allotted to small and midsize companies. With optimism levels reported to be high, a new outlook for the building professions may be on the horizon.
No copyright infringement intended. This article was originally published at constructionexec.com By Brian Gallagher