TCJA: Has the Chance Paid Off?

Two years in with the new tax law, there’s still much uncertainty about its benefits. By CAROLYN KMET | Fall 2019



In December 2017, the Tax Cuts and Jobs Act (TCJA) was enacted as part of a domestic growth strategy designed to fuel job growth, wages, and capital spending. The Act lowered the statutory corporate income tax rate from 38.9 percent to 25.7 percent, bringing the U.S. corporate income tax rate more in line with the Organization for Economic Co-operation and Development (OECD) average of 23.8 percent.

“The Congressional Budget Office (CBO) projected that GDP would grow about 0.3 percentage points faster in 2018 and 2019 due to the TCJA,” explains Kyle Pomerleau, chief economist at the Tax Foundation, an independent tax policy non-profit based out of Washington, D.C.

U.S. GDP did grow in 2018, at a rate of 2.9 percent— about 0.1 percentage points shy of the CBO’s projection. Some analysts believe that lowering the tax rate was not enough, as there are still 22 OECD countries that have statutory corporate income tax rates below that of the United States. Further, due to escalating geopolitical uncertainties over the past two years, it remains challenging to identify the actual impact of the TCJA.

“It’s hard to tell if the TCJA was underperforming, or if the Trump administration’s tariff policies had a negative impact,” Pomerleau says. “Investment did accelerate in 2018 but has since gone back down in 2019. This could have been in response to the TCJA, but it is probably too early to tell.”

Jeff Glenzer is the executive vice president of the Association for Financial Professionals (AFP). He acknowledges that increased risk associated with today’s global uncertainties makes it even more challenging to measure the true impact of the TCJA.

“Consider all the hostility in Washington, the ebb and flow of the relationship with North Korea, the continuing escalation of tariffs, and now China being flagged as a currency manipulator,” Glenzer says. “Each one of these factors creates a new source of real or perceived risk for corporate decision makers.”

Corporate spending, one of the elements the TCJA was designed to spur, is depressed by increased risk and an uncertain environment. A March 2019 AFP liquidity survey indicates that companies may still be hesitant to reap the benefits of the TCJA.

In the 12 months to March 2019, about half of the 496 finance and treasury professionals the AFP surveyed said the size of their cash hoards had not changed much, either domestically or overseas. Fifty-seven percent of survey respondents had not made changes in their spending or allocation patterns, and those that are spending, aren’t spending it on what they were expected to.

“What’s most troubling to me, is that even when companies are drawing down corporate liquidity, the way they’re deploying that corporate cash is not the most beneficial for either the company or the economy,” Glenzer says.

Instead of investing in new products or in building new factories, companies are taking a more cautious approach to their spending strategy by focusing on non-infrastructure investments such as share buybacks and debt reductions.

“If you take your cash and move it into a longer term financial instrument, those decisions are easier to undo as compared to more permanent decisions such as investing in a factory or an acquisition,” Glenzer says.

Glenzer’s bigger concern though, is that due to economic and geopolitical uncertainty, companies are more likely to keep sitting on large pools of corporate cash. “When the market’s psyche changes to where it’s perceived as safe to start drawing down corporate cash, there’s going to be an awful lot of corporate cash chasing a limited number of really strong opportunities. Companies are going to have to be very careful about overpaying for target assets,” Glenzer explains.

The TCJA was also expected to have a positive impact on repatriation of corporate profits through the effective elimination of taxes on repatriated earnings of U.S. multinationals from their foreign affiliates. Indeed, U.S. corporations did repatriate funds in record numbers in 2018, bringing back almost $777 billion, though this was a far lower number than the anticipated $4 trillion expected by President Donald Trump.

According to the AFP survey, only 16 percent of respondent companies repatriated funds. Of the companies that did shift funds domestically, over half moved less than 25 percent of their offshore earnings. “The TCJA probably slowed the growth of the percentage of company funds that are held offshore,” Glenzer surmises.

Glenzer also points out that tax strategy is not the only reason companies keep funds offshore. “There are a lot of companies who have said that they didn’t care about taxes—they cared about the opportunity to use those funds to invest overseas. The TCJA did not change the economic potential of various markets where companies were investing those funds.”

For small businesses, the 20 percent pass-through deduction may have had more of an impact than the tax cut. Under the TCJA, pass-through entities such as partnerships, limited liability companies, S corporations, and sole proprietorships can deduct up to 20 percent of the first $315,000 of qualified business income, or QBI.

