As a Republican tax reform plan heads to President Donald Trump's desk, companies might want to start considering hefty investments, particularly in used equipment or company cars.
While the corporate tax rate has been at 35% in recent years — high by global standards — most companies have paid much less by taking advantage of deductions or tax credits. In 2016, S&P 500 companies utilized deductions to pay an effective tax rate of 25.6%, according to S&P Dow Jones Indices data; that figure includes taxes paid to state and local governments.
Analysts said it is difficult to know whether corporations will pay closer to the new proposed statutory rate of 21%, or something even lower because of deductions. Some of those deductions are going away, such as the deduction for domestic production activities that encouraged manufacturers to host factories in the U.S. Another significant change is a limitation on the amount of interest a business can deduct.
At the same time, there are new ways to lower a company's taxable income. A provision that could be particularly effective at spurring economic growth relates to depreciation. The tax bill increases "bonus depreciation" for the purchase of new or used equipment to 100% of the investment in the first year of service. Previously, bonus depreciation was limited to 50% of the investment.
"While it's in force, accelerated depreciation is one of the most powerful stimulants to new investment," said Stephen Entin, a senior fellow with the Tax Foundation, a Washington, D.C.-based think tank.
By increasing first-year depreciation to 100%, the reform bill allows companies to reduce their net income for tax purposes by the total cost of eligible investments. For example, if a company purchases a $1 million piece of equipment, it can expense the entire amount in the first year, reducing its taxable net income by the full $1 million. Previously, the company could only have depreciated half, or $500,000 in this case, in the first year and then expensed the rest in subsequent years.
Energy companies claimed the most depreciation over the 12 months ended June 30, the latest data available from S&P Dow Jones Indices. The energy sector reported $100.65 billion of depreciation over that time period, significantly more than the next-highest sector, consumer discretionary, with $83.79 billion.
Among energy companies, the subsector of upstream exploration and production companies has already been able to fully expense intangible drilling costs, wrote James Chenoweth and Eric Sloan, tax lawyers for Gibson Dunn, in a Dec. 7 analysis. But tax reform could spur additional depreciation for other energy subsectors.
"For midstream and downstream sectors, the ability to deduct the costs of pipelines, terminals, processing facilities and refinery equipment is game-changing," they wrote.
In addition to doubling bonus depreciation for the first year of an investment, the tax reform bill broadens the scope of eligible investments, said Bassim Michael, an accountant who founded Michael & Co., a Fresno, Calif.-based firm that focuses on tax reduction and accounting services for businesses. Whereas existing law specifies that bonus depreciation is limited to new equipment, the Republican legislation allows the treatment for used equipment as well, Michael and Entin said.
Companies could also utilize an increase to the so-called "luxury automobile depreciation limitation." Previously, luxury automobiles and other business vehicles could be depreciated up to $2,560 in the first year, $4,100 in the second year and less in subsequent years. The Republican reform increases those depreciation amounts for vehicles to $10,000 in the first year, $16,000 in the second year and less in subsequent years. Businesses that regularly use vehicles could benefit and so could corporations that include vehicles as part of executive compensation packages.
S&P Global Inc. owns both S&P Dow Jones Indices and S&P Global Market Intelligence.