5 Noteworthy Tax Reform Impacts on Construction Companies
The Tax Cuts and Jobs Act effectively changed and rebuilt the U.S. tax code as we knew it. Now that the dust has settled, it's time to take a deeper look at the impacts felt by the construction industry in 2018 and beyond.
When signed into law on Dec. 27, 2017, the Tax Cuts and Jobs Act (TCJA) effectively changed and rebuilt the tax code as we knew it. Now that the dust has settled, it’s time to dig into what it means for the construction industry. Many of its impacts are positive; some are negative. All, however, are important to consider as you plan for the remainder of 2018 and beyond.
First, the good news:
Accounting for Long-Term Contracts
In the past, taxable income was generally computed using the percentage-of-completion (POC) method of accounting, unless the small contractor exemption applied. Thanks to the TCJA, the small contractor exemption has increased from $10 million to $25 million. This threshold is important because it stipulates which contactors are permitted to use the cash basis (or other exempt method) versus the POC method of accounting. The TCJA requires only contractors with average gross receipts of more than $25 million to use the POC method.
Whereas the POC method recognizes income when earned and expenses when incurred, the cash method is much more straightforward: revenue is recognized when it’s received. In other words, you pay tax on only what’s in your checkbook. In many cases, this will mean contractors and construction-related businesses will pay less federal income tax from Jan. 1, 2018, to when the TCJA expires in 2026.
It’s important to note that this strictly affects your taxable income—not your generally accepted accounting principles (GAAP) statements. Banks and bonding companies may still require you to report income using GAAP financials (with a disclosure on accrued benefits and negatives for taxes, of course).
Qualified Business Income (QBI) Deduction
If you own a pass-through entity, such as a partnership, S corporation, or sole proprietorship, you are now allowed a 20 percent deduction of qualified business income (QBI), subject to certain limits, on your individual tax return. So, if you made $1 million in net income, you could potentially take a $200,000 tax deduction on your individual tax return, lowering your taxable income to $800,000. This, of course, is a significant tax reform benefit.
Flat 21 percent tax rate for C corporations
Pass-through entities aren’t the only beneficiaries of the TCJA. Contractors doing business as a C corporation now have a flat 21 percent tax rate for taxable years beginning after Jan. 1, 2018. Previously, these entities were subject to tax rates of up to 35 percent.
100 percent expensing for fixed assets
The TCJA also makes it more advantageous to invest in new and used equipment. As of September 27, 2017, the 50 percent bonus depreciation is increased to 100 percent for both new and used property. Now when you buy an asset, such as a large piece of heavy equipment, you can deduct the full amount in the first year. It’s important to note, however, that nearly half of the states, including Minnesota, haven’t conformed to the 100 percent write-off. This 100 percent bonus depreciation is available though 2022 and slowly phases out through 2026.
The not-so-great news:
Elimination of popular deductions and limited ability to carry back certain losses
Unfortunately, the TCJA does include a few changes that aren’t so beneficial for contractors. The domestic production activities deduction (DPAD) was repealed for tax years beginning after Dec. 31, 2017. Previously, 50 percent entertainment expenses were deductible, but the TCJA has eliminated this deduction. What’s more, net operating losses can no longer be carried back two years; however, they can be carried forward indefinitely. Beginning in the 2018 tax year, uses of these losses are now limited to 80 percent of your taxable income. Business losses for non-corporate taxpayers are now capped at $250,000 (single) and $500,000 (married filing jointly) per year.
Make the most of the Tax Cut and Jobs Act for your construction company
The TCJA has brought about sweeping changes; these are just a few of the impacts that will be felt by the construction industry. Making time for tax planning sooner rather than later can help you adjust your business as needed. If you have questions about tax reform impacts on your construction company, please contact me.