The tax breaks that fill the $858-billion Middle Class Tax Relief Act will provide welcome benefits for construction workers, some small firms, family-owned businesses and companies mulling equipment purchases. But the key question for the still-struggling construction industry is whether the measure’s incentives, including an extension of 2001 and 2003 tax-rate reductions, will hoist the economy enough to get more projects under way. If that “trickle up” effect does come to pass, it could give construction markets a boost, but probably not a sharp spike and probably not right away.
Nevertheless, industry economists and financial experts see the legislation, which President Obama signed into law on Dec. 17, as good news. Robert A. Murray, McGraw-Hill Construction’s vice president for economic affairs, says, “The extension of the federal tax cuts is a near-term positive, which should help the fragile U.S. economy gain traction during 2011.” (Engineering News-Record is part of McGraw-Hill Construction.)
Murray predicts that the legislation, partly by stimulating consumer spending, could increase U.S. gross domestic product in 2011 by as much as a full percentage point, to 3.5% from 2.5%.
Ken Simonson, chief economist for the Associated General Contractors of America, says, “Any bill that is putting $850 billion back into private hands is going to have an influence on construction.” The new law does not pump money into specific types of public works, he says.
“It’s much more an attempt at private-sector stimulus,” Simonson says. “By keeping hands off the specific categories of investment, hopefully you make the economy more efficient and make it grow faster, which is good for construction over the long and even the medium haul.”
“For most businesses, the Tax Relief Act may sound like more of the same,” says David Sullivan, partner at DiCicco Gulman & Co., a Boston accounting and consulting firm with a large architect and design firm practice. “But what it does do is eliminate some uncertainty for two more years, which could be the window for growth the A&E industry desperately needs.”
Murray says that growth could prompt companies to increase spending and hiring, which in turn should lead to a pickup in demand for home buying and also reduce commercial real estate vacancy rates. Commercial real estate may not benefit during 2011, he says, “but commercial construction [could] register moderate gains by 2012.”
The positive impact should come more quickly for individual construction workers and for small firms organized as partnerships or S Corporations, which are taxed at individual, not corporate, rates. They will benefit from the two-year extensions for current individual tax rates and rates on capital gains and dividends. All of those rates were slated to expire on Dec. 31.
“The tax bill is essentially all good news for the typical family or employee owned firm. Since the vast majority of the firms pass their income fee obligation through to the owners (Sub S, LLC, LLP, etc.) then income tax rates did not go up,” says Hugh L. Rice, investment banking chairman with construction financial consultant FMI, Denver. “That means more capital in the business to pay salaries, grow or survive.”
Tony Perrone, principal of FMI Capital Advisors Inc., adds that maintaining the tax on dividends at 15% “allows more flexibility in the distribution of profits through compensation or dividends for all types of ownership entities including regular (C corporations).”
Perrone and others who broker merger and acquisition (M&A) deals also see a potential boost in activity from the capital gains tax rate staying at 15% for the next two years. “Owners, especially senior owners, will be encouraged to think seriously about selling their companies,” he says. The M&A movement for further consolidation in the E&C industry will likely accelerate in 2011 and 2012.”
Other two-year provisions include protection for many taxpayers from the alternative minimum tax and, for family-owned businesses, favorable tax treatment for estates. The major new element is a one-year cut in workers’ Social Security payroll taxes, to 4.2% from 6.2%.
“I am relieved that we’re not looking at the higher rates,” says Gabriel Durand-Hollis, president of San Antonio-based DHR Architects, which is an S Corporation. He adds, “Of course, all we did is kind of kick the can down the street. This is only a two-year extension, so we’ll have to see what happens then.”
Durand-Hollis says his employees will benefit from the payroll tax cut. He says, “We’ve just been in survival mode.” His employees haven’t had a large raise in the past couple of years. Durand-Hollis says, “I want to reward them, but hopefully [the provision] will buy me a little bit of time so we can talk about more substantial raises, maybe in the middle of 2011.”
