With the recent tax legislation come changes that affect businesses in every industry. What’s changing? A lot – everything from the tax rates you’ll pay to the deductions you can claim. For government contractors in the construction and manufacturing sectors, TCJA’s impact is mostly positive, although the law is not without costs for these companies. Here’s a look at some of the most significant impacts, both good and bad.
The not-so-good news
Not all changes in the new law are welcome ones. The legislation’s less appealing aspects include:
- Elimination of the Domestic Production Activities Deduction (DPAD). This deduction for C-corps and other business entities is gone, replaced by the reduction in corporate tax rate and the QBI deduction, respectively.
- Limited deduction for business interest expense. For companies with gross receipts of $25 million or more, there is a new limitation on the deductibility of interest. Beginning in 2018 the interest expense deduction is limited to 30% of adjusted taxable income plus interest income.
- Net operating loss (NOL) limitations. NOL treatment is one of the law’s bigger changes. Briefly, NOL carrybacks are eliminated and an income limitation now applies to future losses, capping a year’s deductions under Section 172 at 80% of taxable income. However, the language that controls effective dates and treatment for prior and future losses is still being revised. More details will be coming.
- Excess business losses limitation. Business losses are capped at $250,000 for individuals. Losses above this limit must be combined with the NOL and are therefore subject to the 80% rule. While this provision will not affect large contractors or manufacturers, smaller ones operating as a pass-through entity may be impacted.
- Like-kind exchanges. Deferred gains on like-kind exchanges are now limited to real property, which eliminates the ability to defer gains from vehicle and heavy equipment trade-ins.
The good news
Overall, TCJA is a financial boon to manufacturers and construction contractors. The most noticeable benefit is a dramatic drop in corporate income tax rates, with the top rate on C-corporations plummeting to 21 percent from the previous 35-percent maximum and the corporate alternative minimum tax (AMT) repealed entirely.
Certain pass-through businesses will also find meaningful relief in federal liability by taking advantage of a new 20-percent deduction of qualified business income (QBI). Coupled with lower personal income tax rates, the deduction creates an effective top rate of 29.6 percent.
The QBI deduction does have income-contingent limitations for some taxpayers that cap it based on a percentage of the W-2 wages paid (or W-2 wages plus 2.5 percent of qualified depreciable property). In addition, it cannot be used to generate a net loss for the tax year when combined with capital gains/losses.
Even with these limitations, most businesses will see reduced tax liability from the change. Other aspects of the new law also offer the potential to benefit construction companies and manufacturers. These include:
- Expanded availability of accounting methods. The new law raises the threshold for adopting the percentage of completion method of accounting from $10 million to $25 million in average gross receipts, and expands access to different methods to manufacturers and other C-corps that maintain income-producing inventories. This change will allow many government contractors to opt for the cash or accrual method in certain long-term projects.
- R&D tax credit. With the AMT gone, more businesses may be in a position to claim credits for research and development activities, which can offset some or all of their income tax liability. In some cases, R&D credits may present an alternative for companies that face limitations on net operating losses (NOL).
- Depreciation deductions. Under TCJA, capital expenditures are eligible for 100 percent bonus depreciation treatment. In addition, used assets may also be classified as qualifying assets.
- Section 179 deductions. The IRS limit on Section 179 is now $1 million, doubled from the previous $500,000.
Planning ahead is especially critical after major shifts in tax policy, and within this sweeping legislation exist numerous exceptions, time specifications and phaseouts. Plenty of opportunities exist to profit from the latest changes, but also the possibility for unexpected tax liabilities at the end of the year. Businesses that carefully scrutinize how the law applies to their activities will avoid surprises and reap the most benefit.
With TCJA being the new law of the land, it is imperative for contractors and manufacturers to seek expert advice in determining the most tax-advantaged position. Find your best path forward by contacting the tax professionals at HBP.
Written by: Andy Powell, CPA Managing Partner