Construction Firms: Act Now on Tax Planning

This blog post was previously published on November 7, 2018. It was updated on November 14, 2019.

QBI, R&D and changes to reporting requirements could impact your 2019 tax bill

The ongoing impact of the Tax Cuts and Jobs Act has made year-end tax planning with your advisors more essential than ever. And new accounting method and reporting requirements may mean more even more preparation and planning will be needed for construction companies ahead of tax season.

Maximize deduction for qualified business income (QBI)

Owners of some pass-through entities will continue to receive a 20% deduction on qualified business income, which may reduce their maximum effective tax rate for 2019. Pass-through entities include subchapter S corporations, partnerships and some limited liability companies. There’s another plus for pass-throughs: they keep the deduction on entity-level state and local taxes. 

Also, be aware that filers who claim the QBI deduction must now show how they calculated QBI, by using Form 8995. Each qualified trade or business activity must stand separately and as such, will require its own line on Form 8995.

The QBI deduction limitations and restrictions are set at the owner level. Planning for year-end 2019 should include discussion of salaries, timing and distribution of income in order to maximize the deduction for the tax year.

Consider impact of selling an asset or partnership interest

Section 1061 of the Tax Cuts and Job Acts says that if you sell a capital  asset you’ve held for less than three years, any promote (i.e., carried interest) that you’ve earned on the sale of that asset must be recharacterized from a long-term capital gain to a short-term gain. While long-term capital gains are taxed at 20%, short-term gains are taxed at your ordinary income rate. The IRS has still not issued guidance on which assets are included or excluded in the application of this section.

If you’re selling what may be considered a capital asset that you’ve owned for less than three years, consult with your tax professional.

Don’t overlook R&D tax credit; you may qualify

If your business spends a considerable amount of time and money on innovation, consider claiming the research and development (R&D) tax credit. In addition to allowing companies to write off costs incurred when developing new and improved products, the credit enables companies to offset an income tax liability dollar-for-dollar.

The Tax Cuts and Jobs Act, which went into effect for tax year 2018, also indirectly increased the R&D tax credit’s after-tax benefit when it reduced the corporate tax rate to 21%. Additionally, the tax law’s removal of the corporate alternative minimum tax (AMT) gave more companies the opportunity to take advantage of the R&D tax credit.

The Tax Cuts and Jobs Act also limited the deductibility of net operating losses generated after December 31, 2017. Businesses can only offset up to 80% of their taxable income using net operating losses occurring after 2017. Technology companies expecting substantial revenue growth may consider taking advantage of their R&D tax credit now and apply it against the balance of taxable income that cannot be offset by their net operating losses. 

Startups with less than $5 million in revenue (and no revenue for the period of five years ending with the credit year) can, in the absence of a tax liability, instead apply the R&D tax credit to offset up to $250,000 in payroll taxes each year for up to five years. To do this, you need to keep at least a minimum of documentation of your activities and eligibility. A qualified professional with R&D tax experience can help you assess your eligibility, calculate the amount you could expect from this credit, as well as advise and assist you with proper documentation for claiming the credit.

Finally, keep in mind that, for taxable years beginning after Dec. 31, 2021, taxpayers will be required to capitalize and amortize research or experimental expenditures (which will include all software development costs) over a period of 5 years. Those costs are currently immediately deductible as expenses.

If you’re involved in construction-related activities or processes that you think might be covered, you should consult an R&D tax advisor to learn more about the tax savings opportunities that may be available for your company.

Consider which accounting method is right for your company

Remember that companies with up to $25 million in gross receipts must choose one of three accounting method options.

Cash method: Construction companies with up to $25 million in gross receipts now have the option to choose the cash method of accounting. This creates a simpler process for small businesses from both paperwork and tax perspectives. However, this method may not provide a complete picture of your business profitability – it doesn’t take future revenue or expenses into account. 
Completed-contract method: Contractors with between $10 million and $25 million in annual gross receipts may choose the completed-contract method instead of the percentage-of-completion method. However, there are positives and negatives to discuss with your tax advisor. 
UNICAP exemption: Companies with gross receipts under $25 million are exempt from Uniform Capitalization Rules (UNICAP), which require that some of the costs of construction be capitalized – treated as part of the building produced. Companies under this threshold now have the option to expense these costs during the project. 

If your gross receipts are under $25 million, discuss the pros and cons of these three options with your tax professional. 

Be aware of limitations on business interest deductions

Interest expense deductibility is limited immediately, and it will get worse. For net interest expense that exceeds 30% of adjusted taxable income (ATI), deductibility has been limited. Through 2021, ATI is computed without accounting for depreciation, amortization or depletion, but beginning in 2022 those items are included. This could decrease your ATI, and thus limit your interest expense deductibility further. Tiered structures can further complicate these calculations.

If you’re thinking about taking out a large loan, consult with your tax professional to ascertain whether the interest is deductible.

Reporting requirements continue to grow

Schedule K-1 is one of several forms that will require more information for 2019 tax reporting. This is a good time to touch base with your tax professional to get an idea of new information you may need to prepare. It’s also a good time to check whether you have current, signed, valid W-8s and W-9s from all partners, investors or lenders.

Contact your Kaufman Rossin tax advisor to learn more about these and other tax provisions that could affect you or your business as you plan for the year ahead.