Sunday, March 11, 2018

Trump, Tariffs, Tax Reform and Trade

Tariffs on Steel and Aluminum are big in the news these past few weeks with President Trump looking to impose tariffs on these materials later this month, 25% and 10% respectively.  This has sparked a lot of debate around the country, including within Trump's own administration and potentially being the final straw causing Gary Cohn to resign as Chief Economic Advisor to the President. 

During the Presidential campaign, Trump set a goal of achieving at least 3% GDP growth on a sustained basis.  In his administration’s view, the tax reform package was a significant step toward helping to achieve that goal.  The administration looked around the world at tax rates and observed that our higher tax rates made our companies less competitive on the global scene.  Trump felt that was not fair to U.S. companies and his administration moved to narrow the gap.  Now he has turned his focus to another campaign promise, that of free and fair trade.  The trade deficit has been in existence largely in the past 20 years or so.  On the link just provided, click on MAX to see the history.  One factor contributing to this deficit are the tariffs other nations impose on our goods coming into their country.  China, for example, imposes a 25% tariff on U.S. car companies on vehicles sold into China.  In January 2018, the trading partner with the largest deficit was China at $36 billion dollars, an increase of almost 17% from the prior month.  The cause for the sharp increase was primarily due to much lower exports to China, dropping by 28%, while imports rose 3%.  It seems that China is a primary focus on this issue, not so much other trading partners such as Mexico and Canada.  Exports to Mexico rose almost 11% in January 2018 while exports to Canada dropped by almost 3%.  Imports from both of these countries increased by about 3% from each.  The overall trade deficit in January 2018 was just under $57 billion (again, China is well more than half of this amount at $36B), the largest trade gap since the Fall of 2008.  Although month over month fluctuations could contain one time transactions and other isolated events, it is an interesting indication nonetheless. 

Imposing tariffs on certain trade partners is Trump attempting to continue his mission of leveling the playing field for U.S. businesses, in this case steel and aluminum companies.  Part of the challenge here is that as these companies stand to benefit, others in our economy will incur higher costs for those materials inputs.  The price of goods containing those inputs will increase, some more than others depending on how much of those particular inputs they consume.  As of last year, there are approximately 150,000 workers in the U.S. in the Steel and Aluminum industries (Bureau of Labor Statistics).  The number of U.S. workers who are employed at companies using steel and aluminum as inputs in their manufacturing processes is over 6 million.  The concern some have over these tariffs is that you will probably benefit those 150,000 workers (less foreign competition, more jobs/higher wages), but at the possible expense of the over 6 million using those materials as inputs.  When businesses face higher costs, they make decisions to offset those costs which sometimes comes at the expense of the labor force (e.g. job and wage cuts).  Additionally, consumers stand to get hurt to some extent as the rising costs of goods coming into the U.S. as a result of tariffs will end up being reflected in the price consumers pay for those goods, essentially a trade tax.

As of now Mexico and Canada were exempted from the tariffs, pending continued negotiations on the NAFTA deal, other trade partners may be exempted in the next few weeks per Treasury Secretary Mnuchin.  This should serve to mitigate the increases in the cost of steel and aluminum as we import just a bit over 25% of our steel from those two nations.  China accounts for approximately 3% of our steel imports when looking at direct imports.  The problem with the numbers I just cited is that there is a practice known as “trans-shipping” whereby a country like China sells through to another country, and that country in turn sells it to the U.S.  The import statistics don’t account for this trans-shipping practice so it makes it more difficult to know how much steel and aluminum are actually coming from China and what the tariffs will mean to the cost of goods here.  Trump’s administration has said they will not allow trans-shipping from Mexico and Canada since they will be exempt from the tariffs.  If you hear that tariffs on these materials won’t have much of an impact because we don’t get much of it from China, that may not be entirely true.  Some predict the cost of commercial and industrial construction projects, particularly those that are steel intensive, could rise as much as 4% give or take.  

There are concerns that imposing these tariffs could spark a trade war.  Trump himself has come out and expressed little concern over this possibility, also stating it would be “easy” to win a trade war.  It's often said no party really wins in a trade war, all parties would be hurt at least to some extent.  Even if there is retaliation in the form of new tariffs on U.S. exports, you would think it wouldn't last long-term.  Generally speaking these leaders aren’t stupid, and resolving any issues regarding trade is in everyone’s best interest.  Treasury Secretary Mnuchin stated last week that President Xi of China understands that it is their best interest to reduce the trade imbalance with the U.S.  President Xi knows it exists, the numbers back it up and he obviously knows it’s a serious issue with the U.S. administration presently.

