At the end of 2025, the entire individual tax title of the 2017 Tax Cuts and Jobs Act (TCJA) will expire. That means that—unless Congress acts—all individual tax rates will go up, the Section 199A 20 percent passthrough tax deduction will disappear, and research and development (R&D) amortization will continue to be a requirement. In addition, the corporate tax rate will also likely be part of the 2025 tax debate.
What does it all mean for engineering firms? Clearly, there is a lot at stake.
The 2017 tax law was a boon to the industry—with ACEC and its grassroots lobbying efforts fighting hard to make it happen, says Steve Hall, executive vice president of ACEC. Of course, the winner of the presidential election and a new makeup of the U.S. House and Senate will no doubt influence tax policy debate in the coming months. The consequences of those discussions will be huge for the engineering industry—and ACEC is prepared to redouble its efforts.
“With the law back on the table in Congress next year, it is critical that we protect these gains and also fix more recent issues, with restoring the deductibility of R&D expenses at the top of the list,” Hall says. “The stakes couldn’t be higher. If Congress fails to do the right thing, firms will see their taxes increase at a time when they need to invest more in their workforce and in emerging technologies.”
The TCJA delivered myriad benefits for engineering firms. It includes Section 199A, which provides passthrough entities (such as S corporations, partnerships, and sole proprietorships) with an up to 20 percent deduction from taxable business income. This brings their tax burden more in line with C corporations, says Tom Pace, CFO at engineering firm Thomas & Hutton and chair of the ACEC Tax & Regulatory Affairs Committee.
“Without the deduction, individual taxpayers that own the passthrough entities would be paying higher tax rates than corporations, which simply isn’t fair,” Pace says. “Entrepreneurship is the backbone of the American economy, and smaller, individually owned companies are the majority of the ACEC membership. Tax policies should be more equitable and balanced for corporations and passthrough entities.”
If the tax provisions expire, businesses, capital investment, and international competitiveness could encounter significant risks, says Dr. Gary W. Raba, PE, ACEC chair and chief growth officer at engineering and consulting firm Raba Kistner.
“Given the current scenario of high national debt, escalating deficits, and increased interest rates, Congress is understandably focused on fiscal responsibility in their decisions regarding the extension of these expiring changes,” Raba says. “ACEC’s position is that Congress must avoid economically counterproductive approaches to fiscal responsibility, such as raising taxes on business investment or trade.”
The expiration of the TCJA will also have a domino effect that could impact engineering firms. The outcome “will have far-reaching impacts on all taxpayers, regardless of industry, structure, or income,” says Jennifer Nelson, CPA, managing director of the Tax Group at Stambaugh Ness, a professional services firm with a strategic focus on architecture, engineering, and other sectors. “As we approach this impending cliff, several key changes and potential impacts are particularly relevant for engineering firms.”
For the most part, the engineering firms represented are not publicly traded, Nelson says. “These are employee-owned and family-owned businesses,” she says. “To provide context, the U.S. Census Bureau indicates that 85 percent of engineering firms have fewer than 20 employees. The sunset of the TCJA has the potential to harm these businesses, or at the very least, stall employment, job creation, and innovation.”
When the TCJA was introduced, one of its major changes was the reduction of the corporate tax rate from 35 percent to 21 percent, Nelson says. “While this rate change is considered permanent, there are proposals suggesting it could increase again,” she says. “If the corporate tax rate reverts to a higher level, engineering firms taxed as C corporations could face increased tax burdens, reducing profitability and limiting funds available for reinvestment.”
“ACEC’s position is that Congress must avoid economically counterproductive approaches to fiscal responsibility, such as raising taxes on business investment or trade.”
DR. GARY W. RABA, PEACEC CHAIRCHIEF GROWTH OFFICEr
RABA KISTNER
This would, in turn, affect overall business growth.
The prospect of the TCJA going away is even more concerning with other tax issues mounting across the industry. Engineering firms “have already seen significant increases in their federal income tax payments due to dramatic increases in taxable income resulting from decreased bonus depreciation and research and experimentation (R&E) capitalization,” says Lynn Mucenski-Keck, principal and national lead, federal tax policy at Withum, a professional services firm. “However, the sunsetting of Section 199A and the 20 percent passthrough deduction, coupled with adjustments to individual federal income tax brackets and the top individual tax rate increasing, will cause many engineering companies to significantly adjust their business operations.”
Those adjustments could include potential employee restructuring and the postponement of investments in critical equipment and growth plans.
Most engineering firms “were shocked to see the dramatic increase in their taxable income and, ultimately, tax cash payments due to R&E capitalization,” Mucenski-Keck says. “This has already limited growth and investment and has been highlighted as a significant challenge when engineering firms are trying to transition employees to owners.”
With so much on the line, ACEC has been actively lobbying Congress to protect the business tax relief in the TCJA.
“We’ve stayed engaged in working with Congress on tax issues almost from the day the 2017 bill was signed into law, particularly as it relates to the change in policy on R&D and our efforts to make the Section 199A 20 percent deduction permanent,” Hall says.
Continuing to educate Congress and the public on the impact of these policies is how ACEC will make the biggest impact for the industry, Pace says. “Many people are unaware of the impact already being felt by these policies, and corrective action needs to be taken now,” he says.
