Pouring Salt on the Wound: How Recent Tax Reform Affects You
Wednesday, March 28, 2018
Posted by: Hilary Korabik
Pouring Salt on the Wound:
How Recent Tax Reform Affects You
by Rob Nowak, CPA, MST
In December 2017, Congress and President Trump enacted the most sweeping tax reform legislation in a generation. Contractors are specific benefactors of the Tax Cuts and Jobs Act (TCJA) in the form of incentives for capital expenditures, favorable lives for certain classes of real estate assets, reduced corporate and personal tax rates and a favorable tax rate for pass-through income. Victory for the American contractor! End of story, right? Not so fast.
As the federal government giveth, the states are poised to taketh away. Many states are presently considering legislation that would de-couple their tax codes from the federal tax code. What exactly does de-couple mean? Many state tax codes leverage numerous sections of the Internal Revenue Code (IRC) by generally adopting federal taxable income as their starting point. However, states also decouple, the practice of a state treating income or deductions differently in the computation of state taxable income than for federal taxable income, from various sections of the IRC.
The impact of de-coupling can be significant for contractors. Consider for example the impact on depreciation deductions. The TCJA permits businesses to fully deduct qualified property (new and used tangible property with a recovery period of 20 years or less) acquired and placed in service after Sept. 27, 2017, and prior to Jan. 1, 2023, pursuant to section 168(k). The TCJA also increases the maximum amount a taxpayer may deduct under section 179 to $1 million and the phase-out threshold amount to $2.5 million. The $1 million limitation is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2.5 million. In addition, the TCJA expands the definition of qualified real property eligible for expensing to include any of the following improvements to nonresidential real property placed in service after the date such property was first placed in service: roofs; heating, ventilation and air-conditioning property; fire protection and alarm systems and security systems.
How will de-coupling impact depreciation deductions for state income tax purposes? Numerous states already de-couple from sections 168(k) and 179 by requiring the addition of federal bonus depreciation and immediate expensing deductions back to federal taxable income. Approximately 36 states currently adopt section 179 immediate expensing. However, since most state 2018 legislative sessions have not concluded yet, only a handful of states that do not de-couple from the depreciation incentives have provided guidance as to how they will treat conformity to sections 168(k) and 179 pursuant to the TCJA.
Will changes to state tax legislation end with de-coupling from certain IRC sections? Some states recently increased their individual tax rates or allowed temporary decreases in rates to sunshine. Illinois individual taxpayers suffered a setback in 2017 when the legislature raised income tax rates. However, the state implemented those rates in a unique way.
On July 1, 2017, Illinois raised its individual income tax rate to 4.95 percent from 3.75 percent. Rather than a retroactive increase, Illinois split the difference for the 2017 tax year by averaging out the 3.75 percent rate from the first half of the year and the 4.95 percent rate from the second half to a 4.35 percent blended rate for the 2017 tax year. As of the beginning of 2018, however, the full increase will be in effect. Adding insult to injury, state personal exemptions as well as the property tax credit will no longer be available for high-income taxpayers with income of $250,000 for single filers or $500,000 for joint filers.
Individual income tax rate increases are a silent killer for contractor margins. Most contractors are pass-through entities with company income taxed at the owner level. A 1 percent increase in the state tax rate negatively affects margins. As many contractors are on a percentage-of-completion basis for income tax reporting, a two-year job bid in 2017 with a 3 percent margin might see a larger portion of that margin being paid to state coffers in the later years of the job.
In the end, the TCJA provided much-needed federal tax relief for taxpayers, but especially contractors. Act now to speak with your tax advisor to review emerging guidance on state action relative to the TCJA. Although the state tax story is a tale yet to be told, it is one that contractors should deliberately eye with anticipation.
About the author:
Rob Nowak is a tax partner with member company Baker Tilly, specializing in work with construction companies. He has experience in the technical areas of partnership taxation, taxation of closely held corporations and mergers and acquisitions. Rob can be reached at email@example.com.
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