Construction companies that expect to have substantial federal taxable income in 2015 can still take steps to soften the blow. However, many tax breaks hinge on expired tax provisions that Congress might restore before it adjourns for the holidays. This article highlights some last-minute tax-saving strategies to consider before December 31.
Deduct rather than depreciate
Many construction companies rely heavily on equipment, property and other fixed assets. Some of their biggest expenses are depreciation, supplies, and repairs and maintenance. The sooner they can deduct these costs, the lower their current year’s taxes will be.
- Deduct costs under the repair regs. In general, the Internal Revenue Service’s (IRS’s) final regulations for tangible property costs (commonly known as the “repair regs”) require most tangible property costs to be capitalized and depreciated over several years — rather than deducted in the current year. However, the repair regs include provisions that may warrant consideration of additional qualifying purchases or improvements before year end to lower taxable income.For example, companies can elect to immediately deduct certain items costing up to $500 that would have otherwise been capitalized. A $5,000 threshold applies to companies with applicable financial statements for the year — generally, those with audited financial statements. Other financial statements besides those that are audited may be considered “applicable financial statements” in certain situations. Companies wishing to take advantage of this favorable guidance must have formal capitalization procedures in place and must be consistently applying the proposed treatment on their books and records as of the beginning of the year.A safe-harbor rule also allows businesses to deduct routine maintenance costs. In addition, taxpayers with average annual gross receipts of $10 million or less for the three preceding tax years can deduct improvements to an eligible building property (unadjusted basis of $1,000,000 or less) if the total amount paid during the year for repairs, maintenance, improvements and similar items doesn’t exceed the lesser of $10,000 or 2% of the building’s basis before depreciation.Incidental materials and supplies costs can be deducted in the year they are paid or incurred. These costs include expenditures of $200 or less for noninventory items, as well as costs of noninventory items with useful economic lives of 12 months or less regardless of the size of the expenditure.
- Make the most of Section 179 limits. For tax years beginning in 2010 through 2014, taxpayers could immediately deduct up to $500,000 for purchases of qualifying new or used assets under Sec. 179 for Federal income tax purposes (state rules vary). Included in this limit were new and used equipment, office furniture, some vehicles, computer equipment and purchased software. First year bonus depreciation was also allowed up to 50% of the depreciable basis of qualifying new equipment and purchased software.There’s no word yet whether Congress will restore the 50% first-year bonus depreciation Federal allowance for 2015. As of this writing, the maximum Sec. 179 deduction for tax years beginning in 2015 is only $25,000. Construction contractors should take advantage of this allowance, but it is possible that Congress could restore a higher Sec. 179 allowance and/or the bonus depreciation before year end. If that happens, be prepared to act fast to lower your taxable income for 2015. Remember that assets must be placed in service by no later than the end of your company’s tax year to qualify for the Sec. 179 deduction.
Pay attention to the extenders
A long list of other federal income tax credits and incentives for businesses expired at the end of 2014. In the meantime, create wish lists of fixed asset purchases, improvements and other expenditures to take advantage of last-minute tax breaks that may be available for 2015.
Examine your long-term contract accounting methods
If contracts span a year end, these contracts are considered to be long-term. A method of accounting for these contracts must be elected. Taxpayers with average annual gross receipts of $10 million or less for the three preceding tax years have much flexibility in what method is chosen. Taxpayers over that revenue level generally are required to use the percentage of completion method. However, profit on residential contracts (i.e. apartments and dormitories) or home contracts (i.e. small multi-family or single family homes) may be partially or completely deferred until completion of those contracts in certain circumstances.
In situations where taxpayers are nearing average annual gross receipts of $10 million (using their tax method of accounting) for the three years that will end in 2015, a mandatory long-term contract accounting method change may be coming. Careful analysis so as to not overstate revenues should be performed, as crossing this threshold could lead to an accounting method change entering 2016 that provides less deferral opportunity.
Analyze contracts closing in 2015
If a contractor accounts for its long-term contracts under the “completed contract” method, determine if contracts where a loss is expected can be “closed” by the end of the year in order to recognize this loss for tax purposes. The IRS considers a contract to be completed for tax purposes when 95% of the total costs have been incurred and the constructed property is being used by the customer for its intended purpose.
Analyze your percentage of completion on contracts in progress
Contractors utilizing the percentage of completion method should closely evaluate estimated gross profits at completion on contracts in progress so as to not overstate taxable income on these contracts.
Defer profit on contracts in beginning phases
When a contractor accounts for its long-term contracts under the percentage of completion method, gross profit on contracts that are less than 10% complete on a cost-to-cost basis as of the taxpayer’s year end can be deferred to the subsequent year.
Pay bonuses to your stockholders in 2015
In order to be deducted in 2015, bonuses to some stockholders must be paid by December 31, 2015, depending on your type of entity and ownership percentage.
Understanding the unique needs of contractors, Elliott Davis Decosimo professionals can help you plan for your tax responsibilities. For guidance on your specific situation, check with your Elliott Davis Decosimo tax advisor or contact Jim Hazel at firstname.lastname@example.org or Travis Bogan at email@example.com if you have questions.