According to the major news networks' coverage this past year, it would seem that the Tax Cuts and Jobs Act (TCJA) was the worst thing that happened to the American people. Well, that’s not exactly true. Regardless of residency, there are many positives to this tax reform on the federal level, especially for contractors. Following are three positives aspects of the TCJA for construction contractors.

1. Tax Rates

Tax rates are, by far, are the biggest tax benefit for contractors. Starting for tax years beginning after Dec. 31, 2017, C Corporation tax rates are a flat 21%. This changed from the highest rate of 35%. This is favorable for Contractors that are C corps but most contractors are pass-through entities Partnerships, S Corps or Sole Proprietorships.

For pass through entities, the decrease in the individual tax rates is favorable as the highest tax rate dropped from 39.6% to 37%. To make up for the difference in rate changes (14% corporate compared to 2.96% individual), Congress introduced the 199A deduction. The 199A deduction gives a 20% deduction on Qualified Business Income (QBI). An example would be a $200,000 deduction on $1,000,000 of income. There are two limitations that taxpayers should be aware of. The first limitation is the 50% wage limitation. A company’s QBI deduction is limited to 50% of your companies W-2 wages. This limitation does not apply if its income is under $315,000.

Here’s a limitation example:

• company X has income of $2,000,000
• the W-2 wages paid by company X is $600,000
• the QBI would be limited to $300,000 (2,000,000 x 20% is $400,000 and $600,000 x 50% is $300,000)
• if the wages of company X were $800,000 or more, company X would receive the maximum deduction of $400,000

It is particularly important that contractors know the deduction is firm when it comes to W-2 wages. (1099 employees or subs do not qualify as W-2 wages.) Even though these might be grouped as labor on the tax return. This is very significant for general contractors or construction managers that sub out most of their work and/or do not have high W-2 wages. There are additional rules on aggregation of wages between numerous companies and other limits regarding real estate and specified service companies.

2. Depreciation

The second benefit of tax reform for contractors is the change in depreciation rules. Section 179 allows a one year write off of qualified property in the year it was placed in service. The TCJA expanded the amount from $500,000 a year to $1,000,000 a year. The deduction now starts to phase out after $2,500,000 of purchases.

Another change to depreciation rules is the change to bonus depreciation. Prior to the TCJA, bonus depreciation was 50% on new fixed assets. Post TCJA, bonus depreciation changed to 100% on new and/or used equipment no matter the cost of total purchases.

The important difference between 179 and bonus depreciation is that most states only recognize 179 so if the company is using bonus depreciation expect a state addback. Since the federal tax rate is much higher than the state, the company is still receiving a tax benefit.

3. Accounting Method

The third reform change that helps contractors is the change in required method of accounting for long-term contracts, which is a contract that spans two tax years. Prior to TCJA, if a company’s average Annual Gross Receipts (AAGR) were higher than 10,000,000, it was required to report long-term contracts on the percentage of completion method for tax. The 10,000,000 number was given in 1986 and was never adjusted for inflation.

The TCJA changed the average AAGR number to $25,000,000. Now, if the company’s prior three years revenue from its tax returns, including attribution rules, are under $25,000,000, it does not have to report income on POC for tax anymore. It now has the opportunity to create tax deferrals using a cash basis method (not recognized income or expenses till received or paid) or the completed contract method (do not recognize the revenue or cost on job till it’s higher than 95% and can be used for its’s intended purpose). Using either the cash method or completed contract method leaves more cash in the company by deferring income tax payments to a later date.

Here is an example of how these three changes can benefit a contractor:

The contractor: JDC Construction Company 2017 Tax Year

• Taxable income for 2017 is $4 Million after taking 179 depreciation expense of $500,000.
• For information purposes, the company had:
  • AAGR: 18,000,000
  • W-2 Wages: $2,000,000
  • Qualified fixed asset additions purchased and put into service in the 2017 year: $1,000,000
  • Accounts/Retainage Receivable: $2,000,000
  • Accounts Payable/Accrued Expenses: $1,700,000
  • Federal Income Tax after DPAD Deduction: $1,441,440 (4,000,000 x 36.036%)
• In 2018, using the same Information as 2017 (now using cash basis for short-term contracts and new long-term contracts.)
  • Taxable income (using 500,000 of 179 available in 2017): 4,000,000
  • Tax Reform Benefit with additional 179 deduction Increase (decrease): (500,000)
  • Cash basis adjustment-(Tax Reform Benefit):
    • Accounts Receivable adjustment decreases revenue: (2,000,000)
  • Cash Basis Adjustment
    • Accounts Payable / Accrued expenses decreases expenses: 1,700,000
  • 2018 taxable income of $3,200,000 after taking advantage of additional depreciation and accounting method changes. (4,000,000 – 500,000 – 2,000,000 + 1,700,000)
  • 2018 QBI Deduction Tax Reform Benefit
    • (640,000) not limited because of enough wages (3,200,000 x 20%)
• 2018 Taxable Income: 2,560,000
• 2018 Tax: a. $947,000

The total income tax expense decrease after taking advantage of the tax rates and QBI deduction, plus the additional depreciation changes and the account method changes equaled $494,440. It is always recommended that contractors speak with their accounting advisors regarding all the tax savings incentives available to them.