Corporate America’s best tax days may be over when GOP tax cuts expire

The sun is setting on parts of Republicans’ signature tax reform. As that happens, some American companies are likely to be hit with a renewed tax burden.

Key provisions are set to either change or expire in the next few years. But companies will start altering decisions and capital investment to prepare for that in the near-term, according to a new report from Morgan Stanley this week.

In aggregate, these sun-setting provisions “will result in a scheduled de facto tax increase if Congress does not act to extend the provisions,” Morgan Stanley analyst Todd Castagno said in a note to clients this week.

“This presents one more headwind to U.S. earnings growth and corporate credit,” Castagno said. “Corporate America’s best tax days are likely behind them.”

The 2017 tax overhaul — a key piece of legislation for Republicans and President Donald Trump — lowered the corporate tax rate from 35 percent to 21 percent. It was the biggest change to the U.S. tax system in more than 30 years. But not all of those changes are permanent.

One scheduled change is a phaseout of an expense-recognition benefit called “bonus depreciation.” When a business buys a piece of machinery or equipment, under the current tax laws they can write off that expense immediately. Most businesses want their eligible capital expenditures right away instead of waiting for it to be amortized, or spread out over multiple years. But this won’t last. Bonus depreciation starts petering out at the end of 2022, and fully expires by 2027.

Having money upfront to invest in research and development has been a key driver of increased investment in things like hardware, Morgan Stanley said. Manufacturing and telecommunications companies, for example, both have historically been the “most favorably exposed” to bonus depreciation incentives. This could cause companies to move up their purchases of machines, knowing that eventually that bonus tax rate won’t last forever, according to tax expert Robert Willens.

“The earlier you can realize tax savings the more valuable they are,” said Willens, former managing director in the equity research department at Lehman Brothers. “Future capital expenditure could suffer dramatically because everyone will have accelerated it to get the bonus tax rate.”

Morgan Stanley estimated that scheduled changes “will result in a rate that nearly equals the prior code by 2023, and nearly quadruples today’s rate by 2027 if Congress does not extend these policies.”

Another is a change will affect the portion of interest that will be tax deductible. Right now, the limit on interest deductions is 30 percent of EBITDA — or earnings before interest, tax, depreciation and amortization. If this provision is not renewed by 2023, companies will no longer be able to add depreciation and amortization to determine that base.

“That will mean a smaller portion of their interest expenses will be deductible,” Willens said. “And that of course raises your cost of capital, and makes it more expensive for them to borrow.”

This reduces the incentive for businesses to borrow money to invest in capital projects, Health care, communications services and energy are the most exposed to the interest deductibility limit, Morgan Stanley said.

Global Intangible Low-Taxed Income, or GILTI, is another changing tax benefit. Willens described it as a punitive provision, designed to discourage multinational U.S. companies from earning income outside of the U.S. and encourage them to earn income inside the U.S.

It looks to apply a minimum tax rate on multinational companies that operate in low-tax jurisdictions. Those rates are set to jump to a minimum of 13.1 percent from a minimum of 10.1 percent WHEN. Companies like Ohio-based consumer products maker Procter & Gamble are already seeing crimped profits thanks to that tax, The Wall Street Journal reported this week.

Based on recent filings, Morgan Stanley estimated that companies already paid an additional $2.2 billion in GILTI tax last year. Companies in the health care, materials and industrial sectors were the most affected. Of the 200 companies Morgan Stanley said disclosed an impact, GILTI increased their effective tax rate by 2.2 percent on average.

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