To gain maximum impact during tax season, contractors need to take a holistic approach to tax planning and invest in year-round preparation. While most tax strategies strive to defer income to the next tax year and accelerate expenses in the current year, strategic tax planning takes into consideration many other factors, including how reducing income for tax purposes will affect financial statements, cash position, capitalizing on current elections, and much more. For example, when deciding on a lending and bonding program, lenders and sureties rely on the strength of a contractor’s financial statements and the company’s character, capacity, and capital. Customers also review these metrics to ensure that the contractor is financially strong and can meet their performance obligations.
Whether you work with an accounting firm specializing in the construction industry or not, tax season is not the only time you should meet with your trusted advisor to discuss business planning. These conversations should happen regularly to ensure your business is sustaining growth now and in the future.
Here are year-round strategies to help ensure long-term growth and sustainability.
Find the right advisor.
An advisor who knows your industry and has deep knowledge of local and state tax laws, credits, and pronouncements will save time, frustration, and money. A construction-focused accounting firm with a large book of similar-sized clients can demonstrate the company’s specific experience and strength in the space. Don’t be afraid to “interview” the firm you’re considering working with. Ask about relevant criteria and details about their team’s expertise within your industry and learn who your team members will be.
- Does the firm have any CPAs who are also CCIFPs (Certified Construction Industry Financial Professionals)?
- Have they taken on new construction clients and provided those new clients with changes in tax reporting methods?
- Ask for references and request feedback on why they have stayed and what they’ve learned from working with them.
Your tax advisor is an extension of your team, and you want to ensure it is the right fit.
Determine the proper accounting method.
Even though this year’s tax season is in full swing, there are still things concrete and construction companies can do to benefit from this tax season. Contractors should confirm that the tax reporting method they’re using for each contract is appropriate by determining which projects are or are not considered long-term (longer than one year). Most contractors use the percentage-of-completion method (PCM) for long-term contracts. However, many exceptions exist. For example, residential builders generally qualify to use a different tax reporting method. The definition of a residential contractor is not just a home builder. In addition, under the Tax Cuts & Jobs Act of 2017 (TCJA), tax accounting methods previously available only to smaller contractors can generally be used by contractors with average annual gross receipts of up to $26 million (as adjusted for inflation). Choosing the appropriate method for each contract to reduce tax costs is a tool that is often overlooked, and each contract could have a different method of reporting for income tax purposes.
Determine whether your business qualifies for a research and development tax credit.
If new processes to improve efficiency or reduce/eliminate uncertainty are developed (in the U.S.), contractors may qualify for a research and development (R&D) tax credit. An R&D tax credit is generally taken on a dollar-for-dollar basis on the entire qualified project or the portion that meets the IRS’s criteria. If the R&D tax credit is not fully utilized, it may be carried back to the previous year and forward for 20 years. In addition, qualified start-ups and small businesses that may not have an income tax liability can offset payroll taxes with the R&D tax credit.
Take the energy-efficient building deduction.
The Consolidated Appropriations Act (CAA) of 2021 made the Energy Efficient Building Deduction (Section 179D) permanent. Business owners and government contractors can take a deduction for energy-efficient improvements to commercial and government buildings. A tax deduction of $1.80 per square foot is available to new or existing building owners who install interior lighting, building envelope, heating, cooling, ventilation, or hot water systems that reduce energy and power costs by 50% or more. Any accrued tax deductions from these buildings can be carried back two tax years or forward for up to 20 years. Eligible designers and builders (such as architects, engineers, contractors, environmental consultants, and energy service providers) can also qualify for 179D under a special rule for public property.
Maximize the Employee Retention Credit.
The ERC (Employee Retention Credit) is a refundable tax credit against certain employment taxes. The credit reduces the employer’s share of Social Security and Medicare taxes. The credit can be in excess of the employer’s share of these taxes, which adds to the contractor’s refund. Employer-paid health insurance costs may also be eligible, even if the employer has furloughed workers and is not otherwise paying wages.
Monitor contractual provisions.
It is important to know that contract provisions could impact the tax reporting requirements. For example, a unit price contract or GMP (Gross Maximum Price) contract has a different tax provision than a lump sum contract. Contract provisions that provide pay if paid or paid when paid carry different tax reporting methods. The retainage provision affects tax reporting as well. Therefore, it is paramount that contractors genuinely understand that their contract provisions could provide them with tax opportunities or create tax obstacles.
Take advantage of bonus depreciation changes.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act includes a technical correction to the TCJA that permits 100% bonus depreciation for eligible Qualified Improvement Property (QIP) placed in service after December 31, 2017, and before January 1, 2023. As a result, taxpayers who placed eligible QIP in service from 2018 through 2022 may be eligible to claim 100% bonus depreciation. However, this deduction is limited to 80% of the cost of the property for 2023. REITs, manufacturers, and other businesses that own certain nonresidential real estate improvements on leased land may also be eligible. This can help businesses improve cash flow, especially in the retail, restaurant, and hospitality industries.
Qualify as a real estate professional.
Rental activities and income are generally considered passive income unless the investor qualifies as a real estate professional for tax purposes. After that, it is treated as non-passive income. Losses can be deducted if the real estate professional materially participates in the rental activity. More than 50% of the person’s time and 750 hours must be spent on real estate activities. Holding a real estate license is not required, though other rules apply. However, contractors generally qualify for this provision under the Internal Revenue Code. It is important to assess this opportunity as it becomes a valuable tax planning tool.
State tax credits/programs.
Working with an advisor familiar with the industry will help ensure that you maximize not only the federal credits available but also the available state credits and programs. For example, many states are focusing on environmental issues and green energy credits and incentives. These have a significant impact on the construction industry. For example, New Jersey recently established a credit for concrete manufacturers that meet specific low-carbon standards. This is just one state and one such program, but there are many more, and most states have some initiatives to facilitate development.
Taking a strategic, holistic approach to tax planning can provide many long-term benefits for your business. An advisor who knows your industry intimately will be able to provide guidance on the cost-benefit for all the strategies mentioned above. In addition, once you find a trusted advisor, you can develop your growth plan to ensure company success for years to come.
About the author
Marty McCarthy, CPA, CCIFP, is the managing partner of McCarthy & Company, PC.
The material provided in this article is solely for informational purposes and should not be relied upon for tax or accounting advice. Please consult your tax advisor regarding your situation.
