Tax Reform: Deep Dive on Application to E&C Engineering and Construction Conference June 21, 2018

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1 Tax Reform: Deep Dive on Application to E&C 2018 Engineering and Construction Conference June 21, 2018

3 Business Interest Expense Limitations What is the new law? Limits deduction for business interest expense to sum of business interest income plus 30% of the adjusted taxable income (ATI) for the tax year. ATI is defined similar to EBITDA for tax years beginning after 2017 and before 2022, and similar to EBIT for tax years beginning after Allows disallowed interest deductions to be carried forward indefinitely. At taxpayer s election, limit does not apply to interest of a real property trade or business, but slower method of depreciation must be used. Effective for taxable years beginning after December 31, Impact to E&C E&C companies that leverage financing may be significantly impacted by changes to this deduction. Real Property Trade or Business (RPTOB) election may have a significant impact on E&C companies. Copyright 2018 Deloitte Development LLC. All rights reserved. 3

5 Cost Recovery Enhancements What is the new law? 100-Percent Bonus Depreciation 100% bonus depreciation (i.e., full expensing) for new and used property that is both acquired and placed in service after 9/27/17 and before 12/31/22. Bonus depreciation percentages decrease beginning in 2023 as follows: Bonus Depreciation % Year 80% % % % 2026 As noted above, the requirement that the original use of qualified property must commence with the taxpayer has been removed (i.e., used property qualifies as long as property was not used by taxpayer prior to acquisition) Any asset subject to a written, binding contract in effect on September 27, 2017 is considered acquired before September 28, 2017 and not eligible for 100% bonus. Copyright 2018 Deloitte Development LLC. All rights reserved. 5

6 Cost Recovery Enhancements (continued) Qualified Improvement Property Eliminates the separate definitions of qualified leasehold improvements, qualified restaurants, and qualified retail improvement property, and instead provides for a single asset class called Qualified Improvement Property (QIP) QIP is intended to have a 15-year regular MACRS recovery period and 20-year ADS recovery period There needs to be a technical correction to the law for this to be certain. Applies to property placed in service after December 31, 2017 Appears that QIP acquired and placed in service after September 27, 2017 and before January 1, 2018 may be eligible for 100% bonus. If the Real Property Trade or Business election is made with respect to IRC Section 163(j), this would subject all real property and qualified improvement property held by a taxpayer to ADS depreciation. If the property is depreciated under ADS, it is not eligible for bonus. Copyright 2018 Deloitte Development LLC. All rights reserved. 6

7 Cost Recovery Enhancements (continued) Impact on E&C Given the heavy capital expenditure spending in the E&C industry, E&C companies may benefit from greater cost recovery deductions. If RPTOB election is made under the 163j rules, then real property of E&C companies will be depreciated at a slower rate. Modeling exercises should be considered to see if the IRC Section 163(j) RPTOB election is beneficial. Copyright 2018 Deloitte Development LLC. All rights reserved. 7

9 Section 199 What is the new law? The deduction allowed for domestic production activities is repealed effective for tax years after December 31, Impact to E&C Construction activities may qualify for the domestic production activities deduction ( DPAD ) is the final year to plan for this permanent benefit. Copyright 2018 Deloitte Development LLC. All rights reserved. 9

11 Like-Kind Exchange What is the new law? Limits the scope of like-kind exchange non-recognition treatment to real property not held primarily for sale. Thus, personal property that previously qualified for non-recognition treatment may no longer qualify under the Act. Impact to E&C Many E&C companies routinely use like-kind exchanges in connection with acquisition and disposition transactions. Personal property transferred as part of a larger like-kind exchange of real property is not tax-deferred. Copyright 2018 Deloitte Development LLC. All rights reserved. 11

13 Revenue Recognition What is the new law? Taxpayers are required to recognize income no later than the taxable year in which such income is taken into account as income on the taxpayer s applicable financial statement. However, this requirement does not apply with respect to any special methods of accounting other than for certain rules involving bonds and debt instruments. For the purposes of recognizing revenue no later than which such income is recognized for financial statement purposes under new subsection (b), taxpayers with contracts containing multiple performance obligations will allocate the transaction price to each performance obligation in accordance with financial statement treatment Codified the deferral method of accounting for advanced payments for goods and services currently provided under Rev. Proc , including definition of applicable financial statement and advance payment Impact to E&C Eliminates opportunity to defer unbilled revenue not required to be recognized under PCM Copyright 2018 Deloitte Development LLC. All rights reserved. 13

