The following content is sponsored by CLA.
Before you close your books for the year, review tax planning strategies that could benefit your construction company, and explore traditional tax planning strategies, tax credits and incentives, and alternative accounting methods.
When doing so, consider their implications on the entire company, shareholders, banking, bonding, and other stakeholders, both today and into the future.
Traditional Tax Planning Strategies
Accelerating Prepaid Expenses
Prepaid expenses generally sit on the balance sheet until incurred. A construction company could elect to make an accounting method change to deduct prepaid expenses in this year.
Equipment purchases are generally eligible for an accelerated tax write-off. In today’s economy, equipment purchases usually need to be planned several months ahead of time. In order to depreciate a new piece of equipment, it must be physically available for its intended use.
There are two methods to help accelerate tax depreciation on equipment and other purchases:
- Section 179 — Allows for deduction of up to $1.16 million of purchases. However, if total fixed asset purchases for the year exceed $2.89 million, the deduction is limited.
- Bonus depreciation — Starting in 2023, bonus depreciation is reduced to only 80% of an asset’s purchase price. The remaining 20% is eligible for traditional depreciation. Without additional legislation, bonus depreciation will continue to decrease each year: 60% for 2024, 40% for 2025, 20% for 2026, and 0% beginning in 2027.
While purchasing additional equipment can reduce taxable income, paying for the equipment still reduces cash flow that could be used for other purposes. Purchases should have a business purpose — they should not be used solely for tax reduction purposes.
With accelerated depreciation methods declining, it’s more important than ever that only necessary items are capitalized and depreciated. Verify that you’re following an up-to-date capitalization policy, and review repairs and maintenance for items eligible to be expensed instead of capitalized.
Consider a profit-sharing plan or additional planning to increase the profit-sharing plan’s potential. Particularly for union contractors with few participants in the company plan, it’s possible to provide a benefit to employees while simultaneously helping to decrease taxes and increase the shareholders’ net worth.
State Tax Option for Pass-Through Entities
For pass-through entities, evaluate whether it may be more beneficial to elect to pay state taxes at the entity level instead of at the shareholder level. For states that allow a pass-through entity tax election, the company may be able to pay the state taxes and receive a federal tax deduction. If the shareholder(s) were to pay taxes directly, then they would be limited to a maximum deduction of $10,000 per shareholder.
Qualified Business Income Deduction
Verify that you’re taking full advantage of the qualified business income deduction. The deduction is equivalent to 20% of qualified income from a business operated directly by a taxpayer or through a pass-through entity.
Consider the potential impact of giving bonuses and guaranteed payments vs. distributions. Wages to owners, including bonuses, essentially move income from the business to the individual, netting to the same taxable income for the shareholders. However, wages decrease the amount of business income eligible for the qualified business income deduction, resulting in a loss of the 20% deduction.
Tax Credits & Incentives
Research & Development Credits
This credit could be available if your company has designed products or improved processes. The tax definition of research and development is much broader than the traditional definition. With recent changes, you must capitalize and amortize costs related to research and development over time instead of immediately deducting them.
This credit provides commercial building owners and eligible designers and builders with the opportunity to claim a tax deduction for installing qualifying energy efficient systems and buildings. Deductions related to energy efficient building construction or renovation for a nonprofit or governmental organization can be assigned to the contractor.
Work Opportunity Tax Credit
This credit is available for eligible employers who hire people from certain targeted groups and employ them for at least 120 hours. The credits can reduce federal tax liability by up to $9,600 per eligible employee.
Fuel Tax Credit
This credit is related to fuel used in qualified off-highway vehicles and equipment. The credits vary for gasoline, diesel, and propane.
Accounting Method Considerations
The following are some of the more advantageous accounting methods for contractors to consider:
The 10% Method
Contractors can defer income on jobs less than 10% complete by electing the 10% method. This method is recommended when jobs are started late in the year or for large multi-year projects.
The Accrual Without Retainages Method
This option can be beneficial for specialty contractors and subcontractors. It defers income recognition associated with certain retainages receivable until the retainage is payable per the contract.
Additional Options for Small Companies
Small contractors with average annual gross receipts under $29 million can use a different method of accounting for their tax return than their financial statements. There are several options to consider that could potentially help defer taxable income.
The Cash Method
Income is generally recognized in the year cash is received and deductions are generally taken the year an expense is paid. Construction contracts reported on the cash method of accounting are only taxable to the extent cash has been received.
The Completed Contract Method
This option allows taxpayers to defer recognizing income from a contract until the contract is completed. The completed contract method can result in significant taxable income deferral, potentially for multiple years.
With both the completed contract and cash methods, consider the impact of the alternative minimum tax adjustments necessary for contracts reported.
The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CLA) to the reader. For more information, visit CLAconnect.com.
CLA exists to create opportunities for our clients, our people, and our communities through our industry-focused wealth advisory, digital, audit, tax, consulting, and outsourcing services. CLA (CliftonLarsonAllen LLP) is an independent network member of CLA Global. See CLAglobal.com/disclaimer. Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor.