October 30, 2018 —On December 22nd, 2017 the Tax Cuts and Jobs Act was signed into law. The bill makes major changes to the individual, corporate and international tax code which will have a far-reaching impact on construction companies, investors and employees. Below is a discussion of some of the key provisions impacting closely held construction companies and their stakeholders. We strongly recommend meeting with your trusted tax advisor to discuss your specific tax situation and how the new law will affect you. It may make sense to modify existing business entity structures as well as business and reporting practices as a result of the new tax law.
Energy Incentives
The following energy incentives—commonly used by construction, real estate, and engineering companies—are extended through December 31, 2017, under the Bipartisan Budget :
- 179D extended - designers of government-owned or publicly-owned buildings that meet certain energy-efficiency standards can receive allocations of a 179D deduction. Designers can include construction contractors, engineers, and architects.
- 45L Credit - The 45L credit is available for "eligible contractors" (builders or home manufacturers) that construct qualified new energy-efficient homes. The credit is either $1,000 or $2,000 per home or residential unit.
This extender package was passed on February 9, 2018. Taxpayers who did not take the deduction or credit with their original return should amend their 2017 returns to claim the incentives.
Depreciation
- 100% Bonus Depreciation - taxpayers are allowed to expense 100% of the basis of qualified property, such as equipment and heavy trucks, acquired and placed in service after September 27, 2017, and before January 1, 2023. Unlike the previous 50% bonus depreciation provisions, both new and used property qualify.
- Enhanced Section 179 – the section 179 deduction is increased to $1 million. The dollar limit is reduced by the amount by which the cost of section 179 property placed into service by the taxpayer during the year exceeds $2,500,000.
Accounting Methods - Taxpayers with average annual gross receipts of $25 Million or Less
- Inventory - Construction companies may be required to maintain inventories if the fixtures and materials being installed are a material income-producing factor. Prior to 2018, exceptions to the requirement to maintain inventory applied to certain taxpayers with $1 million or less or $10 million or less in average annual gross receipts. Beginning in the tax year 2018, this threshold is increased to exempt taxpayer's with $25 million or less in average annual gross receipts (determined based on the prior 3 tax years) from the requirement to maintain inventory.
- Cash Method of Accounting - Typically C Corporations, partnerships with C Corporation partners, or taxpayers who are required to maintain inventories are required to use the accrual basis method of accounting. Prior to 2018, there was an exception for taxpayers with average annual gross receipts of $5 million or less. Beginning in 2018, this is increased to allow exempt taxpayer's with less than $25 million in average annual gross receipts for the three prior tax years from the requirement to use the accrual method.
- Percentage of Completion Method - In general, construction contracts that begin in one tax year and end in another ("long-term contracts") are required to be accounted for under the percentage of completion method, regardless of the taxpayer's overall accounting method. Prior law provided an exception for certain contracts entered into by taxpayers with $10 million or less in average annual gross receipts. Beginning in 2018, this is expanded to taxpayers with $25 million or less in average annual gross receipts. To qualify, the contract must be entered into by a taxpayer who estimates (at the time the contract is entered into) that the contract will be completed within two years of commencement.
30% Limitation for Business Interest Deduction and Electing Real Property Trades or Businesses
For any business that has over $25 million in average annual gross receipts, there is a limitation on the amount allowed as a deduction for business interest in any year. Any interest that isn't allowed is carried forward to the following tax year until it is used.
The deduction for interest can't exceed the sum of (a) the taxpayer's business interest income, plus (b) 30% of the taxpayer's adjusted taxable income, plus (c) the taxpayer's floor plan financing interest for the tax year.
A trade or business that is a real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business can make an election to be an "electing real property trade or business". An electing real property trade or business is not subject to the limitations on interest expense deduction. However, they must use a slower depreciation method called ADS to depreciate any of their non-residential real property, residential rental property, and qualified improvement property.
Other Changes that Matter
Here are more general changes brought about by tax reform. This is not an all-inclusive list of the many changes from tax reform but highlights the major changes that impact construction companies and its stakeholders.
Corporations
The following permanent changes apply beginning January 1, 2018:
- Corporate Tax Rate - Pre 2018 law taxed C Corporations at a graduated rate with a top rate of 35%. C Corporations are now taxed at a flat 21%.
- Net Operating Losses - Utilization of net operating losses generated in tax years beginning after December 31, 2017, is limited to 80% of taxable income. Loss carrybacks are now generally disallowed for tax years ending after December 31, 2017, with an unlimited carryforward period.
- Corporate alternative minimum tax "AMT" - repealed.