15 Potential Benefits of Incorporating Method Changes in in Year of Corporate Rate Reduction H.R. 1 includes a Reduction in Corporate Rates of 14% Accounting Method Planning Implemented Prior to Rate Reform May Result in Permanent Rate Reduction for Taxpayers Current Gross DTA Cash Tax Reduction if Deduct in 2017 at 35% Rate Cash Tax Reduction if Deduct in 2018 at 20% Rate Permanent Benefit of Accelerating Deduction into 2017 $100,000,000 $35,000,000 $21,000,000 $14,000,000 Generally, a taxpayer changing its method of accounting for an item of income or expense shifts the recognition of such items between deferred and current tax expense. The change would typically produce cash tax savings but rarely creates a permanent tax benefit. In taxable years bordering a change in federal corporate tax rates, however, taxpayers can capitalize on a permanent tax savings opportunity by decreasing current tax expense in years where a decrease in rates is anticipated. Tax Reform has provided Companies with an opportunity to apply accounting method changes that may result in cash tax savings as well as permanent rate savings. Fixed Assets Repair analysis Dispositions / Casualty loss Indirect cost analysis for self-constructed property Bonus depreciation IRC 174 costs Ready and available/lag Federal Tax Planning Considerations Deductions & Credits Prepaid expenditures Accruals and reserves review Rebate methods Recurring Item Exception Inventory and UNICAP analysis Revenue Recognition Unbilled revenue on professional services Deferred revenue Disputed revenue Defer advanced payments Other Planning Fiscal Taxpayers Prepayments VEBA Planning Captive Insurance Pension funding Asset reclasses Copyright 2018 Deloitte Development LLC. All rights reserved. 15

17 Summary of Other Provisions Impacting E&C Companies Provision Overview Corporate Rate Reduction The Act reduces the corporate tax rate from the current 35% to a flat 21% for tax years beginning after 2017 Net Operating Losses NOLs arising in tax years beginning after 2017 may only carried forward and may only be used to offset up to 80% of taxable income 20% Deduction on Domestic Qualified Business Income May deduct 20 % of qualified business income ( QBI ) from a pass-through entity as well as 20% of qualified REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income. Meals & Entertainment Changes to deduction for meals and entertainment Ranges from 100% deductible to 100% non-deductible Corporate Alternative Minimum Tax Corporate AMT is fully repealed. Local Lobbying Expenses Elimination of local lobbying expenses Fines & Penalties Expansion of non-deductibility of fines and penalties to include amounts paid in relation to the violation of a law or investigation in the potential violation of a law Transition Tax One-time transition tax on undistributed foreign earnings, payable over 8 years Global Intangible Low Taxed Income ( GILTI ) New system of taxation, including anti-deferral provisions (GILTI) Base Erosion Anti-Abuse Tax ( BEAT ) New minimum tax system related to certain outbound related-party payments Copyright 2018 Deloitte Development LLC. All rights reserved. 17

State tax conformity to IRC as of January 1, 2018 Rolling conformity to IRC currently in effect Conforms to IRC as of a specific date (as noted for each affected state) Selectively conforms (as noted

) Specific Date Conformity AZ 1/1/17 Selective Conformity AL Current WA Not applicable b/c state does not levy an entity level tax with a IRC reference point FL 1/1/17 GA 1/1/17 HI 12/31/16 ID 1/1/17

19 State tax conformity to IRC as of January 1, 2018 Rolling conformity to IRC currently in effect Conforms to IRC as of a specific date (as noted for each affected state) Selectively conforms (as noted for each affected state to IRC currently in effect, or to IRC as of a specific date. ) Specific Date Conformity AZ 1/1/17 Selective Conformity AL Current WA Not applicable b/c state does not levy an entity level tax with a IRC reference point FL 1/1/17 GA 1/1/17 HI 12/31/16 ID 1/1/17 IN 1/1/16 IA 1/1/15 AR Varies by IRC section CA 1/1/15 MS Current OR ID MT WY ND SD MN WI MI* NY/NYC VT* NH MA CT ME RI KY 12/31/15 ME 12/31/16 MI* Current or 1/1/12 MN 12/16/16 NH 12/31/16 NC 1/1/17 SC 12/31/16 TX 1/1/07 VT* IRC in CA NV AZ UT CO NM NE KS OK IA MO AR IL MS IN TN AL KY OH GA WV SC PA DC VA NC MD NJ DE Over 35 state legislatures currently in session effect for 2016 TY VA 12/31/16 AK TX LA FL WV 12/31/16 HI WI 12/31/16 Copyright 2018 Deloitte Development LLC. All rights reserved. 19

