As the end of the year creeps up, now is the time to consider tax strategies and financial statement performance for your operation. Planning will be especially important this year considering the passage of the Tax Cuts and Jobs Act (TCJA). 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 for year-end reporting.
Below we have outlined the major changes contractors should consider when planning their year-end tax-saving strategy.
Qualified Business Income Deduction (QBI)
Under the new tax code, owners, partners, and shareholders of S corporations, LLCs, and partnerships will receive a tax break. As long as they aren’t part of the carve-out group, those who pay their share of the business’ taxes through their individual tax returns will have a 20 percent deduction starting in 2018.
The Qualified Business Income Deduction (QBI) is a great financial planning opportunity, but there are exceptions. Qualifying for the deduction depends on your income threshold and field of business. Calculating the QBI deduction depends on whether a business is considered a “specified service.” A Specified Service Trade or Business (SSTB) is any trade or business that involves the performance of services.
The new legislation specifically exempts architects and engineers from the definition of a specified service trade or business. Both are eligible for the 20 percent reduction, regardless of personal taxable income level. Architects and engineers operating as sole proprietors should also consider the benefits of converting to an S corp status while firms looking to retain earnings should consider C corp status.
For firms that qualify, the next step is to consider your qualified business income, defined as the amount of profits after wages and guaranteed payments. If your taxable income is less than $315,000 (married) and $157,500 (single), you are entitled to the 20% deduction. The QBI deduction can get complicated. For example, if your taxable income exceeds these thresholds, the rules change.
Corporate Alternative Minimum Tax (AMT)
The repeal of corporate AMT is good news for small contractors that use the completed contract method. Pre-tax reform, contractors were required to recalculate alternative minimum taxable income using the percentage of completion method. This requirement often led to large add-backs of the completed contract deferral, which no longer rings true ow that the AMT for C corporations has been repealed. Construction and engineering firms should take a second look at past returns to determine if they have any historical AMT tax credits, which is now refundable.
Domestic Production Activities Deduction (DPAD)
Pre-TCJA, this deduction helped manufacturers, contractors, engineers, and architects receive a deduction equal to a percentage of the taxable income from qualified production activities. The QBI deduction should help offset those that will be impacted by the elimination of this deduction.
Leverage Long-Term Contracts
Pre-tax reform, contractors with average annual gross receipts of less than $10 million were exempt from using the percentage-of-completion method of accounting. After the passage of TCJA, the exception expanded to $25 million. Contractors that utilize the completed contract method will benefit from the opportunity to defer tax due until the job is complete. These changes will only apply to long-term construction contracts entered into after December 31, 2017.
The TCJA expands the bonus depreciation deduction for qualified property. Equipment purchased after September 27, 2017, and before January 1, 2023, is fully deductible if it is the business’ first use of that asset. This bonus depreciation deduction applies to new and used property.
In light of the new tax law, 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. Failure to address how these key provisions will impact your firm can hurt your bottom line. Call us today to understand how the passing of the new tax laws will affect your year-end tax planning.