How Tax Reform Will Impact Retail and Consumer Products

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On December 22, 2017, the conference version of the tax reform bill was signed into law, marking the largest change to U.S. tax policy in decades.

With most of the provisions set to go into effect in 2018, it’s important that the retail and consumer products industries review these legislative changes to understand the impact to their businesses.

What Changes Await Retail and Consumer Products?
To help businesses navigate the key provisions affecting retail and consumer products, we’ve summarized top considerations and implications below:
 
Provision  Summary of Changes Implications for Retail
Reduced Corporate Tax Rate
 
Reduces the top corporate tax rate from 35% to 21%.
 
Allows a 20% deduction of taxable income for certain pass through entities
 
Effective Date: Taxable years after Dec. 31, 2017.
 
 
Industry View: Positive
 
What’s at stake: The drop in the corporate tax rate is great news for retailers. Historically, corporate taxable income is subject to tax under a four-step graduated rate structure, with the top corporate tax rate of 35% on taxable income in excess of $10 million. Now, the new corporate tax rate will stand at 21%.
 
For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, taxpayers who have domestic “qualified business income” (QBI) from a partnership, S corporation, or sole proprietorship are entitled to deduction of the lesser of such QBI or 20% of taxable income. The deduction reduces taxable income, not adjusted gross income, and eligible taxpayers are entitled to the deduction whether or not they itemize.
 
Bonus Depreciation
 
 
Companies will be able to fully expense certain capital expenditures on personal property, including acquisitions of used property, starting with assets placed in service after Sept. 27, 2017, in 2018.
 
 
 
Effective date: 100% expensing of personal property is effective for assets placed in service after Sept. 27, 2017 through Dec. 31, 2022.
 
The percentage of allowable expensing will be phased out at a rate of 20% per year from 2023 (80%) to 2026 (20%), starting with assets placed in service after Sept 27, 2017, in 2018.
Industry View: Positive
 
What’s at stake: The bonus depreciation provision allows growing retailers to immediately recover investments for equipment and other personal property. This is likely to encourage more capital spending on new stores.
 
The repair regulations will still apply to store “refreshes” or remodels which continue to allow a 75% deduction of these expenditures. With the remainder taken over the life of the asset.
 
Real Property placed in service after Dec. 31, 2017 will need to be capitalized over 39 years unless it can be expensed under Section 179. (See Box on Qualified Retail Property below.)
 
The taxpayer may elect out of bonus depreciation.
 
Qualified Retail Property Eliminates the separate definitions of “qualified leasehold improvement property,” “qualified restaurant property,” and “qualified retail improvement property” and now provides for a single definition for Qualified Improvement Property (QIP).
 
Effective Date: Taxable years after Dec. 31, 2017.
 
Industry View: Mixed
 
What’s at stake: While it appears that Congress intended to provide a 15-year recovery period for QIP under the MACRS general depreciation system, the provisions set forth in the Act do not provide a 15-year recovery period for QIP at this time. Therefore, the property will not be eligible for bonus depreciation after Dec. 31, 2017.
 
At this point, Qualified Retail Improvement property is generally eligible for 50% bonus depreciation to the extent acquired and placed in service by Sept. 27, 2017, and generally eligible for 100% bonus depreciation if acquired and placed in service from September 28, 2017, to December 31, 2017.
 
QIP placed in service on or after January 1, 2018, is recovered more than 39 years and is not bonus eligible until such point as a technical correction to the Act is enacted.
 
Repeal of the Corporate Alternative Minimum Tax (AMT) Conforming to the repeal of the corporate AMT, the bill also repeals the election to accelerate AMT credits in lieu of bonus depreciation.
 
Effective Date: Taxable years after Dec. 31, 2017.
 
Industry View: Positive
 
What’s at stake: Under present tax law, an AMT is imposed on a corporation to the extent the corporation’s tentative minimum tax exceeds its regular tax. This tentative minimum tax is computed at the rate of 20 percent on the AMTI in excess of a $40,000 exemption amount that phases out. The repeal of the corporate AMT allows the use of credits, particularly the R&D credit, to further reduce tax liability. Absent this repeal, this credit would not be allowed to reduce a minimum tax liability and would provide no value to a taxpayer.
 
Amortization of Research and Experimental (R&E) Tax Deduction Companies will be required to write off research expenses, including software development expenditures, over a longer period of time.
 
Effective date: Effective for taxable years after Dec. 31, 2021.
 
 
 
Industry View: Negative
 
What’s at stake: In the past, retailers could immediately deduct software development expenditures. Now, they must amortize expenses over 5 years. For example, in the past, installing a new pricing system costing $7 million would warrant a $7 million deduction immediately. Now this deduction will be spread throughout 5 years.
 
 
Limitations on Interest Deductibility
 
Revises Section 163(j) and expands its applicability to every business, including partnerships. Generally, it caps deduction of interest expense to interest income plus 30% of adjusted taxable income, which is computed without regard to deductions allowable for depreciation, amortization, or depletion. Disallowed interest is carried forward indefinitely. Contains a small business exception.
 
Effective date: Effective for taxable years beginning after Dec. 31, 2017.
 
Industry View:  Negative
 

What’s at stake: This would limit the interest deduction to 30% of EBITDA for four years, then 30% of EBIT thereafter. Taxpayers with a high level of debt to fund operations and expansions will be required to defer the interest expense deduction.
Work Opportunity Tax Credit
 
The House had a provision in their bill to eliminate the credit, but the final result is no change in this valuable credit for retailers.
 
