This information is designed to provide general information on the subjects covered; it is not, however, intended to provide specific tax advice. Please consult your tax advisor.
This time of year, construction contractors are often starting to think about getting ready to file their tax returns. The Tax Cuts and Jobs Act passed in December 2017, and put into effect January 2018, is, as MossAdams.com writes, “perhaps the most significant change to the tax law in over three decades.”
The Tax Cuts & Jobs Act introduced some major (and beneficial) changes that positively impact construction contractors.
The first is the lower tax rate. Whether you are a C corporation or a pass-through entity, you will see a decreased rate of 21% (down from 35%) and 37% (down from 39.6%) respectively.
But what else should construction contractors know about the tax reform?
Deduction for pass through income
Another perk for pass-through entities, there is now a new deduction for non-corporate taxpayers. Here are some key takeaways from this change:
- This is for tax years beginning in 2018 and lasting until 2026.
- The deduction limit is 20% of the taxpayer’s qualified business income, which generally equates to the greater of 50% of W-2 wages or 25% of W-2 wages plus 2.5% of qualified property. Qualified business income can include income from construction, architectural, and engineering activities.
- The W-2 wage limitations will not apply if the owner’s taxable income is less than $157,500 (filing single) and $315,000 (married filing jointly).
- If the owner is in the maximum tax bracket of 37% AND isn’t affected by the above W-2 limitation, the highest tax rate will be 29.6%, which is much lower to previous years’ 39.6%.
Repeal of domestic production activities deduction
Previously, construction contractors were able to take up to a 9% deduction for construction activities performed in the United States. However, the Tax Cuts and Jobs Act repeals that deduction starting in 2018.
While it seems like a drawback, it was replaced with the two other changes above – the 21% tax rate for C corporations and 20% tax deduction for pass-through entities – which make a significant difference to the construction industry.
Increased threshold for percentage-of completion/completed contract reporting
If you’re a construction contractor that has made $10 million or less a year, then you may be familiar with the completed contract method of accounting. It essentially means that you have previously been able to postpone taxation on income from long-term contracts that were expected to be completed within two years.
If, however, your business made more than $10M, you’d have used the percentage of completion method and recognized income as the job progressed. So what’s changed?
- The threshold to report using the percentage-of-completion method is now $25 million. This allows more businesses to use the completed contract method of accounting and postpone taxation until after long-term projects are completed.
- This only applies to contracts entered into after December 2017 and the average annual gross receipts is calculated based on prior three tax years.
Section 179 and Bonus Depreciation
MossAdams.com describes bonus depreciation: “Effective for qualified property placed in Service after September 27, 2017, taxpayers can deduct 100% of the cost of qualified business assets as additional first-year depreciation.”
The 100% deduction is effective until December 31, 2022 and will begin to phase out by 20% each year after that until it gets to 20% in 2026.
Section 179, although less of a benefit now with 100% bonus depreciation, is still a great tax deduction for the construction industry. It allows small businesses to deduct new or used (but new to you) equipment purchased and put into use before December 31 of the tax year. The maximum amount that can be expensed has been increased to $1 million, up from $500,000 in years past.
This act has also increased the number of qualified assets that are included in the Section 179 deduction. For construction, they include:
- Heating, air conditioning, and ventilation
- Fire protection and alarm systems
- Security systems installed on nonresidential real property after a building was placed in service
Taxes don’t always have to be daunting, especially when there are changes to the tax laws that positively benefit you and your business. But remember to always check with your tax advisor during this process to find out what tax deductions make the most sense for your construction business!