Though the outlook for construction is strong right now, with several states putting considerable amounts of money into infrastructure projects that will keep the industry busy and growing for quite some time, the signs of a potential downturn may be on the horizon.
Historically, the construction industry has followed the growth and recession trends of the real estate industry. Currently, residential real estate appears to be softening. Margins are being squeezed and labor and material costs are increasing, but there’s still work available.
Here are some strategies construction executives can use to plan ahead.
Assess the Company’s Infrastructure and Technology
Consider the way the business is capitalized, including the debt-to-equity ratio. Now is the time to pay off debt, including deferred tax liabilities. A common tax strategy is to defer revenue to a later date, but lower rates are in place right now, so it could be a good time to begin paying off tax liabilities. The more cash and less debt the company has, the more it will be able to sustain business through a difficult economy.
Consider balancing spending with paying off debts and building a strong cash reserve. This includes carefully analyzing whether to buy out other companies and managing cash flow when taking on huge jobs that require lots of cash up front.
Assess the company’s communication capabilities and consider making any necessary upgrades so the technology is in place long before a downturn should occur. The ability to communicate in real time and instantly make changes to work orders and jobs online instead of having to submit paperwork are proven to have significant benefits to a business. Be aware of what competitors are doing in this area because technology will be a differentiator sooner than later.
Consider Various Tax Strategies
Tax reform fundamentally changed the tax landscape, creating new strategies and opportunities. Contractors should plan for a few things in the context of a potential economic downturn.
For example, the ability of pass-through entities to use business losses to offset other income has been limited to $250,000 for single filers and $500,000 for married couples filing jointly.
Additionally, for contractors that are involved with real estate, mortgage interest can be business interest, so the Section 163(j) limitations could have a significant impact. These new rules limit the amount of deductible interest expenses to 30% of what is essentially Earnings Before Interest, Depreciation and Amortization (EBIDA).
In the event of a downturn, contractors are generally more leveraged and have more interest. Previously, one of the most common tax strategies was to carryback these losses, but the new rules remove this option and instead create a net operating loss carryforward.
Another reason to consider deferring less revenue is the qualified business income deduction. The general concept here is to grant non-C corporation taxpayers a deduction equal to 20% of their QBI (business income) from a qualified trade or business. While bonus depreciation rules allow contractors to expense new or used equipment until Dec. 31, 2022, which in turn reduces their tax liability, in the event of a downturn, they won’t have this deduction in later years and could end up with higher taxes when they don’t have the work or the cash to pay them.
Companies may want to consider utilizing more of the QBI deduction and saving depreciation for later. This deduction isn’t a deferral and could help with cash flow.
The IRS seems to be watching for certain things to be included in tax returns, including often overlooked changes related to non-deductible fringe benefits and parking arrangements. These limitations and rules could impact a company if not properly accounted for.