20 Tax reform Multistate considerations for corporations Tax reform legislation includes several major changes for federal taxation of corporations that include: Federal corporate rate reduction to 21%; state issues include: State corporate rates generally expected to remain constant Blended federal rate for fiscal year taxpayers may encourage acceleration of deductions Immediate expensing under IRC section 168(k); state issues include: Conformity State budgetary pressures may lead to legislative action State credit and incentives opportunities Limitations on federal interest expense deduction under IRC section 163(j); state issues include: Conformity Federal-state filing group differences Do not consider provisions in isolation! Look for connections between these and other tax reform provisions 163(j) now limits 3rd party interest expense impact on conduit exceptions for state tax addbacks? Copyright 2018 Deloitte Development LLC. All rights reserved. 20

Captive Tax Benefits Rapidly Closing opportunity with Tax Rate Change Federal: Acceleration of tax deduction: Captive takes deduction when loss reserve is set, rather than when loss is actually paid.

22 Captive Tax Benefits Rapidly Closing opportunity with Tax Rate Change Federal: Acceleration of tax deduction: Captive takes deduction when loss reserve is set, rather than when loss is actually paid. Potential source of cash that monetizes deferred tax assets State and local: Insurance companies are generally not required to file in a unitary return in the U.S. and are subject to a premium and/or self procurement tax in lieu of a state income tax. The premiums and self procurement taxes are based upon premiums written by the insurance entity; therefore, the underwriting and the investment income earned within the captive would not be subject to state income tax. Copyright 2018 Deloitte Development LLC. All rights reserved. 22

23 Closing Window on Potential for a Permanent Benefit related to DTAs Flat 21% corporate rate, effective January 1, 2018; blended rate for fiscal year filers $10m Reserves for Retained Insurance Losses Opportunity to accelerate deductions to higher-tax year, including accounting method changes Requires re-measurement of deferred tax assets/liabilities at lower rate $3.5m Deferred Tax Asset at 35% rate $1.4m DTA lost in Tax Rate Change $2.1m DTA at new 21% rate 2 Copyright 2018 Deloitte Development LLC. All rights reserved. 23

24 Supporting Favorable Tax Treatment for Captive Two Approaches Brother-Sister Approach (The Humana Model) Third Party Writings Approach (The Harper Group Model) Parent Parent Sub Sub Sub Sub Sub Sub Sub Sub Sub Sub Sub Sub Captive Not-Deductible Deductible Captive Outside Business Deductible Business Greater than 30% of annual net earned premium Brother-sister approach creates tax benefits when large proportion of risk resides with sibling subsidiaries to the captive. Parent company risks generally not deductible. When majority of risk at the parent (or an insufficient number of subsidiaries) a significant volume of unrelated business needed for captive to be respected as an insurance company by the IRS. Rent-a-Center case (January 2014) changed the thinking on minimum requirements for risk distribution. A substantial volume of unrelated business (which could include risks of employees -- i.e., benefits) may support deductibility of parent risk using the Third Party Writings approach. Copyright 2018 Deloitte Development LLC. All rights reserved Engineering and Construction Conference June 20-22,

Designing / Pricing / Executing a Loss Portfolio Transfer Transaction Need a Reserve/Loss Projection performed by a qualified/credentialed actuary, which should include: Expected reserves Expected

25 Designing / Pricing / Executing a Loss Portfolio Transfer Transaction Need a Reserve/Loss Projection performed by a qualified/credentialed actuary, which should include: Expected reserves Expected payout Undiscounted Discounted to reflect the time value of money at a risk free rate (usually T-bill with duration matching the average duration of the liabilities) Confidence level analysis, including expected and 90 th percentile confidence level NOTE: Transaction must be considered an insurance transaction; that is, it must deal with risks considered insurable, and it must pass tests for sufficient risk transfer. Additionally the captive and its ownership and capital structure must pass tests discussed above. Copyright 2018 Deloitte Development LLC. All rights reserved Engineering and Construction Conference June 20-22,

27 SEC Staff Accounting Bulletin No. 118 SAB 118 addresses situations where the accounting under ASC 740 is incomplete for certain income tax effects of the Act upon issuance of an entity s financial statements for the reporting period in which the Act was enacted. Incremental disclosures Categories ( Buckets ) under SAB Accounting is complete Incomplete, can determine a reasonable estimate record provisional amount Incomplete, cannot determine reasonable estimate no provisional amount recorded a) Qualitative disclosures of income tax effects for which the accounting is incomplete b) Items reported as provisional amounts c) Existing current/deferred tax amounts for which income tax effects of tax reform have not been completed d) Reason why initial accounting is incomplete e) Additional information needed to complete accounting requirements under ASC 740 f) Nature and amount of any measurement period adjustments recognized during reporting period g) Effect of measurement period adjustments on effective tax rate h) When accounting for income tax effects of tax reform has been completed SEC comment letters on disclosures Copyright 2018 Deloitte Development LLC. All rights reserved. 27

