Tax Reform Becomes Reality
Are you ready for tax reform? On Dec. 22, 2017, President Trump signed the “Tax Cuts and Jobs Act” (TCJA) into law, meaning the tax rate for incorporated security dealers, integrators and businesses will be reduced from its current 35-percent rate to 21 percent for the 2018 tax year and thereafter.
The new tax code brings even better news for both the security channel and its customers, thanks to updates to a long-standing IRS provision that will enable your customers to write off the expense of fire protection and security alarm systems.
“Since 2003, SIA has advocated in favor of federal tax code changes allowing businesses to fully expense the cost of implementing safety and security measures during the year in which they incur those costs,” Security Industry Association CEO Don Erickson said in a statement. “These tax code revisions eliminate a significant disincentive to adopting new and effective security and life safety technology, particularly at a time of rapid advancement for security tech. SIA is pleased the White House and Congress saw the importance of making it more affordable for businesses to best ensure the safety of their patrons and employees.”
The combination of these two potential favorable outcomes of the tax bill seems to be fueling an increase in optimism in the security industry; in fact, 67 percent of security dealers and integrators polled for our upcoming Fast50 market research think the tax bill will have a positive effect – in that it will enable companies to increase outside hiring, invest more internally, and pave the way for even more mergers and acquisitions.
“With a favorable tax cut, it will allow us to reinvest revenue into the organization to grow, create jobs, penetrate potential markets more aggressively, and offer more benefits to our current staff,” says Matt Zucker, president of sales for New York-based Beacon Protection.
“We can expect favorable economic conditions, which implies accelerated GDP, more discretionary capital spending and continued investment in new construction,” says Carey Boethel, President and CEO of Dallas-based Securadyne Systems.
What Integrators are Saying
We asked several integrators the following: Will the Tax Cuts and Jobs Act have a significant impact on your business/operations? Here’s what they had to say:
Carey Boethel, President and CEO, Securadyne Systems: “Yes, absolutely. Lowering of the corporate tax rate will free-up precious cash for companies like Securadyne to invest in growth. A decreased corporate tax rate will help strengthen balance sheets and increase the pace at which our economy is growing, which should benefit all aspects of the electronic security supply chain, including integrators.”
- Matthew Ladd, President, The Protection Bureau:“If there are major tax credits, I see this as an opportunity for clients to invest in security and M&A.”
Michael McWilliams, President & CEO, Red Hawk Fire & Security: “The new tax code changes that provide incentives for businesses to invest in security, fire protection and alarm systems are welcome changes.”
Matt Zucker, President of Sales, Beacon Protection: “If small businesses located in our geographical coverage are able to take financial advantage, we feel that it will create sales opportunities. If businesses have more disposable income via tax reductions and economic support, we are hopeful that current/potential commercial clients will have more capital to dedicate to security-based services.”
Jennifer Graham, VP Marketing, Kastle Systems: “We are looking to see how we can leverage these tax cuts to encourage our customers to upgrade or expand their systems when they may otherwise not have wanted to make the investment.”
Here’s an in-depth look at the TCJA provisions that should have the most significant impact on security businesses and their customers. Keep in mind that with a few exceptions, potential savings listed will not be seen by many dealers or integrators until the tax bill for comes due in 2018.
Perhaps the most significant boost to a security dealer’s profit potential is a change to “Section 179” – a section within the Internal Revenue Code that traditionally allows for the expensing of business property that is purchased and put into service the year the expenditure is made.
Upgrades, improvements and the purchase of new fire protection, alarm and security systems did not qualify for Section 179 expensing under the old tax codes; however, thanks to the lobbying efforts of SIA, the Electronic Security Association (ESA), National Fire Sprinkler Association (NFSA), National Systems Contractors Association (NSCA) and others, the provision has now been expanded to include them.
“Sensors, switches, control panels and many other electronic components have lifecycles that come nowhere near the prior IRS depreciation schedule (up to 39 years) for this type of equipment,” explains Chris Heaton, ESA’s VP of Membership and Chapter Relations. “This made the need and value of Section 179 expensing more important for business growth and building safety.”
Section 179 allows up to $1 million of expenditures made for business equipment and property to be treated as an expense and immediately deducted in the year it is put into service, which was doubled from the
previous $500,000. The ceiling after which the Section 179 expensing allowance must be reduced dollar-for-dollar has also increased from $2 million to $2.5 million.
“The savings are real, and for many small businesses, tax benefits like this translate into business expansion through reinvestment, greater job growth and overall economic development, because those dollars are put back into the economy,” Heaton adds. “It also means enhanced safety for employees and customers wherever these improvements are made.”
The immediate write-off, or “expensing” of capital assets, is appealing because, unlike so-called “bonus depreciation,” the use of equipment does not have to begin with the security dealer, integrator or business.
Other areas affected by Section 179 include roofs and HVAC systems.
While regular “C corporations” will be taxed at a flat 21-percent tax rate, the majority of small businesses and professionals doing business as pass-through entities, unfortunately, may face new personal tax rates that could potentially be higher than the new corporate tax rate.
