As we approach the end of 2017, it’s once again time to explore strategies for reducing your construction company’s tax bill.
Because every business is different, it’s important to work directly with your CPA to determine the right moves for you. Nonetheless, here are some key areas to explore when looking for savings.
Deferrals and accelerations
If you expect your tax rate to be the same or lower in 2018, you’ll likely benefit by deferring income to next year and accelerating deductions into this year. There are several ways to do so, including:
- Delaying billings or prepaying expenses (for cash-basis companies),
- Postponing the performance of services until after year end or deferring taxes on qualifying advance payments (for accrual-basis companies),
- Making contributions to qualified retirement plans, and
- Deferring payment of year-end bonuses to nonowner employees. (Accrual-basis companies can deduct bonuses on their 2017 returns provided they pay them by March 15, 2018.)
On the other hand, if you expect to be in a higher tax bracket next year, you may be better off shifting some income to this year by accelerating income or deferring deductions. Keep in mind that tax reform may affect your tax rate or other tax attributes this year or next, so be sure to monitor congressional developments in the coming months. (See “How will tax reform impact year-end planning?”)
The 10% solution
If your construction company uses the percentage-of-completion method to account for long-term contracts, consider electing the “10% method” on your 2017 return (if you haven’t already done so on a previous return).
This method allows you to defer recognition of gross profits on jobs that are less-than-10% complete as of the last day of the tax year. Be aware that, once you make the election, you’re required to defer profits on all eligible jobs, this year and in future years, unless you apply to the IRS for a change in accounting method.
A good strategy for generating deductions in 2017 may be to take advantage of depreciation-related tax breaks. It’s a particularly opportune time to acquire assets that qualify for “bonus depreciation.” Currently, this tax break allows you to deduct 50% of the cost of certain depreciable assets, on top of regular depreciation deductions. This percentage is scheduled to drop to 40% in 2018 and to 30% in 2019, after which the deduction faces elimination.
Bonus depreciation is available for new assets that fall into one of four categories:
- Tangible depreciable property with a recovery period of 20 years or less,
- Water utility property,
- Computer software, or
- “Qualified improvement property.”
Qualified improvement property includes any improvement to the interior of a nonresidential building that’s placed in service after the building was first placed in service (other than elevators, escalators or internal structural framework).
Another option is Section 179 expensing, which allows you to deduct 100% of the cost of qualified depreciable assets, such as equipment and vehicles. One advantage it has over bonus depreciation is that Sec. 179 expensing is available for both new and used assets. On the other hand, there’s a cap on expensing ($510,000 in 2017) and the deduction is phased out once a company’s total purchases exceed a certain threshold ($2.03 million in 2017).
Tax credits are always a worthy area of exploration. There are a couple of noteworthy ones to look into.
First, consider the research credit (sometimes called the R&D credit). It isn’t limited to pharmaceutical, biotech, software and manufacturing companies. If you commit resources to developing new construction techniques, improving business processes or other innovations, you may be eligible for the credit — which can reach as high as 6.5% of qualified research expenditures.
Second, don’t overlook the domestic production activities deduction. It allows you to deduct up to 9% of your income from “qualified production activities,” including many activities related to constructing or substantially renovating real property located in the United States.
The big tax picture
These are just a few of many year-end strategies to consider. Again, work with your CPA to develop a comprehensive strategy based on your construction company’s overall situation. In addition to year-end moves, discuss longer-term strategies that may improve your tax picture. These include re-evaluating your entity choice and changing your accounting method.
How will tax reform impact year-end planning?
As you review your year-end tax planning options, be sure to consider the potential impact of tax reform. As of this writing, both the White House and members of Congress have proposed reducing corporate and individual tax rates and revising a variety of deductions, credits, exemptions and other tax benefits.
If it appears that your tax rate will drop in 2018, for example, the benefits of deferring income and accelerating deductions will be even greater. On the other hand, if you believe your effective tax rate will go up next year, it may make sense to shift some income into 2017.
But don’t assume that lower tax rates automatically translate into lower taxes. Some proposals would reduce the number of individual income tax brackets from seven to three, while reducing the top rate from 39.6% to 33%. As a result, many taxpayers would enjoy lower tax rates, but some would experience an increase. For example, taxpayers currently near the top of the 28% bracket would find themselves in the 33% bracket under the proposed tax table, an increase of 5%.