Higher costs related to steel and aluminum are already showing up in the market, and determinations need to be made as to who will bear that cost.  If you are a producer of steel, you will get higher prices and fare well under this policy.  If you are a consumer of steel, you will be paying the producers more.  Work that is in process as these price increases are currently flowing though will be borne by the party consistent with the contract terms in place.  If you already have market volatility terms in your contracts, that’s great!  If you don’t, wording such as this might make sense... “Escalation costs may be added via equitable adjustment due to current market volatility”.  As always, consult with your legal counsel to ensure the objectives you are trying to reach are being well served by any terms and wording you include in your contracts. 

Sunday, February 11, 2018

Buying Commercial Real Estate - Making the New Tax Law Work for You

Acquiring a commercial building may have become a little more achievable with the recent changes in the tax code. For years we have been able to break down the components of a building into shorter depreciable lives via Cost Segregation Studies. This allows taxpayers/investors to take advantage of accelerating depreciation of certain asset classes over a much shorter period than the typical 39 years for commercial real estate. The new law enhances this ability, allowing the investor/taxpayer to obtain an immediate write-off for a portion of the purchase price, subject to possible limitations depending on circumstances, in the year of acquisition. The cash flow savings that can be achieved from combining the effect of a Cost Segregation Study with the enhancements to bonus depreciation under the new law can be significant.

The Tax Cuts and Jobs Act of 2017 (TCJA) has changed many provisions in the tax code. Many of them are favorable while some take away certain benefits such as the elimination of the Domestic Production Activities Deduction and the ability to deduct state and local taxes on your personal returns. One area that we’ve seen since 2001 be of great benefit to business taxpayers is bonus depreciation. This provision was slated to be completely phased out by 2020, but it was expanded and new life breathed into it. In 2017, it was limited to 50% of the cost of acquired qualified property, with that number reducing to 40% in 2018, 30% in 2019 and eliminated in 2020.

With the passing of the TCJA, we now have bonus depreciation allowing for taxpayers to immediately write off 100% of the cost of qualified property (think equipment, furniture/fixtures and other depreciable assets). The new law allows for 100% bonus depreciation for certain property placed in service after September 27, 2017 (both new and used, essentially “new” to the taxpayer) with phaseouts starting in 2023 and expiring fully after 2026.

Section 179 expensing has also been modified and expanded, moving from $510,000 in 2017 (phaseout begins at $2,030,000) to $1,000,000 in 2018 (phaseout begins at $2,500,000). Section 179 has been further expanded to include the following previously excluded categories:



         Fire/Alarm/Security Protection Systems

There have historically been differences between bonus depreciation and Section 179, but now that both are offering 100% write-offs for both new and used property, the differences aren’t as great. One of the differences remaining has to do with depreciation recapture with Section 179 if business use of the subject property falls below 50%. Your tax professional can assist in making determinations on how to best use these options depending on circumstances.

With the performance of a Cost Segregation Study, the ability to carve out a piece of the cost of building into different asset classes allows for the use, again with certain possible limitations, of the new provisions to greatly reduce the cash flow obligations by taking an immediate write-off in the year of acquisition for part of the purchase price.

With the tax law changing, many creative opportunities arise. As with any information you read, consult your professional services provider to address your particular situation.

Sunday, January 7, 2018

Negotiating Contract Terms

by Ilse Baeck, Owner of Contract Review Services for Construction

"Everbody signs our contract..."  If you are a subcontractor, this probably sounds familiar to you. Another oldie, but goody: “We do not allow changes to our boiler plate.” I consider both to be opening statements to negotiations.

As a general contractor you face similar situations. The competition on the top is fierce. And owners don’t miss a chance to alleviate their risks. Lately, design-build contracts are used to put responsibility for the architect, chosen by the owner, on the general contractor. And subcontractors, who are the essence of every project, who bring expertise, who do most of the work, and who basically finance the whole building project, are expected to assume all the risks as well.