Pass-through businesses operating as partnerships, limited liability companies (LLCs), S corporations or sole proprietorships pass their income to their owners, who pay tax at the individual tax rates. The TCJA created a 20-percent deduction that applies to the first $315,000 of income (half that for single taxpayers) earned by security businesses operating as pass-throughs.
Regardless of whether they are service professionals or not, all businesses falling below the income thresholds can take advantage of the 20-percent deduction. For pass-through income above this level, the new law also provides a deduction for up to 20 percent, but only for “business profits” – reducing the owner’s effective marginal tax rate to no more than 29.6 percent.
The TCJA places limits on who can qualify for the pass-through deduction, with strong safeguards to ensure that so-called “wage income” does not receive the lower marginal tax rates for business income.
Thus, that 20-percent deduction applies only to business income that has been reduced by the amount of “reasonable compensation” paid the owner – an amount that has not been defined as of yet.
In the end, the 21-percent flat rate for C corporations may encourage companies to consider converting from an S corporation or other partnership – although these conversions face new rules under the TCJA.
Cost Recovery and Increased Expensing
Unlike in past years, when a business was required to claim depreciation – spreading the recovery of their equipment expenditures over several years – many businesses will now be able to fully and immediately deduct the cost of equipment and business property. What’s more, this provision has been made retroactive to Sept. 27, 2017.
The faster write-off of equipment costs is only temporary. It is at the 100-percent level for expenditures between Sept. 27, 2017 and Jan. 1, 2023. After 2023 and before 2025, the amount deductible drops to 60 percent, with a further decrease to 40 percent after 2025 and to 20 percent after 2026. On Jan. 1, 2027, the equipment cost write-off disappears.
With a few exceptions, interest expense is usually a legitimate business expense; however, in an attempt to “level the playing field” between businesses that capitalize through equity and those that borrow, the TCJA caps the interest deduction at 30 percent of an operation’s adjusted taxable income.
Every security business is subject to “disallowance” of deductions for net interest expense in excess of 30 percent of the operation’s adjusted taxable income; however, a special rule applies to pass-through entities that require the 30-percent determination to be made at the entity level rather than at the tax filer level – in other words, at the partnership level instead of the partner level.
Other exceptions exist for small businesses – generally those with gross receipts that have not exceeded a $25 million threshold for a three-year period – enabling them to write off the interest on loans that help them start or expand a business, hire workers and increase paychecks.
Cash-Based Accounting for SMBs
Simplifying the rules governing the method of accounting that must be used for tax purposes is a welcome aspect of the new tax plan. Businesses with average annual gross income of less than $25 million may now use the simple cash-basis accounting method.
With the cash method of accounting, a security business can account for inventory as non-incidental materials and supplies. Alternatively, a security business with inventories using the cash method of accounting can account for its inventories using the same method of accounting used for its financial statements or its books and records.
Under the new law, the current $5 million threshold for corporations and those partnerships with a corporate partner is increased to $25 million, and the requirement that such businesses satisfy the $25 million limits for all prior years has been repealed. Also, the average gross receipts test will now be indexed to inflation.
Like-Kind Exchanges Redefined
IRS Section 1031 governing like-kind exchanges previously allowed security dealers, integrators and other businesses to defer the tax bill on the built-in gains in property by exchanging it for similar property.
Although more a strategy for deferring a tax bill when business assets are sold, traded or swapped, multiple exchanges enabled gains to be deferred for decades, and ultimately, escape taxation entirely.
Under the TCJA, like-kind exchanges are now limited to so-called “real” property (but not for real property held primarily for sale). The provision redefines like-kind exchanges and includes language that would limit Section 1031 exchanges to exchanges of like-kind “real” property. This ensures real estate investors maintain the benefit of deferring capital gains realized on the sale of property.
The frequently overlooked and often misunderstood Research & Development (R&D) Tax Credit – originally created to encourage businesses to develop cutting-edge “Made in America” products and services – has been preserved. A security dealer, integrator or business can forgo a current deduction, capitalize R&D expenses, and recover them ratably over the useful life of the research – a period no longer than 60 months (15 years if conducted outside the U.S.). Alternatively, companies may choose to recover them over a period of 10 years.
The TCJA also extended the tax credit for increased R&D expenditures. For the most part, however, R&D expenditures are usually charged to the operation’s capital account and amortized over a five-year period.
New limits on the write-off for the cost of so-called “luxury” automobiles and personal-use property were included in the TCJA. For passenger automobiles and light trucks placed in service after Dec. 31, 2017, where the additional first-year depreciation deduction is not claimed, the maximum amount of allowable depreciation has increased to $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year and $5,760 for the fourth and later years in the recovery period.
For passenger automobiles placed in service after 2018, these dollar limits are indexed for inflation. And for those eligible for bonus first-year depreciation, the maximum first-year depreciation allowance remains at $8,000. Similar rules apply to not only passenger automobiles, but to any property used as a means of transportation.
Net Operating Loss Deduction
One of the major benefits of Net Operating Losses (NOLs) was that they could be carried back to more prosperous years to create a refund of taxes paid in those earlier years and provide an immediate infusion of badly-needed cash.
The NOL deduction in the TCJA has been severely limited. The write-off is now limited to 80 percent of taxable income, and only in special cases will a NOL carryback be permitted. There is no limit on how far forward NOLs may be carried.