Americans are headed to the polls on November 8 to elect the next president of the United States. This election will play an important role in determining who will shape future tax policy. There are some current tax planning opportunities that construction companies can still take in the 2016 tax year, though.
1. Section 179
Construction companies can expense (rather than depreciate) certain qualified equipment purchases. Making this expensing election is not new. However, this allowance, which was frequently allowed to lapse, is now permanently extended. Some pertinent items to keep in mind include:
- The accelerated depreciation applies to new and used qualified property.
- Entities can elect to expense up to $500,000 per year. This expense limit is subject to a phase-out amount when the total amount of qualifying additions exceeds $2.01 million.
- In the future, the expensing limitation and the phase-out amount will be indexed for inflation.
2. Bonus Depreciation
Bonus depreciation can be claimed on the cost of qualifying depreciable property. The bonus depreciation deduction is 50 percent of the cost for property placed in service during 2015, 2016 and 2017. The deduction phases down to 40 percent in 2018 and decreases again to 30 percent in 2019. It is important to note that businesses cannot take both the bonus depreciation and the Section 179 allowance for qualified equipment purchases. A company that purchases a previously used qualifying asset may take a Section 179 expense for that used asset, but that used asset does not qualify for bonus depreciation.
Construction entities debating between either of the aforementioned depreciation options may want to do the following:
- Identify and gather invoices for machinery and equipment purchased during the current tax year.
- Decide whether the company will need new machinery and equipment in the coming months.
- Determine whether it is beneficial to purchase and place the equipment in service before the end of the tax year, as doing so may generate an additional Section 179 tax deduction.
- Some companies may choose not to place additional assets into service in 2016, if those additions might increase their total to more than $2.01 million and make them ineligible for the Section 179 deduction (although the bonus may still be available).
3. Section 199
Most businesses in the construction sector should consider Section 199, the domestic manufacturing deduction. This deduction includes a valuable tax break equal to 9 percent of income for businesses that perform domestic manufacturing and certain other production activities.
Construction of real property in the U.S. is eligible for the manufacturing deduction. Real property does not include machinery, unless it is a “structural component.” Note that the deduction generally does not apply at the state level. Examples of businesses that may be conducting eligible construction activities include:
- Residential remodelers
- Commercial and institutional building construction contractors
- Foundation, structure and building exterior contractors
- Structural steel and precast concrete contractors
- Electrical, plumbing, heating and air-conditioning contractors
Companies that are contemplating a Section 199 deduction may want to follow these steps:
- Speak with a tax advisor before year-end to identify qualifying activities and gather information required to calculate this deduction.
- Ensure that the calculated deduction does not exceed 50 percent of employee wages. Surpassing this 50 percent threshold could impose a limitation on the deduction and adversely impact tax benefits.
4. Method of Accounting
Determining which accounting method to use for tax purposes can be difficult. Many factors are in play, including contractor size and types of jobs. A cash-method taxpayer recognizes gross income in the tax year during which those items are actually or constructively received. Expenditures are deducted in the tax year during which they are actually paid. However, depending on the entity type and size, there are limitations on the use of the cash method. When the cash method is not a viable option for tax purposes, contractors must rely on the accrual method.
Generally, under this method, income is to be included in the taxable year when contractors earned the income. Expenses can be accrued when contractors have incurred a liability. A major benefit of the accrual method is that it provides a more accurate matching of revenue and expenses—both of which are recorded when incurred, not necessarily when paid.
This method can also allow additional tax planning opportunities through year-end accruals. Due to the accounting complexities of long-term contracts, the IRS requires contractors to specify the long-term, contract accounting method for these arrangements.
A contract is considered “long term” if it is not completed in the same tax year it is started, regardless of the time needed to finish the job.
Although there is often no single correct choice for an accounting method, construction companies still have a decision to make. Therefore, consider the following before choosing an option:
- Consult a tax advisor to confirm the overall method of accounting for tax purposes on the company’s most recently filed income tax return.
- Consider the tax implications of switching to a more favorable method of accounting for income tax purposes.
5. WOTC Program
The Work Opportunity Tax Credit Program (WOTC) offers employers federal income tax credits for hiring individuals who often encounter barriers to employment. The WOTC program allows for tax credits for targeted groups hired between December 31, 2014, and December 31, 2019. The federal government recently extended WOTC eligibility to qualified, long-term unemployment recipients that begin to work on or after January 1, 2016, and before December 31, 2019.
6. R&D Tax Incentives
Many companies are unaware that the federal government, as well as some state governments, offers generous research and development (R&D) incentive programs for construction companies. To qualify for an R&D tax incentive, a project should:
- Strive to improve a component that a company uses in business operations
- Eliminate uncertainty regarding the need to improve the targeted component
- Evaluate different alternatives to achieve the goal
- Incorporate scientific principles
- Involve construction engineers and other specialists spending a substantial portion of their time developing superior designs and practices to help their businesses remain competitive.
A well-informed approach to these credits may require these steps:
- A company that has hired a qualifying individual should complete the forms to determine WOTC eligibility.
- Evaluate ongoing and future projects and determine if any of them might be eligible for an R&D tax incentive.
There is still time this year to take advantage of these benefits in the tax code. Contact your tax advisor to build a strategy for your specific needs.