Taxes and Planning in 2010 for Your Construction Business

Written by Adam Polakov

There has been a flurry of tax-related legislation since President Obama took the oath of office. On February 17, 2009, the President signed the American Recovery and Reinvestment Act of 2009 (ARRA), a $790 billion stimulus package intended to spur the American economy.

The House of Representatives approved an unemployment insurance extension bill on November 5, 2009, which included a provision allowing businesses with net operating losses (NOLs) in 2008 or 2009 to carry back those losses for up to five years. This bill, known as The Worker, Homeownership and Business Assistance Act (the Act), was signed into law on November 6, 2009.

Tax Rates

It is expected that the President and Congress will raise the capital gains and ordinary income tax rates beginning in 2011 on higher-income taxpayers (individuals earning more than $200,000 and joint filers earning more than $250,000). President Obama has indicated that effective January 1, 2011, the following changes will impact those taxpayers:

The qualified dividend income and long-term capital gains rate increased from 15 to 20 percent
The top individual income tax rates (currently 33 and 35 percent) reinstated to 36 and 39.6 percent
Limitations established on the benefits of itemized deductions (home mortgage interest, charitable contributions, etc.) for taxpayers in the 36 and 39.6 percent tax brackets
The cap on payroll taxes raised to bolster the social security trust fund (Currently, all taxpayers remit payroll taxes on earnings up to $106,800. Pursuant to the President's proposal, payroll taxes will be re-instituted on taxpayers in higher income tax brackets, i.e., joint filers in excess of $250,000 and on earnings of individual filers in excess of $200,000. For example, if you are married filing jointly and earn $300,000 in wages, then your social security tax base would be $156,800 [$106,800 + $50,000 (earnings in excess of $250,000)]. Based upon the 6.2 percent payroll tax rate currently in effect, the joint filer in this example would owe an additional $3,100 ($50,000 x 6.2 percent) in social security taxes).

Construction business owners need to plan carefully during 2010 to take into consideration the impact of these projected increases in taxes. It is difficult to project, with certainty, exactly how legislation effective January 1, 2011, will be written, but one thing is for certain-taxes are going to increase.

As part of a Health Care Reform package, the House of Representatives recently passed a 5.4 percent tax surcharge, amongst a myriad of other taxes, on higher-income taxpayers. As this article is being written, the ultimate fate of health care reform is unknown.

Five-Year NOL Carry Back

The Worker, Homeownership and Business Assistance Act (the Act) expands the NOL carry back provision from the ARRA passed in February 2009. Businesses may now offset 50 percent of taxable income in the fifth preceding year and 100 percent of taxable income in the remaining four carry back years. In summary, there would be no limit on carry backs for the first four years of the carry back period, but for year five, the carry back would be limited to 50 percent of a taxpayer's taxable income in that year.

The NOL carry back provisions from the Act do NOT include any gross receipts test limitations and are available to taxpayers with losses in either 2008 or 2009. The Act provides an election for taxpayers to either carry back 2008 losses five years or 2009 losses five years to recapture taxes that have been paid in years when the taxpayer was profitable. Eligible small businesses are able to carry back losses five years for both the 2008 and 2009 tax years.

Deferred Taxes on Cancellation of Indebtedness Income

Taxpayers that incur cancellation of indebtedness (COD) income during 2009 or 2010 have the option to defer any COD income arising from the reacquisition of a debt instrument for five years and then are allowed to recognize the deferred COD income pro-rata over the following five years. This means that the deferred COD income will be recognized ratably from 2014 through 2018.

Treasury regulations and the ARRA broadly define the reacquisition of a debt instrument to include the following:

An acquisition of a debt instrument for cash
The exchange of a debt instrument for another debt instrument
The exchange of corporate stock or a partnership interest for a debt instrument
The contribution of a debt instrument to the capital of the issuer
The complete forgiveness of a debt instrument by the holder of such instrument.

The following example illustrates how taxes could be deferred on the realization of COD income:

ABC Corp. has a $10 million loan with the bank. In 2009, ABC Corp restructures the loan to $6 million. ABC Corp. realizes $4 million of debt discharge income on the re-negotiated debt instrument, but doesn't recognize that income in 2009. Instead, it recognizes $800,000 of debt discharge income ($4 million/5 yrs) in each of the five years from 2014 to 2018.

Homebuyer Credit

The homebuyer credit has been extended for first-time homebuyers and has also been expanded to include current long-term homeowners and taxpayers in higher-income tax brackets. The credit has been extended to include all contracts initiated on or before April 30, 2010, and which close no later than June 30, 2010.

The tax credit program includes a tax credit of up to $6,500 for existing homeowners who have owned and occupied a primary residence for a period of five consecutive years during the last eight year period. The purchase price must be less than $800,000 for both current and first-time homebuyers. Congress has also increased the adjusted gross income limitations for qualifying taxpayers. Single tax filers who earn up to $125,000 are eligible for the full credit amount. Single tax filers earning between $125,000 and $145,000 will receive a partial credit and a complete phase-out of the credit occurs with an adjusted gross income in excess of $145,000. Joint tax filers with an adjusted gross income of $225,000 or less are eligible for the total credit amount. Joint tax filers will face a partial phase-out of the credit as earned income climbs towards $245,000 with a full phase-out of the credit occurring if adjusted gross income exceeds $245,000.

Estate and Gift Taxation

There has been much speculation regarding future exemption levels on estate tax. The President has proposed freezing the estate tax exemption at its current 2009 levels of $3.5 million per individual with the excess taxed at a top tax rate of 45 percent. The estate tax is scheduled to expire next year, but it is highly unlikely that Congress will allow a one-year gap in estate taxation to occur in 2010. Many pundits believe that the proposed exemption level of $3.5 million per individual will pass Congress in the upcoming year and will likely be implemented through 2020.

Failure to File Penalties Increasing

The penalty for failure to timely file partnership and S corporation returns is increasing for returns required to be filed after December 31, 2009, from $89 per each partner/shareholder for each month that the return is not filed to $195 per partner/shareholder per month. This large increase in penalties (almost a 120 percent increase) has been implemented to promote higher filing compliance from S corporations, partnerships and LLCs.

Construction business owners need to be pro-active in discussing these tax law changes with their CPAs, lenders and bonding agents. Those construction companies who can more effectively stabilize their business through smarter allocation of resources and tax planning strategies will be better positioned once we emerge from the economic downturn.

Construction Business Owner, January 2010

Adam Polakov is a CPA at Porter Keadle Moore, LLP. He can be reached at 404.420.5974.

Tags: 2010 January Issue , accounting , financial