Tax reform: what it may mean for you
Updated November 13, 2017
As the old saying goes, in this world nothing can be said to be certain, except death and taxes. But one more thing is certain: everybody hates the tax code. Incredibly complex, inequitable, economy-stifling, an accountant’s dream but a businessperson’s nightmare, the US tax code is something Washington policymakers have tried for years to reform since its last overhaul in 1986.
This year, though, with Republicans in control of both Congress and the White House, the possibility that lawmakers will rewrite the tax code is greater than ever, with massive implications on architects and the built environment. On November 2,, the House Ways and Means Committee released its tax reform overhaul proposal, known as H.R. 1, the Tax Cuts and Jobs Act. A week later the Senate Finance Committee introduced its tax reform legislation, also called the Tax Cuts and Jobs Act. Both bills contain some major risks for the architecture profession.
Here’s what tax reform could mean for you.
The big picture
The tax reform “framework” that the White House and Congressional Republicans released at the end of September proposed reducing the tax rates on individuals and businesses and making the tax code simpler. The bills in the House and the Senate largely follow the path established in the Framework. On the House side, the plan would compress the current seven tax brackets to five. For corporations, the plan would lower the rate from the current 35 percent to 20 percent. On the Senate side, the seven tax brackets are kept but rates are lowered for both businesses and consumers.
To pay for this, both plans would eliminate a large number of tax incentives. They also predict strong economic growth to help increase revenue to the government, although most economists believe the predicted rates of growth are unrealistic. In practice, both plans would add to the federal budget deficit.
The devil, of course, is in the details. And that is where the biggest impacts may lie, particularly for architecture firms that organize as pass-through entities like S Corporations. According to AIA’s 2016 Firm Survey Report, 57 percent of US architecture firms organize as pass-through entities. The Framework proposed creating a new, lower maximum tax rate for these type of firms. However, both the House and Senate proposals exclude professional services companies, such as architecture firms, from tax relief.
The House Ways and Means Committee has approved its version of the bill, which now goes to the House for a vote. Meanwhile, the Senate Finance Committee introduced its draft proposal on November 9. It began marking up the bill Monday, November 13. Both versions will need to be reconciled and sent to the President. The White House and Congressional Republicans hope to get a bill signed into law by the end of the year.
Why the change to the tax treatment for S Corporations?
Current law enables partners of an S corporation to determine how much of their income to classify as wages (subject to generally higher tax rates) and how much as investment income (subject to lower rates). However, this provision has been abused, with some companies taking advantage of this structure to legally pay themselves artificially low salaries and therefore a lower tax rate.
This prompts some policymakers to raise the concern that with a lower tax burden for S corporations, partners could “classify” most of their income as business income and not as salary subject to a higher individual rate. As a result, the tax reform drafts contain language that would exclude specific industries from the lower rate. This means that partners in an architecture pass-through would be forced to pay the higher individual tax rate on all their income, while partners of a pass-through in another industry would get the lower rate.
While there is a legitimate problem with some S corporation partners “gaming” the system, excluding whole industries from the ability to access lower small business rates is like using a buzz saw to do the work of a scalpel. This could subject hundreds of architecture firms across the country to an effective tax increase.
No more incentives?
The tax reform legislation presents other potential challenges for the design and construction industry, through the reduction or outright elimination of tax incentives that help finance building projects.
The good news is that the legislation specifically calls out several building-related incentives for keeping, notably the Low Income Housing Tax Credit and the Mortgage Interest Deduction. The bad news is that other incentives—like the Historic Tax Credit, energy tax incentives like 179D, and others—are on the chopping block.
In the case of the Historic Tax Credit, this means that a financing tool that has been in place since 1981 as an incentive to economic development would be eliminated in the House bill and severely reduced in the Senate legislation. The purpose of the HTC is to address a financing gap, as rehabilitation is more expensive than new construction. Without the credits, properties sit idle, often for decades, exerting a blighting influence on surrounding neighborhoods.
On average, the credit leverages over $5 of private investment for every $1 in federal funding, creating highly effective public-private partnerships. The cumulative $23.1 billion cost of this program has been more than offset by the $28.1 billion in federal tax receipts generated solely by these rehabilitation projects.
Losing financing tools like the Historic Tax Credit—combined with potential tax increases on small architecture firms—would be a double whammy on the profession, hurting it at a time when the design and construction industry has finally recovered from the Great Recession.
Where AIA stands
In 2013, when lawmakers began discussing tax reform more seriously, AIA adopted three broad principles for tax reform:
- We support comprehensive tax reform that lowers marginal tax rates for individuals, pass-through entities, and corporations, while broadening the tax base and simplifying the tax code.
- Tax policies aimed at strengthening small businesses, including tax policies that maintain the ability of businesses to choose pass-through forms of entities, should be preserved.
- Tax policies should provide incentives for innovative, economically vibrant, sustainable, and resilient development that creates jobs and will revitalize our nation’s buildings and infrastructure.
Speaking up for what matters
What can you do to help shape the final bill?
First, join AIA's Legislative Action Network (LAN) and receive in-depth, up to date information on this and other key issues. You also can make your voice heard now by sending a letter to your members of Congress to urge them to protect the Historic Tax Credit and the 179D green building tax incentive, as well as to ensure tax rate fairness for architecture firms. Please take a moment to tell your representative how you feel.
But more importantly, stay alert. This bill is moving fast, and architects will need to mobilize quickly. If you see an AIA Action Alert in your inbox, don’t delete it: Read it and act. It may be our only opportunity to weigh in with Congress on tax reform.
Ian McTiernan is AIA’s manager of federal relations.