How Tax Reform Changes Are Impacting Your Construction Business
The Tax Cuts and Jobs Act is the most significant tax reform legislation in decades. The new tax rules are numerous and complex. Even though we are still awaiting more guidance from the IRS and Treasury Department on certain provisions, it is important to understand what this tax reform means for your company now, and what you need to account for in the future.
Here are some provisions in the new tax law that will directly impact your construction business:
Methods of Accounting for Long-term (LT) Contracts
- Certain construction contracts may be eligible to use cash or the completed contract method of accounting for LT contracts.
- Under the Old Law – Contractors with average gross receipts for the prior three years under $10 million are exempt from the requirements to account for LT contracts using the percentage of completion method (POC) for income tax reporting.
- Under the New Law – The $10 million threshold is increased to $25 million for contracts entered into after December 31, 2017. Thus, construction companies with average annual gross receipts under $25 million may be exempt from the requirement to use POC.
- The exemption only applies to contracts expected to be completed within two years of the commencement of the contract.
- Considerations – If eligible, does it make sense to switch to a cash method of accounting for LT contracts? Any deferral of income or acceleration of deductions create permanent tax savings due to the reduced business and individual tax rates under the new tax law.
Tax Rates Reduced
- For contractors operating a construction business as a C-corporation – the tax rate has been reduced to a flat rate of 21% for taxable years beginning after December 31, 2017.
- Fiscal year C-corporations have a “blended” 2017-2018 tax rate.
- Considerations – C-corporations in the lower tax bracket in prior years will experience a tax rate increase. Does it make sense to convert to a S-corporation?
- Considerations – The tax rate differential between C-corporations and pass-through entities warrants a reexamination of entity choice.
- Considerations – For fiscal year corporations, a 2017-2018 blended tax rate will result in a higher tax bracket in 2017-2018 then in future years when the corporation is taxed at 21%. To benefit from the higher tax rate in 2017-2018, fiscal year corporations should take actions to defer income to a future year and accelerate deductions to the 2017-2018 tax year.
- Known as the Qualified Business Income (QBI) Deduction, this new deduction is available for non-corporate taxpayers.
- Generally, the deduction is 20% of qualified business income from a partnership, S-corporation or sole proprietorship.
- Certain limitations apply to service related businesses. There is also a limitation based on W-2 wages and the adjusted basis in acquired qualified property.
- Considerations – The greater the qualified business income, the greater the QBI deduction. Analyze strategies to increase the bottom line – but keep in mind that you must have a business purpose that falls within IRS guidelines.
There is always uncertainty with change, especially when there is limited guidance available. A positive, however, is that tax reform opens new doors regarding business and tax planning that can be valuable if you appropriately prepare. It is important to act now to capture beneficial opportunities and to eliminate any negative “unforeseen” consequences.
Please reach out to Sax’s Construction Practice to help you navigate the complex terrain of tax reform. We can help you evaluate both the short-term and long-term effects that impact future cash flow, analyze your current entity structure and maximize the 20% QBI deduction.
Gina Perrone, CPA, MST is a Senior Tax Manager at Sax LLP and an integral member of Sax’s rapidly growing Construction Practice, specializing in high quality tax services and planning opportunities to meet client’s ultimate goals and objectives. Gina can be reached at [email protected].