“[The outcome] will have far-reaching impacts on all taxpayers, regardless of industry, structure, or income. As we approach this impending cliff, several key changes and potential impacts are particularly relevant for engineering firms.”
JENNIFER NELSON, CPAMANAGING DIRECTOR, TAX GROUPSTAMBAUGH NESS
ACEC leaders are fully dedicated to advocacy efforts surrounding multiple variations of tax reform, Nelson says. “Between lobbying heavily with Congress to implement tax reform, advertising campaigns surrounding the R&D amortization requirement, and involving members of the organization, they are a leading voice in the fight for fair taxation of engineering firms across the country,” she says.
A prime example of the advocacy efforts is ACEC’s role on the steering committee of the Main Street Employers Coalition, Nelson says. The coalition is comprised of national trade groups representing businesses owned by individuals and families.
“This group is working with the House Ways and Means Committee to pass a Section 199A permanence bill,” Nelson says. “Various roundtables with the public are being held throughout the country, and ACEC is inserting members into the meetings with legislators.”
“The stakes couldn’t be higher. If Congress fails to do the right thing, firms will see their taxes increase at a time when they need to invest more in their workforce and in emerging technologies.”
STEVE HALLEXECUTIVE VICE PRESIDENTACEC
ACEC is eager to stimulate sweeping changes well before the TCJA expires, Nelson says. “Nevertheless, tax law changes take time and bipartisan agreement,” she says.
ACEC is looking at multiple key tax policy issues. One is balanced tax treatment of engineering firms of all business types.
“Without a doubt, balanced tax treatment is necessary,” Nelson says. “The upcoming disparity between the corporate tax rate of 21 percent and the restoration of pre- TCJA individual rates, coupled with the loss of the Section 199A deduction, illustrates the massive disadvantage most passthrough engineering companies will face in terms of the overwhelmingly huge income tax rate differential.”
ACEC is actively advocating for a level playing field between the two entities, Nelson says. “Without this, growth and ownership transition will most certainly be stifled,” she says.
Another area of focus is the need to repeal the R&D amortization requirement.
“For the past two years, the R&D amortization issue has been affecting engineering companies of all sizes, especially smaller firms,” Pace says. “Delaying the deduction of R&D expenses in the period they are incurred over a five-year period increases the firm’s taxable income and therefore their tax liability. This is creating pressure on many firms’ cash flow, because not only have the expenses been paid for, but taxes are also being paid on those expenses.”
Over the five-year amortization schedule, there is a cumulative effect of the increased tax liability without the accompanying cash flow to pay the taxes due, Pace says. “Some smaller firms have taken out loans to pay their tax liabilities while others are contemplating shutting their businesses down,” he says.
The R&D amortization requirement also discourages U.S. companies from investing in innovation and magnifies the competitive disadvantage against other countries that provide more incentives for R&D.
“Engineering is by nature an innovation industry, and the tax code has traditionally incentivized that innovation by making R&D expenses deductible the year they occur,” Hall says. “Starting in the 2022 tax year the rule changed, requiring firms to amortize those expenses over five years. Now firms are being penalized for the innovation our economy so desperately needs.”
“The sunsetting of Section 199A and the 20 percent passthrough deduction, coupled with adjustments to individual federal income tax brackets and the top individual tax rate increasing, will cause many engineering companies to significantly adjust their business operations.”
LYNN MUCENSKI-KECK
PRINCIPAL AND NATIONAL LEAD
WITHUM
ACEC is also working on ensuring the preservation of employee stock ownership plans (ESOPs), which help promote employee ownership and involvement, Nelson says. “They receive favorable tax treatment to do so. Preserving this favorable tax treatment helps ESOP engineering firms retain talent, enhance productivity, and ensure a stable ownership structure. Any changes reducing the benefits of ESOPs could undermine these advantages.”
Finally, the Council is pushing for an extension and expansion of Section 127 of the Internal Revenue Code that allows employers to provide tax-free educational assistance to employees. Among other things, this enables companies to help employees repay student loans and cover other educational expenses.
“Extending and expanding this provision would help engineering firms attract and retain skilled employees by offering valuable educational benefits,” Nelson says. “It also aids in reducing employees’ financial burdens, contributing to a more motivated and educated workforce.”
“Delaying the deduction of R&D expenses in the period they are incurred over a five-year period increases the firm’s taxable income and therefore their tax liability. This is creating pressure on many firms’ cash flow, because not only have the expenses been paid for, but taxes are also being paid on those expenses.”
TOM PACECHAIRACEC TAX & REGULATORY AFFAIRS COMMITTEECFO, THOMAS & HUTTON
It’s imperative to resolve the tax policy uncertainty. Depending on what happens, firms could be facing a reduced cash flow, which impedes them from investing in their future, Pace says. That in turn would negatively impact the country’s future.
“With an aging American infrastructure, why would we penalize innovation when other countries incentivize it?” Pace says. “How can American engineering companies make investments in technology, investments in our workforce, and continue to be the industry leader if we are being held down by our tax policies?”
Bob Violino is a business and technology writer based in Massapequa Park, New York.