Jerry Gorski, president of Gorski Engineering, Collegeville, Pa., a family-run design-build S Corporation, says keeping his firm’s tax rate from rising in January will help it stay afloat in difficult economic times. The law also will provide more clarity ahead for businesses, he says. “The uncertainty that exists in the economy in general is one of the things that causes people to postpone making investments, which obviously includes construction.”
But other S-Corp. design firm executives are lukewarm on the benefits. “From our perspective, the tax legislation does not help for 2011 or 2012. It doesn’t hurt us, but certainly does not provide incentive to create jobs,” says James Johnston, president of environmental and energy consulting for Birdsall Services Group Inc., Cranford, N.J. “Jobs will be created when additional professional services are required by clients and that work cannot be absorbed among existing professional staff.”
The law also exempts estates valued at up to $5 million from the federal inheritance tax and sets the rate at 35% above that amount. The old exemption would have been $1 million, the marginal rate 55%. Robert Dietz, the National Association of Home Builders’ assistant vice president for tax and policy issues, says his group would have preferred estate-tax repeal but says the new exemption and rate are “certainly a step in the right direction.”
Also on the plus side are depreciation breaks, including a provision that lets companies write off capital goods in the year they were purchased. Small companies get an extension of the Section 179 write-off, though the maximum they can “expense,” starting in 2012, is $125,000, down from $500,000 in 2011.
John McClelland, American Rental Association vice president for government affairs, says bonus depreciation “clearly will help those who are already committed to investing and would possibly make it a yes decision for folks who are on the fence.” But, he adds, “There are also some businesses that just don’t believe that their balance sheets are strong enough for them to be able to go out and buy new equipment, even if they can get a pretty great tax benefit from it.”
For the housing industry, an extension of a mortgage-insurance deduction will help first-time buyers, says Dietz. However, he says, “There’s nothing here that’s a game changer and that will dramatically affect new and existing home sales in the same way that, say, the home-buyer tax credit did” in 2009 and 2010.
Groups such as the Solar Energy Industries Association were pleased to see a one-year continuation for grants for renewable-energy projects. Those grants are in lieu of tax credits to companies who lack income to benefit from a credit.
“Of particular interest for both individual and corporate taxpayers for 2010, is that the R&D tax credits will not be limited to the Alternative Minimum Tax,” says design firm accountant Sullivan. “We are encouraging our A&E clients to take advantage of any credits available to them in 2010.”
Still, construction industry officials were disappointed that the bill didn’t extend Build America Bonds. The program, which has helped finance public-works projects since April 2009, will expire on Dec. 31.
And others are wondering what’s ahead. “The big negative of this bill is that it is only effective for two years. Depending on the political climate and the party in power in two years will determine whether these provisions are extended, made permanent, or completely revised,” says FMI’s Rice. “This uncertainty creates an environment where making long-term decisions is difficult. Why can’t tax changes be “permanent” anymore?”
Adds Birdsall’s Johnston: “This one time hit to total federal revenue will have to be made up somewhere — a tax increase in the future is likely.”
|Individuals, S Corporations, Partnerships|
|Extends 2001, 2003 income-tax rates, averting increases|| |
|Increases exemption amount from alternative minimum tax|| |
|Cuts Social Security payroll withholding to 4.2% from 6.2%|| |
|Extends unemployment insurance benefits|| |
|Extends tax rate on capital gains, dividends, averting increase|| |
|Exempts estates up to $5 million from tax; sets 35% marginal rate for estates over $5 million. 2011 exemption would have been $1 million|| |
|100% write-off of capital purchases|| |
|Extends Section 179 expensing, but lower maximum eligible|| |
2012 & beyond
|Extends 15-year write-off period for leasehold, restaurant and retail improvements|| |
|Extends R&D tax credit|| |
|Renewable-energy projects’ Section 1603 grant in lieu of credit|| |
|Energy-efficient new-home credit|| |
|Energy-efficient upgrades to existing homes|| |
|Extension for Build America Bonds|
|Revenue-raising tax hikes to offset the bill’s tax breaks|
|Source: senate finance committee, Industry executives|