“This pass-through deduction has freed up cash for hiring and expansion,” says Tom Wheelwright, CEO of WealthAbility, a tax strategy service provider based in Tempe, Ariz.

As a result of increased liquidity provided by the TCJA, Wheelwright has invested in growing his business this past year.

“We just purchased a building for the office and are building a second property for the business. We are also hiring for new positions versus just replacing old positions,” Wheelwright says.

Wheelwright believes that some companies may be slower to leverage the TCJA because of political uncertainty. “The hesitation is primarily because of legislators threatening to undo the legislation. This creates uncertainty regarding the longevity of the corporate tax rates and makes corporations unsure they can count on the lower rates in the long run,” Wheelwright explains.

However, not all small businesses have similarly benefited from the TCJA.

“As a business owner, the TCJA has negatively impacted me,” says Brian Cairns, CEO of ProStrategix Consulting, a New York-based small business management consulting agency. “We, unfortunately, fall under the ‘Professional Service’ section of the Act. Our benefit is capped at $150,000, which is an extremely low number for a successful small business. We actually paid more in taxes than prior—first because of the cap and second because of the elimination of the state and local tax write-off.”

Cairns notes that overall, the impact of the TCJA on small businesses has ranged from neutral to negative: “When you balance the loss of the tax write-offs, the increased costs of compliance, and the caps, there was little left for reinvestment. I would argue that the TCJA has done very little, if anything, to improve the economic conditions of small businesses in my area.”

Beth Logan, an enrolled agent with Kozlog Tax Advisers in Chelmsford, Mass., points out that the TCJA did not lower the corporate tax rate. Rather, it flattened the rate table.

Prior to the TCJA, the tax rates for C corporations, which are separate entities filing their own taxes as opposed to entities whose taxes pass through to the owners, varied from 15 percent to 35 percent. The TCJA flattened the rate to 21 percent.

“For small C corporations, the tax rate went up from 15 percent to 21 percent. Congress, while claiming to want to help small businesses, actually damaged small C corporations with less than about $150,000 of profit,” Logan says.

Logan also says that another interesting result of the TCJA is the different treatment of partnerships and S corporations. S corporation owners are required to take a salary reported on a W-2, and the resulting profit is not generally subject to Social Security contributions. Conversely, partnership owners are not allowed to take a salary reported on a W-2 and must claim all profits as income subject to Social Security contributions.

“The catch is that the Qualified Business Income Deduction (QBID) is based on profits,” Logan explains. “A partnership gets all their income included as QBI, and therefore gets a higher deduction. The S corporation owner only claims the profit as QBI and therefore gets a much lower deduction, all else being equal.”

For salaries below the Social Security contribution threshold, the partnership pays more taxes due to the Social Security contributions. For salaries above that threshold, the S corporation generally pays more taxes.

Logan says this has generated a great deal of discussion about entity selection. By her observation, some companies are changing to partnerships from S corporations and others from C corporations to S corporations.

“The reasoning behind the QBID was to allow pass-through entities to get a tax savings like C corporations without changing entities,” Logan explains. “It hasn’t worked.”

Additionally, the QBID is based on profit minus other business-related deductions, including retirement plans like SEP, SIMPLE, and 401(k). It is not after IRA contributions because those are not tied to the business. Because of this, Logan suggests that small business owners consider contributing to a traditional IRA and claiming the higher QBID rather than using their business’ established retirement plan.

Pomerleau’s stance at the Tax Foundation is that the impact of the TCJA will continue to roll out over the next decade. He believes that the lower tax rate will reduce corporations’ incentives to shift profits overseas to reduce domestic tax liability. He also expects that companies will start planning around the new international tax regime.

“Specifically, companies may shift their intellectual property into the United States to benefit from the new FDII (foreign-derived intangible income) provision and to avoid the new GILTI (global intangible low-taxed income) provision,” Pomerleau says.

And finally, Pomerleau believes that companies—at least in the short run—will accelerate their investment decisions in response to the temporary 100 percent bonus depreciation provisions in the law.

While the impact of the TCJA may not yet be fully realized, Glenzer says it has the potential to shift business strategy away from the economics of taxes, enabling companies to be more focused on the economics of their businesses.