If you, as the subcontractor, insist on getting the terms changed, you will find that most general contractors are willing to talk. General contractors will agree to negotiate for very good reasons:
·         They used your number to prepare their own bid for the owner,
·         They selected you, because you were either the lowest bidder or had the most solid and comprehensive estimate,
·         You have a good reputation in the industry and most likely are financially strong.

The last thing any project needs is a contractor going broke in the middle of it. Not negotiating with you means that the general contractor must now hire the second-best choice. That second choice subcontractor’s bid might have expired, their price might have gone up.  Plus, the owner may not approve a substitute.  It is a lot more headache for the general contractor to be rigid than to sit down with his top choice and negotiate.

Incidentally, the same is true for the general contractor. The owner will agree to negotiate for all the same reasons:
·         You have the best number
·         You have the best reputation
·         You are financially solid
·         You have most experience with the kind of project the owner wants you to build.

I remember meeting with a general contractor’s team in which their opening was “nobody else had a problem with our contract; you are the only one.” A half hour into the meeting, the main negotiator turned to his associate and announced “on this change, let’s use the same wording we did with that other sub.”  Aha! Nobody else asked for changes, right?

Sometimes reading a contract can be frustrating; for example, when allowances for deductions are listed within the billing requirements.  Who would expect them there?  Or when you are asked to indemnify the owner or the general contractor for their “whole omission and/or fault.” Personally, I love to ferret out the little and the big pitfalls that can cost a contractor a lot of money. If you look at it that way, it might become fun for you, too. Of course, these documents are prepared by lawyers and it does not mean that the person presenting them is not a good and decent customer. However, even the best customers get off the straight and narrow when they themselves risk losing money. For that reason, protections written into the contract are immensely important.

The best advice for a good outcome of any negotiation is to listen. Listen most of the time and once you hear all the reasons that your customer insists on a certain clause, offer a solution that works for both sides, changes the wording and spreads the risk evenly. It is also important to put not only the absolute deal breakers on the table. Be very detailed and mark absolutely everything you don’t like. That way, your negotiation ends with mutual wins and losses. Customers always need to know that you have their best interest in mind, but that you also need to have some basic protections for yourself in place. And in the end, once you have negotiated your contract, you have earned the customer’s respect.

In summary, I want to encourage everybody to negotiate, negotiate, and negotiate. There is a saying in the construction industry that there will always be jobs that lose money.  It does not have to be that way! With the inclusion of agreed-upon terms that will protect you, before the project even begins, you will be more likely to walk away with profit once it’s completed.

Friday, December 29, 2017

Best Summary of Current Tax Law vs. New Tax Law

One week ago the President signed the Tax Cuts and Jobs Act.  Northern Trust published an excellent summary of the new law, laying out in easy to read tables the law as it stands currently in 2017 and the new law effective next week in 2018.  The piece covers Pass-Through entities, Corporations, Individuals, Estates/Gifts, etc.  It is by far the best summary I've seen, please see below and Happy New Year to all!

Wednesday, December 20, 2017

Tax Reform Package - Let the Games Begin

Some states, including California, are already beginning to work with tax strategists to identify methods to mitigate the impact of the loss of the state and local tax deductions for federal tax purposes.  The governors of high income tax states such as California, New York and New Jersey are in close contact with one another to work towards a solution for higher income tax payers who may be hurt by the loss of these deductions and they are already coming up with some creative workarounds.

One option being considered is to completely eliminate the state income tax system and replace the lost revenue via increased payroll taxes.  States would tax corporations an amount approximating how much state income tax an employee would have paid under the current system.  This would allow corporations to get that lost tax deduction transferring it from the individual to the corporation and enhance revenue in these states.  I do wonder about possible fallout from unintended consequences here, what moves corporations may make in response.

Another option on the table for these states is to allow public school systems to be recognized as 501(c)3 organizations.  The thinking here is that the portion of property taxes, currently slated to be capped along with state income taxes on a combined basis at a $10,000 deduction on your federal tax return, relating to schools would be allowed as a charitable deduction.  That’s a very creative solution to help individual taxpayers get over the new and increased standard deduction limits slated at $24,000 for joint returns, $18,000 for single parents and $12,000 for individuals.