The WOTC is a tax credit available for employers hiring individuals from one or more of ten targeted groups of employees. 
 
Industry view: Positive
 
What’s at stake: Since many retailers often hire employees whose demographics qualify them for this credit, retailers stand to benefit from the continuation of this credit.
 
$1 Million Deduction Limitation on Executive Compensation
 
Adds the CFO to the definition of “covered employees” and eliminates the exception for commissions and performance-based compensation, including stock options, from the definition of compensation subject to the $1 million deduction limitation.
 
Effective date: Taxable years after Dec. 31, 2017.
 
A transition rule applies to grandfather payments if the right to participate in the plan is included in a written binding contract in effect on Nov. 2, 2017, and which was not modified on or after this date.
 
Industry view: Negative
 
What’s at stake: In the past, this deduction was allowed if performance metrics where included in determining compensation in excess of $1 million. This change could cause some high- level retail executives’ compensation to not be deductible therefore total taxable income for the company will be higher.
Repeal of Domestic Production Activities Deduction (DPAD or Section 199)       DPAD was a tax incentive for businesses that manufactured property, at least partially, within the United States.
 
Effective date: Taxable years after Dec. 31, 2017.
 
Industry View:  Negative
 
What’s at stake: Consumer product manufacturers that previously claimed the section 199 deduction will no longer be able to reduce their tax rate by using this benefit. However, this impact will likely be offset by the significant reduction in overall tax rates. Retailers that engage in a manufacturing activity such as food prep or chemical mixing will lose the rate benefit of performing this activity.
 
Eliminate Ability to Carryback Net Operating Losses (NOL)
 
This change will generally eliminate taxpayers’ abilities to carryback net operating losses, and will limit the use of NOLs to 80 percent of taxable income. NOLs will no longer have an expiration period.
 
Effective date: Effective for losses arising in taxable years after Dec. 31, 2017.
 
Industry view: Negative
 
What’s at stake: Costs incurred in one year will not be able to offset 100% of taxable income in the next year. In situations where retailers’ earnings are volatile, the restrictions on the carryback and use of NOLs could present a significant cash flow obstacle.
 
Transition Tax on Existing Overseas Profits
 
 
Imposes a one-time tax on U.S. shareholders on the accumulated, untaxed earnings and profits of controlled foreign corporations (CFC) and certain foreign corporations wherein a domestic corporation owns at least 10 percent, at a rate of 15.5 percent on the foreign corporations’ earnings held in cash and cash equivalent assets, as well as an 8 percent rate on earnings attributable to non-cash assets, regardless of whether or not the amounts are actually distributed.
 
An election may be made to pay the tax over eight years, using a backloaded installment schedule.
 
Effective date: Effective for the last taxable year of a foreign corporation that begins before Jan. 1, 2018 and, with respect to U.S. shareholders, for the taxable years in which such taxable years of the foreign corporations end. Earnings and profits (E&P) generally determined as of Nov. 2, 2017 or Dec. 31, 2017, whichever is higher.
 
 
Industry view: Negative
 
What’s at stake: This measure is designed to raise tax revenue from income that has not previously been subject to U.S. taxation. But it’s also meant to entice companies to invest some of their foreign profits stateside.
 
To help get the bill over the line during reconciliation, the rate of tax was increased from that proposed in both Houses. The effective tax rate is significantly higher than it was when the American Jobs Creation Act of 2004 temporarily created the last tax holiday on the repatriation of foreign earnings at an effective tax rate of 5.25 percent.
 
 

TACKLING TAX REFORM: 5 STEPS RETAILERS CAN TAKE NOW

Tax professionals are busy assessing changes caused by this bill and are waiting for additional guidance on many key provisions to ensure the overall impact is fully understood. In the interim, here are five steps retailers can take now to begin tackling tax reform:
  1. Assess impact. Tax professionals will likely need to review the bill text manually and measure their organization’s specific circumstances against it to assess the impact of each provision, as well as the holistic effect on their bottom line.
  2. Establish priorities. When considering what to undertake in the coming months, focus on the areas that could have the greatest impact on your organization. Consider your expansion plans and remodels, factoring in the write-offs that are now available. It would also be wise to look at how your businesses tax liability will change: C corporations can measure expected tax payments and S corporations and partnerships can look at tax distributions to see how that will change this year.
  3. Initiate tax reform conversations with your tax advisor. Tax reform of this magnitude is the biggest change we’ve seen in a generation and will require intense focus to understand not only how the changes apply at a federal level, but also to navigate the ripple effect this is likely to have on state taxation.
  4. Reevaluate R&D tax credits. Given the new limitations to carryback for net-operating losses, retailers should revisit the R&D credit, which can be used for process improvements. Now that retailers are expected to have competitive omnichannel strategies, many initiatives to improve the process of their technologies and platforms could qualify for the R&D tax credit.
  5. Pay attention to states’ compliance. State governments likely won’t follow every federal provisional change, especially bonus depreciation. Efficient state tax structures will become more important for companies under tax reform. Most companies will find state tax expenses will become a larger portion of their total tax expense. Although states rarely provide income tax incentives to retailers, they also have employment and training tax credits to attract retailers; companies should revisit these opportunities. 

For more information on how tax reform will impact you and your business, contact Scott Ziemer at sziemer@bdo.com.

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