With so many uncertainties in the world today – a seemingly endless pandemic, an unpredictable economy, and potential tax law changes to name a few – construction companies need to look closely for every tax savings opportunity available to them now. Here are several often-overlooked tax strategies that can offer substantial benefits for those in the construction industry:
Employee Retention Credit
Companies that held on to their employees despite lower revenues in 2020 and 2021 could be eligible for thousands of dollars in tax credits per employee. The credit is available up to $5,000 per employee for 2020 and up to $7,000 per employee per quarter for the first three quarters of 2021. This credit can add up quickly and provide much-needed cash to fund continued operations.
To qualify, eligible employers must either have business operations fully or partially suspended by government order due to COVID-19 or have quarterly gross receipts that are much lower than the corresponding quarter in 2019. For 2020, receipts in a qualifying quarter must be less than 50% of gross receipts for the corresponding quarter in 2019; for 2021, receipts must be less than 80% of gross receipts for the corresponding quarter in 2019, measured as reported on the entity’s federal income tax returns.
Unlike Paycheck Protection Program (PPP) Loan Forgiveness, these credits result in a disallowance of the wage deduction for the amount of the credit in the fiscal year in which the applicable quarter ends.
Construction-specific Income Deferrals
The Internal Revenue Code (IRC) contains several pro-construction provisions that allow a company to defer taxable income to later years, which is usually preferred in an environment of stable tax rates. Here are the most widely applicable:
- Gross profit on contracts < 10% complete
Large contractors using the percentage-of-completion (POC) method to recognize revenue can defer the gross profit on contracts that are less than 10% complete.
- Gross profit on multi-family contracts – 30% deferral
Large contractors using the POC method and who work on multi-family contracts (defined as a contract to build a residential building with more than 4 dwelling units) can defer 30% of the gross profit they recognize on those contracts.
- Gross profit on home contracts – 100% deferral
Large contractors using the POC method who work on small-scale residential contracts (4 units or fewer per contract) can defer 100% of the gross profit recognized on the contract until the year completed.
- Cash basis and completed contract method for small contractors
Small contractors (generally, those with average annual gross receipts for the three prior years of $26 million or less) can choose to use the cash basis for tax purposes, which ensures that tax is assessed only after the taxpayer has received the cash that generated the tax liability. Also available to small contractors is the completed contract method, which allows them to include in taxable income only the gross profits on contracts that they completed during the year. However, there are alternative minimum tax considerations that go along with using this method, so it’s important to discuss with your tax adviser ahead of time.
Many contractors are owned and operated by a small group of stakeholders, many of whom are family. In such situations, an unexpected illness or death can leave a void within a company from which it is difficult to recover and can even signal the beginning of the end for an unsuspecting company.
Devising and executing a plan to install the next generation of owners and leaders is vital. Whether it’s a planned purchase of stock, gifting, the formation of a new company that will eventually absorb the old one, or installing a new management team, various strategies exist to ensure that the company continues to deliver the services its customers expect for generations to come. A successful succession strategy may take years to execute, making advanced planning crucial.
With possible changes to the estate tax regime looming on the horizon, now is the time to put in place a succession plan that ensures a smooth and equitable transition to the next generation.
A successful exit strategy outside of family is also very important. These strategies can take the form of stock sales within and outside of the management team, formation of a new company, ESOP or several other organizational structures. As noted above, advance planning is critical. Successful strategies typically require between five and ten years to fully implement.
R&D Tax Credits
If your company provides design services, uses new or alternative materials or construction methods, you may be able to claim a tax credit for research and development (R&D) costs. It’s important to note that claiming an R&D tax credit without the proper support to back up the credit amount can be risky, so be sure to have a proper R&D study performed before taking advantage of this credit.
Sec 179D Deduction – Energy Efficient Commercial Building Property
Certain improvements made to a commercial building that increase its energy efficiency may result in a deduction based on the square footage of the entire building. Interior lighting, HVAC and hot water systems, or building envelope systems that reduce energy consumption by 50% or more compared to a theoretical baseline model building are needed to qualify.
State and Local Tax Considerations
Although federal tax considerations are important and impactful, state and local tax issues merit the same care and consideration as you examine opportunities for tax planning. While each state should be approached individually, here are some trending issues at the state and local level:
- Election to be taxed at the entity level for pass-through entities
In response to the $10,000 federal cap on deducting state and local taxes as an itemized deduction, many states are allowing pass-through entities to elect to have their income taxed at the entity level. By paying tax at the entity level, business owners receive a deduction for the full amount of tax instead of the tax being subject to limitation. States have different requirements for electing this entity-level tax treatment, making it important to be well-informed of the requirements in the jurisdictions in which the company operates.
- Job credits at the state and local level
Several states offer tax credits to employers who increase the size of their workforce or who employ apprentices. Ask your tax adviser about opportunities in the states in which you operate.
We Can Help
If you would like help in understanding how these tax strategies may affect your business, please contact us.
The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.