Countless industries will be impacted by the recent passage of the Tax Cuts and Jobs Act and the construction industry is no exception. Touted as the most sweeping tax policy change in the United States in more than 30 years, the Act will have a major impact on the construction industry by presenting expanded opportunities to defer taxable income, free up cash flow and ultimately pay tax at lower rates. It’s not all good news though, as some historical go-to deductions for the industry have been eliminated.
Doeren Mayhew’s construction CPAs share six key tax reform changes and planning opportunities which construction companies should be aware of.
In the past, the taxable income from long-term contracts was generally computed using the percentage-of-completion method of accounting. Contractors with average annual gross receipts of less than $10 million were exempt from this rule for projects expected to be completed within a two-year timeframe. Now, with an increase in the exemption level to $25 million, even more contractors will get to take advantage of a more tax-friendly accounting method. This is a welcomed change since the prior threshold was established way back in 1986 and never adjusted for inflation.
Those businesses meeting the average annual gross receipts test will be permitted to use the completed-contract, cash or any other permissible exempt contract method available to them. The provision applies to contracts entered after Dec. 31, 2017. Contractors affected by this provision would change methods on a cut-off basis. In other words, any contract started before 2018 would continue to be accounted for on the percentage-of-completion method, and any new contracts beginning in 2018 would be accounted for under the completed contract method.
Amplifying the benefits of the accounting changes to long-term contracts is the repeal of corporate AMT. This is because long-term contracts are required to be reported using the percentage-of-completion for AMT. With the repeal of corporate AMT should come an elimination of the significant swings in tax liability resulting from the use of the completed-contract method for regular tax and the percentage-completion method for AMT purposes.
For those contractors in a pass-through entity, you will still need to consider how individual AMT will affect you since that has not been repealed. The good news is the exemptions and phase-out limits were increased to $86,000 and $1 million for married filing joint taxpayers, respectively. Many taxpayers that used to be subject to AMT in the past will likely no longer be affected by it. Unfortunately, that won’t be the case for all contractors. Those smaller contractors previously mentioned will still be required to calculate their current long-term contract adjustments and look-back calculations for AMT purposes.
With most construction firms operating in some form of a pass-through structure, many, including architecture and engineering firms, will qualify for the new pass-through entity deduction.
A taxpayer who’s taxable income does not exceed certain thresholds may claim a deduction equal to 20 percent of QBI (comprised of certain items of income, gain, deduction or loss) generated by the qualifying business. However, once those taxable income thresholds are exceeded, then the calculation becomes much more complex, as it may be adjusted by wages paid, property owned or losses incurred.
The deduction may also be limited to 20 percent of the taxpayer’s taxable income with adjustments made for capital gains and qualified cooperative dividends, if this amount is less than the deduction calculated as described above.
The deduction calculation is made at the taxpayer (owner’s) level, which subjects the allocation of the components that make up QBI to the same allocation percentages as the partnership or S corporation allocates them at to the taxpayer.
Under previous law, this deduction allowed construction firms, specialty contractors, building product manufacturers, and engineering and architectural firms working on construction projects to get a deduction equal to 9 percent of the taxable income from qualified production activities performed in the United States. With its repeal after the 2017 tax year, contractors and those alike will likely take a hit to their taxable income. For pass-through entities the QBI deduction referenced above will offset the loss of DPAD.
The Act expanded the bonus depreciation deduction to allow full expensing (100 percent bonus) for “qualified property” placed in service after Sept. 27, 2017, and before Jan. 1, 2023. Beginning Jan. 1, 2018, the bonus depreciation deduction for qualified property placed in service is then phased out over four years:
Contractors may elect 50-percent expensing in lieu of 100 percent for qualified property placed in service during the first tax year ending after Sept. 27, 2017. The amendments apply to property that is both acquired and placed into service after Sept. 27, 2017. The provision now applies to both new and used property.
With the passing of new tax laws, now it’s more important than ever for contractors to choose the right entity type. Your goals may be different depending upon whether your business is new, growing, or if you are planning to transition or sell the business soon. The new tax law has provided many enticing incentives – 21-percent-flat corporate income tax rate, 20 percent pass-through deduction and bonus expensing to name a few – that should cause you to pause. Contractors should have a choice of entity analysis performed by a construction accounting firm to evaluate the numerous factors that need to be taken into account, including the cost of conversion. Choosing to do business under the wrong entity type might cost you – literally.
To understand how these key provisions and much more will impact your construction company, contact construction accounting firm Doeren Mayhew. Our construction CPAs stand ready to help guide you through the tax law changes with a focus on building a tax-saving strategy plan to boost your bottom line.
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