As we creep toward the end of the year, now is the time to consider tax strategies and financial statement performance for your operation. There are different tax methods available and unlike many industries, construction can choose more than one. Working closely with your accounting professional is key in determining how your chosen strategy will impact your tax liabilities, flow-through income and financial statement strength for year-end reporting.
Consider the following five steps when planning your year-end tax saving strategy.
Projection of Taxable Income
An important step in your planning is projecting your taxable income for the remainder of the year.
With the assistance of your accounting professional or internal accounting staff, gather estimate reports for your operation. Compare the estimates to the prior year’s actual results and determine key differences between the years. Identify external components, such as governmental regulations or unexpected weather delays.
Contractors customarily have entities related to their construction operation to manage their equipment, rentals or varying trades. Reviewing the reports for those entities may result in beneficial losses or lower tax bracketing that can be optimized for the owner.
Tax Depreciation
As mentioned previously, contractors are allowed several tax methods to choose from. Those related to depreciation and capitalization of expenses for tax purposes can be very beneficial.
Depreciation of construction equipment spans over a five-year period for tax purposes, even if the useful life might be much longer.
Section 179 is a beneficial tax depreciation that contractors may utilize. Deductions are equal to $500,000 if total purchases do not exceed $2 million. New equipment purchases receive 50% bonus depreciation.
Construction equipment repairs are currently deductible for contractors vs. required capitalization because of the high cost and long GAAP useful lives of construction equipment. An expenditure that does not enhance the performance of the equipment or extends the useful life of the equipment is generally not capitalized.
Alternative Minimum Taxes (AMT)
The method(s) chosen by the contractor can affect AMT. For instance, differences between the Tax Percentage of Completion method and other methods used in the tax return for long-term contracts can create AMT. Contracts that are exempt from AMT include: home contracts, contracts less than 10% and non-long-term contracts. An acceleration in tax depreciation can also create AMT.
Tax Credits and Deductions
Several tax credits or deductions are available to contractors. If eligible, utilizing the credits and deductions in a year-end planning strategy will prove beneficial.
- Construction activities are eligible for a manufacturing deduction of 9%. The lower of either net income for the company or gross profit from construction is the basis of the deduction.
- As an incentive to use “green” construction materials (Section 179 D), the contractor can be awarded deductions of up to $1.80 per square foot on projects that meet certain energy savings.
- Other credits contractors may be eligible for are research and development credits, energy credits and work opportunity credits.
Be Mindful of Pass-Through Entities and Owner’s Tax Situations
Accounting for tax liability at the company level, while also considering any tax burdens for the pass-through owners is important when planning. Consider maximizing lower tax brackets and deductions between the companies and owners. If applicable, calculate the AMT at the owner level and consider the timing of payments between related parties to include bonuses, which must be made prior to year-end to be deductible.
Contractors have an incredible opportunity when it comes to tax planning for their operation. Utilizing one or more methods that suits your operation and working closely with your accounting professional will likely result in expected tax savings.