After the upheaval of 2020, tax planning for 2021 looks like a daunting challenge. With ongoing political controversy over possible COVID-19 stimulus legislation and continued economic strain, many construction contractors might be questioning whether tax planning is even possible. In this environment of increased uncertainty, tax planning is not only possible, it is a critical step in preparing for 2021.
The past year was particularly difficult for construction companies. Many contractors depleted their backlogs faster than they could replenish them, and increased competition in the bidding process suppressed profit margins. For some contractors, a good tax plan for 2021 could make the difference in getting through these turbulent times.
While new legislation could bring helpful tax provisions for struggling companies, the passage of such legislation is far from certain. With this in mind, contractors should understand several provisions under the current tax law that could help them plan for 2021. These include changes from the Coronavirus Aid, Relief, and Economic Security (CARES) Act as well as older tax provisions that companies often overlook.
Bonus Depreciation The Tax Cuts and Jobs Act (TCJA) increased the bonus deprecation deduction to 100% for certain property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023. More recently, the CARES Act made qualified improvement property (QIP), which is generally interior improvements to nonresidential property, depreciable over 15 years and eligible for 100% bonus depreciation. Construction companies should consider whether they have qualifying property, including QIP, and whether they should use the bonus depreciation this year.
Tax Credits and Deductions A number of tax credits and deductions could help contractors reduce their tax liability. For example, contractors that test new techniques or processes on construction jobs could be eligible for research and development tax credits. They could also be eligible for a deduction of up to $1.80 per square foot for energy-efficient commercial buildings that they build for federal, state or local governments.
Lastly, construction contractors can take advantage of tax credits for certain energy-efficient residential properties. The deduction and credit for energy-efficient buildings expire at the end of 2020, but Congress has extended these provisions several times in the past.
Qualified Business Income Deduction A change from the TCJA that is particularly beneficial to the construction industry is the replacement of the 9% “domestic production activities deduction” under IRC Section 199 with a 20% Qualified Business Income deduction under IRC Section 199A. This change increased the deduction and expanded eligibility to include more businesses. Contractors should start planning how to maximize this deduction and seek guidance from their tax advisor on how to navigate the complex rules and limits around the calculation.
Accounting Method Changes While most large commercial contractors are required to use the percentage of completion (POC) method of tax accounting, smaller firms have additional options. Construction companies with average gross receipts from the three previous years of less than $26 million could be eligible to use cash, accrual, completed contract or “accrual less retainage” accounting methods. These methods often make it easier to control the timing of revenue recognition, allowing companies to accelerate revenue to offset current losses and recognize revenue now in anticipation of higher future tax rates.
In addition to understanding the tax provisions that could help them plan for 2021, contractors should consider several additional steps to help them minimize the risks of ongoing economic and political uncertainty.
Construction contractors should consult with their tax advisors to discuss which tax planning and business decisions will best help them manage through these difficult times.
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