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The first major tax overhaul in decades is now a reality and its provisions will impact the construction industry in positive and negative ways. Construction industry leaders need to work with their tax advisers to fully understand the law, assess their unique situations and make decisions in response that position their businesses for long-term success.

Tax changes and incentives for capital investments present opportunities
The law lowers the corporate tax rate from graduated rates of up to 35 percent to a flat rate of 21 percent. This rate also applies to personal service corporations such as architecture and engineering firms, which previously faced a 35 percent tax rate. Additionally, C corporations will no longer be subject to alternative minimum tax.

Many construction companies are pass-through entities—either S corporations or partnerships/LLCs. These companies will benefit from the new 20 percent deduction for qualified business income. This deduction impacts taxable income rather than adjusted gross income. Calculating the deduction is complicated, but the bottom line is that this provision does provide tax relief for many small businesses, as it lowers the effective top tax rate on business income from 39.6 percent to 29.6 percent.

Further, the law allows companies to expense 100 percent of the cost of new or used qualified property. This bonus depreciation will be phased out between 2023 and 2026. Additionally, Section 179 property can now be expensed up to $1 million. This deduction starts to phase out when capital expenditures exceed $2.5 million. Subject to limitations on certain types of property, contractors should be able to take a 100 percent deduction for capital investments between these two tax incentives, allowing them to immediately write off the costs of equipment and qualified building improvements.

Accounting method changes offer a mixed bag for some contractors
Under the prior tax law, many small contractors used the cash method of accounting when starting their businesses. But once their three-year average gross receipts exceeded $5 million, C corps were forced to use the accrual method. Additionally, all construction companies with three-year average annual gross receipts of $10 million or more were required to use the percentage of completion method for contracts that spanned two or more tax years. This method forces companies to pay taxes on a project before it’s completed.

The new law expands the number of companies eligible to use the cash method. The method now may be used by taxpayers if their average annual gross receipts over the prior three taxable years do not exceed $25 million. This provision particularly benefits C corp construction companies due to the repeal of corporate alternative minimum tax. Further, these small contractors will be exempt from percentage of completion treatment for contracts they expect to complete in two years. Smaller contractors might also want to consider using the completed contract method, which generally provides for the maximum amount of tax deferral.

However, the fact that the law did not eliminate the alternative minimum tax for individuals could pose challenges for some business owners. If a construction company’s income passes through to shareholders or partners, the company’s contracts will still be subject to percentage of completion accounting for alternative minimum tax calculations, potentially resulting in higher taxes for these individuals.

S corp to C corp conversions
Given the changes in the law, construction companies may contemplate revoking an S corp election or converting a partnership to a C corp. While the lower rates and other incentives to elect C corp status are attractive, companies thinking about making this move should consider that C corp shareholders will still be subject to double taxation on dividends and gains on stock sales.

Companies should review the potential short- and long-term impacts, as well as the effect of the 20 percent deduction for pass-through entities, before deciding to change to a C corp. There may also be benefits to setting up multiple companies to take advantage of both the C corp and pass-through entity tax changes under the new law.

Capitalize on tax reform
Provisions throughout the tax law will affect construction companies—from tax rate reductions and increased depreciation deductions to limitations on some deductions and the expansion of several credits. Every company faces distinct challenges, and the law will impact different firms in different ways. As a result, all taxpayers need to work closely with their tax advisers to maximize the business benefits of the new law.


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