28 SAB 118 implementation issues Global intangible low-taxed income (GILTI) policy election Does SAB 118 apply to Uncertain tax positions (UTP) i.e. ASC Indefinite reinvestment assertions i.e. ASC Not required to adopt a policy in period of enactment but must disclose if not adopted If policy is still open, a policy is not established by including an estimate of current year GILTI in AETR If deferred taxes for GILTI are recorded, a policy is considered made even if amount recorded is provisional Subsequent adjustments would not be subject to ASC 250* if (1) occur within one-year and (2) amounts recorded in prior periods were provisional Once deferred tax amount for GILTI is considered final, ASC 250* would apply to any future adjustments related to company s policies used to calculate such amount Uncertainties about how the Act should be interpreted may be accounted for provisionally until a MLTN assessment can be completed Adjust provisional estimates as new information becomes available A MLTN assessment must be completed within the one-year measurement period Whether a tax technical matter is within the scope of SAB 118 depends on facts and circumstances and requires considerable judgment If plans are finalized and calculations are complete, entity should disclose plans and record tax effects If reasonable estimates can be made, record provisional amounts and disclose status of efforts If insufficient progress made to reasonably estimate plans, disclose status of evaluation and do not adjust previous indefinite reinvestment assertions Plans for reinvestment/repatriation could be affected by matters other than the Act and should be evaluated outside the SAB 118 framework * ASC 250 Changes in estimate versus error Copyright 2018 Deloitte Development LLC. All rights reserved. 28

29 SAB 118 measurement period Potential measurement period considerations: Deferred taxes Method planning GILTI deferred taxes (policy) Valuation allowances FTC credits Net operating losses and state attributes Interest limitations GILTI inclusion Transition tax E&P studies and foreign tax pools Cash vs non-cash Method planning GILTI Deferred method or period cost policy election Inside basis (TBBS) Expense allocation (for FTC) Outside basis GILTI basis differences ASC assertions Previously-taxed income State tax consequences Deemed and actual repatriations Apportionment factors GILTI/FDII deduction Period of Enactment (includes December 22, 2017) First period after enactment (e.g., Q1) Second period after enactment (e.g., Q2) Third period after enactment (e.g., Q3) Final period- last possible end of measurement period (e.g., Q4) Copyright 2018 Deloitte Development LLC. All rights reserved. 29

30 Disclosure requirements SAB 118 post enactment periods Deloitte Frequently Asked Questions About Tax Reform 12.5 What incremental disclosures does SAB 118 require entities to provide in periods after the enactment period of the Act? While SAB 118 does not explicitly state whether such disclosures pertain to annual financial statements, quarterly financial statements, or both, we note that all registrants were required to provide such disclosures in the period of enactment and, provided that items remain provisional or incomplete in subsequent filings, we believe that entities will need to refresh their disclosures on a quarterly basis Accordingly, we believe the following: Items that were disclosed as complete in a prior Form 10-K (or Form 10-Q) do not need to be repeated in subsequent Form 10-Q filings; however, an item reported as complete in a prior Form 10- Q would generally be repeated in the entity s next Form 10-K filing. Items that were disclosed as provisional or incomplete (Buckets 2 and 3) and, hence, are considered open would generally be treated as more akin to material contingencies. Accordingly, we believe that the relevant SAB 118 disclosures would need to be updated or refreshed (or both) as necessary in follow-on filings for these items until the accounting for such items is completed. In other words, entities should still, at a minimum, continue to denote those items for which the accounting remains provisional or incomplete in future filings, regardless of whether a significant change in the status of such items has occurred since the prior filing date Note: Consultation with attest firm is recommended Copyright 2018 Deloitte Development LLC. All rights reserved. 30

31 About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee ( DTTL ), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as Deloitte Global ) does not provide services to clients. In the United States, Deloitte refers to one or more of the US member firms of DTTL, their related entities that operate using the Deloitte name in the United States and their respective affiliates. Certain services may not be available to attest clients under the rules and regulations of public accounting. Please see to learn more about our global network of member firms. Copyright 2018 Deloitte Development LLC. All rights reserved. 36 USC

The 2018 National Multistate Tax Symposium Take the lead Tax reform and fortifying state positions. February 7-9, 2018

The 2018 National Multistate Tax Symposium Take the lead Tax reform and fortifying state positions February 7-9, 2018 Planning for future-state taxation regimes And the future state Scott Schiefelbein,