Republicans in Congress recently released their initial plans to overhaul the tax code. Most of the news was good, some was bad and some will require a little more work to determine whether or not the construction industry will benefit.
It is worthwhile to begin by talking about the process. Republicans have chosen a process called reconciliation to move tax reform. You may have heard this term used before in conjunction with Congress’ failed attempts to move healthcare reform and before that as the retroactive negotiating chip employed by House Democratic Majority in 2010 to coax House Democrats to pass the Senate passed version of the Affordable Care Act (ACA, Obamacare) after Senate Democrats lost their filibuster-proof majority when Scott Brown (R-Mass.) won the election to succeed Ted Kennedy (D-Mass.). Fearing that the bill would need to be changed substantially to overcome Republican filibuster in the Senate, then-Speaker Nancy Pelosi (D-Calif.) promised House Democrats who were reluctant to pass the Senate version a follow-up bill that would make budgetary and financing changes (only) to the ACA, and thus under reconciliation rules only required a simple majority vote in the Senate. This bill was signed into law just a week after the ACA was signed by President Obama. The same tactic will be employed for tax reform, which would allow a simple majority to pass the measure in the Senate.
On Oct. 19, 2017, the Senate passed the fiscal year 2018 budget by a vote of 51-49, with Rand Paul (R-Ky.) being the only Republican to vote ‘no’ with all Senate Democrats and Independents. The budget would allow up to $1.5 trillion to be added to the deficit in order to account for lost tax revenue that is expected when the Republican tax reform plan lowers the tax rate.
Now that the process has been determined, Republicans can focus simply on putting a plan together that appeases just 50 Senators (assuming the plan also avoids too many Republican defections in the House, which at this point seems increasingly unlikely). Remember that in the event of a tie, Vice President Pence will cast the tie-breaking vote. The plan that Republicans released Sept. 27, 2017, provides general principles and outlines for their tax code overhaul, but many details remain missing.
First, the international business tax code will be morphed almost entirely from our current system, which only taxes foreign profits that are brought back to the United States, to a territorial system. The current code has allowed American-owned companies operating overseas to harbor money overseas where they either pay a much lower rate or no tax at all. Some experts have judged this bucket of cash to be approaching $3 trillion which the U.S. Treasury cannot touch under the current code. The proposed plan will no longer allow corporations to retain liquid assets untaxed overseas. Dividends from foreign subsidiaries will be exempt from taxation, but there will be a one-time repatriation on all income held overseas at a rate still to be determined.
Second, the corporate and business tax rates will be cut. The corporate rate will be cut to 20 percent and small businesses that pay taxes as pass-through entities will have their income taxes capped at 25 percent while eliminating the Alternative Minimum Tax (AMT). The plan will also retain the business tax credits for research and development and low-income housing, but eliminates almost all other deductions and credits.
Of particular interest to the construction industry, which requires some further investigation, is how the new plan will deal with business expenditures. The plan calls for 100 percent immediate expensing of new investments in depreciable assets. What the industry will have to determine in terms of dollars is whether this makes the significant cut in rates worthwhile, especially in tough financial years where the current code allows depreciable assets to off-set income taxes when the business operates at a loss. This may result in more companies renting or leasing assets rather than purchasing them and adding them to their balance sheet. Immediate deductibility of assets will replace current tax mechanisms such as bonus depreciation and Like-Kind-Exchanges. Lawmakers hope that business industries will agree to this mechanism and the loss of existing tax mitigating mechanisms in exchange for a simplified code and lower rates. It remains to be seen how the economics and accounting will actually impact businesses’ bottom lines.
On the individual side of the tax code, the plan offers a significantly simplified and lower rate structure. Tax brackets will be decreased from seven to three at 12 percent, 25 percent and 35 percent tax rates, respectively. The standard deduction will be doubled for both individuals and married filers, which will essentially create a new and larger class paying a zero percent rate. The estate tax will be repealed as will almost all other individual deductions with the exception of the mortgage interest deduction and the charitable giving deduction.
Questions remain concerning the final tax reform plan, but we know this is the basic structure Republicans would like to pursue. If Congress continues to be steadfast on closing nearly all of these loopholes, tax reform could move quickly. However, at the mere inkling of any special interest winning concessions for prized deductions or credits, either by the force of their lobbying apparatus or in negotiations by lawmakers for enough support to pass the legislation, you can count on the whole lot, including the construction industry, to put their full advocacy and lobbying efforts toward special tax treatment which will almost ensure an elongated process and put reform in jeopardy.