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!

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.

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.  

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 3^rd 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:

	West	South	Northeast	Midwest	National
September 2017	48.4	54.0	56.9	50.4	49.1

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

	West	South	Northeast	Midwest	National
March 2013	51.9	53.6	54.6	53.9	51.9

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.

LA Stadium Project - Marquis Projects, To Pursue or Not Pursue

The much anticipated Inglewood stadium project plans are well underway, and with that the construction marketplace resources required to execute on this $2.6 billion dollar project will be spread that much thinner.  The stadium itself is expected to be completed in 2019, with all the surrounding development (labeled a “mini-city” by some) expected to be finished by 2023.  Many contractors will eagerly pursue work on such marquis projects leaving limited resources in the market to conduct other, recurring construction activities.  This drawdown on the supply of construction resources to the LA stadium project, as well as a host of other larger high profile projects online or soon to come online, could be a support for the pricing of all other projects.  This is welcome news for the southern California construction economy.

Contractors who work on marquis/trophy projects most certainly have the privilege of saying they worked on XYZ project.  What I've seen over the years is often times, in the final analysis, the financial performance of those projects doesn’t work out quite as originally planned.  Contractors may end up “paying” for the right to say they worked on a special project.  That payment is only financial, the stress involved in executing these large projects is not measured in dollars.  Why do these projects, in some cases, not turn out as originally planned?  For starters these contracts aren't the type typically executed by the contractor.  The factors involved are usually different than most every type of job a contractor has ever done before.  Additionally, sometimes the owners of these projects can be very tough on changes, having the attitude that the contractor is “lucky” to be associated with such a name brand company/project.  Generally, the contractor just bit off more than they could chew.  The technical challenges could be new,  perhaps it's their largest contract ever, or working in a new geography they weren’t familiar with or able to effectively manage.

With the above being said, one strategy might be to steer clear of the stadium project and focus on other opportunities.  Like I mentioned, there may be a built-in support for pricing giving the supply/demand impact the stadium project is likely to have on construction resources.  It might be worthwhile to not participate on the stadium project and do other work which should have good pricing opportunities. 

Some contractors I’ve spoken with have relationships with large contractors already committed to the project and consequently, will also need to work on the project due to that relationship.  Those cases are fine as long as the history generally supports that the smaller contractor will be taken care of in a fair manner.

I am not saying that a contractor should not consider pursuing large, trophy projects.  I am saying to carefully measure the opportunity, reconcile it with your capital (including bonding capacity utilization) and personnel structure, capacity, skillsets, and your other backlog.  Also consider the opportunity cost regarding other potential projects if you don’t take on such a large contract.  Although it may be more expensive to administer ten $2MM projects, the concentration risk associated with executing one $20MM project could be too great.  So consider whether it makes sense to pursue a large, marquis project…especially if it is different than anything you’ve done before.  Remember the old saying…”discretion is the better part of valor.”

Piece-Rate Compensation - AB 1513 and its impact on contractors

On October 10, 2015 Governor Brown signed AB1513 into law.  The modifications to employment law that AB1513 made deal with workers’ compensation and piece-rate compensation.  This post addresses the latter.

A few industry associations asked a law firm to provide an opinion of the new law as it relates to piece-rate compensation.  The law firm did an excellent job addressing the various points of the new law.  You can view their memorandum here.  Their memorandum outlines the “safe harbor” provisions contractors will need to comply with, by December 15, 2016, in order to avoid fines and penalties.  The changes required by the new law may prove costly for contractors whom have historically compensated their workers on a piece-rate basis.  At a minimum, changes to how these contractors compensate their employees in California appear to be on the way.

A significant element of the changes have to do with contractors being required to pay workers for rest and recovery periods and other non-productive time.  The administrative requirements being imposed by this new law all but assure the demise of piece-rate pay, at least as it has been known historically.  If you have been compensating workers on a piece-rate basis and you want your voice to be heard regarding these changes, I suggest either connecting with an industry association (as referenced in the memo linked above) or contacting your local state representative directly.  In the meantime, you need to become aware of the issues and requirements surrounding the new law and act accordingly.

Controlling Workers Comp Costs - Mobile First Aid

One of the highest costs to businesses in California is Workers Compensation Insurance.  For those that have done business in California for at least the last 15 years, you have experienced roller coaster like moves in rates.  Those rate swings seem to have come out of left field some in some years, with political and other market forces working behind the scenes to artificially impact those rates.  Those factors are mostly out of your control.  What is within your control is how you approach the issue of safety, how you handle incidents when they do occur, what processes you have in place to mitigate false claims as well as managing other variables.  How you address these areas will have a tremendous impact, positively or negatively, on your experience loss modification. 

One way to deal with potential negative events that would adversely impact your experience modification is to address problems at the earliest opportunity.  Some of my clients use this mobile first aid service, click here for details, to help address work site injuries as they occur.  The service is a 24 hour, 7 day a week operation and they offer a host of other services, as listed on the document along with pricing, designed to help run a tight ship with respect to your field workers.  Beyond the services they offer, I think it is a good idea to have an independent third party tend to these matters as that could benefit you in the event of litigation.

As usual, I am not affiliated with this organization in any way.  It seems like a good service worth investigating to help address these injury events as they occur.  As I mentioned earlier, there are some factors that are out of your control with respect to Workers Comp Insurance.  Creating and maintaining a culture of safety is within your control and you should do everything you can to maximize this area as it will result in substantial savings over time.