While the Tax Cuts and Jobs Act of 2017 (TCJA) will have a significant impact on all businesses, construction companies in particular are in a strong position to benefit from the recently passed federal reforms.
Business owners in this highly competitive industry need to be proactive by strategically planning how to address the project cycles, cash flow, financing, bonding and operational issues unique to their company.
There are tremendous tax planning opportunities as a result of the TCJA for construction companies and their owners who have not filed 2017 returns, as well as major considerations that will impact how their tax picture unfolds for 2018. Some of the top opportunities for construction companies include:
- Beginning in 2018, the requirement to use the Percentage of Completion Method (PCM) for accounting lends exceptions for companies with an average annual gross receipt of $25 million or more (up from $10 million under previous code) for long-term contracts entered into beginning in 2018. Businesses that meet this exception will be permitted to use PCM (or any other permissible method).
- Under prior law, net taxable income from pass-through business entities, such as sole proprietorships, partnerships, S corporations and limited liability corporations (LLCs), was simply passed on to owners. It was then taxed at the owner’s tax rates. For tax years beginning in 2018, construction company owners could be eligible for a new 20-percent deduction based on their qualified business income. Certain items still need to be defined around the types of work that would qualify, as well as the stipulations for companies whose principal asset is the skill and reputation of its owners.
- The management of cash flows can often be difficult to account for and strategize around for construction companies. Under prior law, taxpayers had several requirements and limitations related to the use of the cash method of accounting. Many of these
limitations have been loosened or removed for companies with more than $25 million in taxable income under the TCJA, resulting in a major potential benefit for those companies.
- Construction companies who are C-corps will benefit from the tax rates being lowered to 21 percent from 35 percent and the repeal of the corporate alternative minimum tax (AMT), allowing corporations to continue to use prior-year minimum tax credits
to offset their regular tax liability. These changes have many companies considering what business structure will be most beneficial for them.
- The research and development tax credit, which is typically underutilized by construction companies, was explicitly preserved in the final TCJA legislation. With the changes in the AMT, more companies could be eligible to leverage the credit. Furthermore, the 179D “Green” Deduction was extended retroactively for 2017 by the Bipartisan Budget Act of 2018, adding additional potential incentives.
Along with these opportunities, the federal government is expected to provide additional clarification on several aspects of the tax law that could impact construction companies beyond the initial analysis. For example, qualified business income does not include compensation paid to an owner for services rendered to the business or any guaranteed payments to a partner or LLC member. Those compensation levels may be reassessed to maximize the qualified business deduction for profitable, pass-through entities.
Furthermore, as part of the TCJA, significant limitations have been applied to meal and entertainment deductions. Under prior law, businesses could deduct 50 percent of expenses paid or incurred for meals and entertainment directly related to the active conduct of the business.
Under the TCJA, no deduction is allowed for entertainment, amusement, or recreation; membership dues for a club organized for business, pleasure, recreation or other social purposes; or fees for a facility used in connection with any of the above. The deduction is only for 50 percent of food and beverage expenses associated with operating a trade or business.
The TCJA does enlarge this deduction to include providing meals to employees through a facility that meets the requirements for a de minimis fringe and for the convenience of the employer, which would sunset after December 31, 2025.
What does this all mean for construction companies? These changes will make entertainment significantly more expensive for companies, potentially changing their approach to these activities.
It is essential for construction companies to analyze, plan and strategize for the impact of the TCJA on their businesses. Whether you are trying to leverage tax-saving opportunities or strategizing your approach for some of the potential challenges, planning is important. The decisions construction companies make now for their 2017 and 2018 tax returns will have tremendous impact on their businesses moving forward.