Given the current strength and positive economic outlook for the construction industry, contractors often forget that cyclical periods of growth and downturn are normal and should be expected. Financial preparation for a future downturn during a strong economy can position a business to successfully weather the effects of a recession, and part of that preparation begins with understanding the tax consequences of a downturn.

Let’s take a look at a few implications that can affect a contractor facing a tax loss rather than net income tax.

Qualified Business Income Deduction: Losses

While contractors doing business as pass-through entities have been enjoying the positive tax impact of the new 20% deduction for qualified business income¹ (QBI) that began in 2018 (see “The New Qualified Business Income: An Overview”² in the September/October 2018 issue of CFMA Building Profits), one aspect that is often overlooked is the effect of losses on this new tax deduction. Losses from QBI sources can reduce the current year’s deduction to zero, and any unused negative QBI must be carried forward to the following year.³

For example, if Bob, a GC, has a net negative QBI of $120,000 in year one, he must carry forward the negative QBI to year two. So, in year two, if Bob has a net positive QBI of $500,000, the prior year’s negative QBI carry forward reduces his year two QBI to $380,000 ($500,000 - $120,000). Instead of a QBI deduction in year two of $100,000 ($500,000 x 20%), Bob has a QBI deduction in year two of $76,000 ($500,000 - $120,000 = $380,000; $380,000 x 20%).

Any excess losses generated specifically under the QBI calculation are carried forward and negatively impact potential deductions in the following and future years until the deduction sunsets after 2025.⁴ Importantly, these carry forward QBI losses must now be tracked.