Also, some governors are already investigating possible legal action against the Federal government under the premise that this tax reform package violates the protection of states’ rights under the U.S. Constitution.  So sit back, open a bag of popcorn and continue watching as certain states maneuver and assess what actions they might be able to take to help preserve some of the status quo with respect to these state and local tax deductions.

Monday, December 11, 2017

Overview of Proposed Tax Reform

By now most have heard about some of the proposed tax changes coming out of Washington, D.C.  There are some differences between what the House is proposing vs. the Senate and The Associated General Contractors of America have prepared a nice table showing those differences.  The chances are very good at this point that we will see reform for 2018, a little over 30 years after we saw the last major overhaul.

The changes will be widespread, affecting corporations and individuals alike.  Of special note for the construction industry are the following:

  • ·         Repeal of the Domestic Production Activities Deduction (DPAD)
  • ·         Small Contractor Exemption Increase from $10MM to either $15MM or $25MM

Also, Cash Accounting will be available up to either $15MM or $25MM in gross receipts (currently $10MM for Pass-Throughs and $5MM for C-Corps), including inventories.  Both the House and Senate have provisions for full expensing of new equipment (the House includes used equipment here as well) for 5 years.

There is a lot of change on the horizon, much of it should bode well for businesses and the economy.  Should you wish to discuss any of these provisions further, their possible impact and what actions might be advantageous as we head into 2018 please feel free to contact me.  Given some or most of these changes will be occurring, there are measures to take to position your business for the maximum benefits.  For a more detailed overview of the proposals in the House and Senate, see below.  

Tuesday, November 7, 2017

Current Outlook and Architectural Billings Index

One of the questions I’m often asked is “What do things look like out there?”, typically followed these days with “How long will these better times last, when will it end?”.  Every contractor has their own experiences, their own challenges and successes.  The generic answer needs to address the “typical” experience out there, the contractor who falls somewhere in the middle of the bell curve.

The answer I give today is things are generally pretty good out there, not as euphoric as it was just prior to the great recession, circa 2006 or 2007) but increasingly good in recent years.  My perspective is that things bottomed out, for the average private commercial/industrial contractor, sometime in 2012.  Each year since 2013 we’ve seen further modest improvement, stabilization and good earnings for contractors here in Southern California.

Frankly, a few years ago, I thought based on listening to economists and others that 2017 might be the peak and we’d fall off from there for a while.  Well we are within a handful of weeks from getting out of 2017 and things still look pretty good.  Backlogs are strong into 2018, with some of my clients reporting commitments into 2019. Business optimism remains strong.    Of course a large geo-political event could put work to a halt like we saw after 9/11, commitments notwithstanding.  That being said, it looks like we have good times for the foreseeable future and we can only hope it continues.  

The concept of "reversion to the mean" creeps into my mind as we currently enjoy the 3rd longest economic expansion in U.S. history.  Hopefully the Federal Reserve and others whom have control over how our economy behaves pull on the all the appropriate levers in all the right ways at all the right times, or something close to that metaphor.

A quick look at the Architectural Billings Index, a leading indicator we’ve touched upon a number of times over the years on this blog shows that here in the West, things appear to have softened some with a reading of 48.4 for September 2017.  These numbers are just indications of work to be performed, more of a guideline than a rule.  If you aren't familiar with how the index works, click on the link in the preceding sentence for more background.  One poster on the AIA website from the West indicated that a few of their projects were put on hold, citing rising construction costs and labor shortages.  Interesting, makes sense given the data out there, particularly with the historically low unemployment levels we are currently experiencing.

These regional numbers for September 2017 are shown in the table below:

September 2017

By contrast, taking a look back to July 2014 numbers, we see the following:

March 2013


Perhaps the lower input costs for materials in 2013 as well as the more available labor market created conditions for increased construction activity, correlating to our experiences in 2013 and the ensuing years.  At that time, the unemployment rate quoted by the Bureau of Labor Statistics for March 2013 in the West was 8.3%, the highest in the nation with supply of labor more available than today.

Could the current labor market and the implied labor shortages be a precursor to slowing construction activity?  Or possibly stable construction activity with increasing prices?  Inflation in construction inputs could also be a factor to watch.  For the immediate future, it seems to be steady as she goes.  

The actionable takeaway from this data is to always be vigilant regarding your fixed overhead, keep it low and be prepared to make dispassionate decisions regarding your variable costs, including your labor.