Individuals
The following changes to individual taxation are effective for taxable years beginning after December 31, 2017, and before January 1, 2026, unless otherwise stated.
- Individual tax rates cut - The bill cut individual tax rates and modified the current income tax brackets for ordinary income. Currently those rates are 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The revised rates are 10%, 12%, 22%, 24%, 32%, 35% and 37%.
- Exemption Phase-outs - The income thresholds at which the alternative minimum tax exemptions of $70,300(S)/$109,400 (married filing jointly, or MFJ) begin to phase out have increased to $500,000/$1,000,000 (MFJ).
- Standard Deduction - increased to $24,000 for married filing joint taxpayers, $18,000 for head-of-household taxpayers, and $12,000 for all other taxpayers.
- Personal exemptions are suspended for tax years 2018 through 2025 (previously $4,050 per dependent/taxpayer - subject to phase out).
- Enhanced Child Tax Credit - increased from $1,000 to $2,000, with a higher phase out ($200,000 or $400,000 MFJ). In addition, a partial credit of $500 is allowed for dependents that aren't qualifying children such as full-time college students under 24.
- State and Local Income and Property Tax Deduction Limited to $10,000 - the combined deduction for state and local income and property tax is capped at $10,000. Property taxes on rental activities and sole proprietorships are not limited.
- Home equity interest - the deduction for home equity interest is suspended.
- Miscellaneous itemized deductions temporarily repealed. To ensure deductibility, C and S Corporation owner/employees should ensure the business reimburses the owner for all business-related expenses paid personally.
- New Limitations on "Excess Business Loss" - For tax years beginning after December 31, 2017, and before January 1, 2026, non-corporate taxpayers are disallowed any "excess business losses", the amount by which the taxpayers net business losses exceed $500,000 MFJ or $250,000 all other taxpayers. These excess business losses are treated as an NOL carryforward to subsequent tax years.
Qualified Business Income Deduction
For the approximately 95% of businesses not currently set to reap the benefit of the corporate tax rate reduction, such as entities structured as partnerships, S Corporations, and sole proprietorships, the tax bill allows an up to 20% deduction for "qualified business income".
Qualified business income is income effectively connected with a US trade or business. W-2 wages and guaranteed payments do not count in determining qualified business income.
The qualified business income deduction is limited to the greater of two thresholds for taxpayers whose taxable income exceeds the threshold amount of $157,500 ($315,000 in the case of a joint ):
- 50% of the W-2 wages paid by the business; or
- 25% of the W-2 wages paid by the business plus 2.5% of the unadjusted basis of the businesses qualified tangible property.
Taxpayers in certain specified service industries such as lawyers, accountants, and consultants are generally precluded from taking the deduction unless they are below the taxable income threshold amount above. However, engineers and architects are specifically excluded from the definition of "specified service" industries.
If a taxpayer has net losses from qualified business activities, those losses are carried forward and offset future year's qualified business income.
The qualified business income deduction and the individual rate reductions are currently set to only apply to tax years beginning after December 31, 2017, and before January 1, 2026.
Business Deductions and Credits
- Domestic Production Activities Deduction Repealed - The domestic production activities deduction previously allowed many construction, architectural, and engineering companies to deduct up to 9% of their qualified domestic production activities income. The deduction is repealed for tax years beginning after December 31, 2017.
- Modification to Meals & Entertainment Deductibility -
- Entertainment-related expenses are now generally 100% nondeductible.
- The 50% deductibility limitation on meals is expanded and includes meals provided on site for the convenience of the employer.
- In a cost-plus arrangement, reimbursed meals can be subject to the limitation at either the contractor or subcontractor level, depending on how the contract and invoices are structured.
- Please visit https://redpathcpas.com/tag/meals-and-entertainment/ for further details. Companies may need to modify their accounting practices to ensure expenses are being properly classified under the new rules.
- Qualified transportation fringe benefits - Employers can no longer deduct qualified transportation fringe benefits incurred after 12/31/2017, such as parking fees, transit passes, or commuter transportation in a commuter highway vehicle. This only applies to the extent fringe benefits are not included in the employee's taxable wages.
- Family Medical Leave Act Credit - For tax years 2018 through 2019, an income tax credit is allowed for employers who provide paid family and medical leave to qualified employees equal to at least 50% of the employee’s normal wages. The credit ranges from 12.5% up to 25% of the wages paid while the employee is on leave. The percentage increases for the percentage points by which the rate of payment exceeds 50% of the employee's normal wages.
- Research and Development Expenses - For construction companies claiming the research and development credit, R&D expenditures will be required to be capitalized and amortized ratably over 5 years in tax years beginning after December 31, 2021.