AGC Committee Examines Financial Issues Affecting the Construction Industry
In June 2017, members of the Financial Issues Committee (FIC) of the Associated General Contractors of America (AGC) met in Minneapolis to discuss emerging industry developments. The committee is composed of financial leaders of construction companies nationwide and experienced professionals practicing in the industry.
Republican Congressman Erik Paulsen from Minnesota, an influential member of the House Ways and Means Committee, opened the dialogue. Representative Paulsen observed that our economy’s growth rate should be accelerating while corporate inversions should be decelerating. An outdated tax code was seen as a key underlying cause of the nation’s stifled growth and the increasing number of corporate headquarters migrating abroad. Paulsen was optimistic that a tax code overhaul based on objectives of growth, simplicity, international reform, and permanency may yet be achievable in 2017, though likely very late in the year.
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Representative Paulsen supports reform objectives, including modified corporate taxation, that reduce inversions while not impairing the success of small business, though he requested input from the committee on defining “small” for these purposes. He favors enhanced federal infrastructure funding, but sees this legislation evolving separately from tax reform. He noted the border adjustment tax has been a contentious issue that faces strong resistance. In regard to the estate tax, Paulsen favors keeping the current asset basis step-up at death, even in the event of estate tax repeal. AGC staff members Jeff Shoaf and Matthew Turkstra, along with CLA’s John Dorn and I, then updated the committee on other tax matters. Discussions included tax proposals for increasing capital asset expensing and eliminating interest expense deductibility. We also considered new challenges posed in conversion from pass-through status into C-corporation form.
Current Trump and House proposals replace many depreciation rules with full asset expensing, a model of taxation more closely tied to cash flow. This seems indirectly linked to the loss of much interest expense deductibility also included in these proposals. Dorn noted, “Today’s tax code favors borrowing over equity capital since interest expense is deductible while dividends are not. In the absence of an interest deduction, borrowing costs would effectively rise, diminishing the benefits of financial leverage. This imposes a high and permanent cost on many businesses and is likely to encourage the retention of earnings in the business and a corresponding reduction in debt.”
A drop in tax rates may allow companies to accumulate equity more quickly to make this shift, but it would still take time. Meanwhile, much capital investment becomes immediately deductible, which, for equipment intensive contractors, reduces taxable income in the short run (a very favorable change) though it is essentially a change of timing.
I foresee there will be winners and losers in this reform, even within our own industry, with equipment intensive and well capitalized contractors likely to gain the most, while challenges for undercapitalized start-ups will stiffen.
Discussion of Capitol Hill proposals revealed that there are efforts afoot to limit access to S corporation status or its traditional tax benefits. Some committee members saw this as a threat to the heart of the AGC’s membership, who rely heavily today on the S corporation as their preferred tax reporting framework. “Modifying the tax code to discourage use of S corporations could be a setback for the industry,” Dorn noted. “Conversions to C corporations may undermine decades of tax practice, estate planning, succession planning, financing relationships, bonding capacity, and operating practices if corporate tax liabilities are brought back onto contractors’ books and a double tax regime applies again. The committee will be vocal in expressing its concern with these proposals,” he added.
In addition to these tax topics, the committee discussed financial reporting changes to revenue recognition and leases, led with comments by Cullen Walsh, assistant director of the Financial Accounting Standards Board (FASB). Committee members, including Brad Uherka from CLA, led discussions focused on recently developed implementation guidance. The effective date for revenue recognition changes is just months away for public businesses and a year later for private entities.
FASB’s discussion has now shifted from theoretical examples to specific issues raised by the new implementation guidance. Companies now need to execute on the many implications for uninstalled materials, variable consideration, and contract costs. “The rules have changed,” Uherka said, “and most contractors will need to expand disclosures. Contract analysis is required to fully understand the consequences, though often final numbers will be fairly close to the existing standards.”
How we can help
In an age where Snapchat and Twitter are considered reliable news sources, it’s more important than ever to have contractors engaged with their industry associations, like AGC, who speak with authority as they work for the enduring vibrancy of the construction industry. The AGC’s Fiscal Issues Committee monitors federal tax and financial accounting matters so that it can thoughtfully offer effective advocacy on critical issues. CLA’s construction professionals fully participate in the industry at many levels so we can better know and serve our clients.