Tax experts urge contractors to tend to unused credits, accounting practices
Buoyed by a continuing strong economy and spared from major changes to the tax code, most construction companies are heading into a relatively routine tax season. But finance professionals stress there are tax opportunities, potential pitfalls and financial management issues that you should devote attention to.
Although Congress passed changes to the federal tax code two years ago, some contractors aren’t taking full advantage of credits included in the new law, said Michael Gentry, a Director and Co-Chair of the Construction Services Group at KatzAbosch.
For example, more S corporations could claim the 20 percent tax break on pass-through income. Contractors can also claim enhanced tax credits on equipment purchases
until the end of 2022. The revised tax code doubles deductible equipment and software purchases to $1 million a year, expands qualifying deductions to include such items as new roofs or HVAC upgrades, and allows contractors to claim 100 percent depreciation in the first year.
In addition, “Maryland has a lot of tax credits for businesses. It’s worth it for contractors to go through them to see which credits might apply to them,” Gentry said. The state, for example, offers credits for tractors that pull trailers and research and development tax credits that can apply to some work by specialty subcontractors and engineering firms.
CHANGES AND CHALLENGES
The 2018 federal tax law presented contractors with opportunities — and possible complications — related to accounting methods. The new law raised the ceiling for companies which can practice cash accounting, from $10 million to $25 million in annual gross receipts. For some companies, that change presented an opportunity to simplify their accounting … until they tried it.
“If you are using accrual or completed project or percentage completion accounting, it’s very easy to do tax planning because you can project what your profits are going to be,” said Don Hoffman, Managing Partner of The Hoffman Group.
With cash accounting, that predictability and financial control can be undermined by large payments or expenses at the end of the fiscal year. It also requires contractors’ accounting staff to complete “significant additional effort, typically between Christmas and New Year’s,” Hoffman
said. Those circumstances have prompted some contractors who switched to cash accounting, to ask if they could switch back.
Regardless of their accounting method, contractors need to calculate their alternative minimum tax, Gentry said. “We see a lot of contractors who are on the cash method or completed contract method, ignore that rule. ”That omission can lead to unpleasant surprises when companies file their tax returns.
Contractors also need to become informed about new regulations from the Financial Accounting Standards Board, which went into effect in December 2019, Hoffman said. The ASC 606 New Guidance aims to create a common framework for recognizing contract revenue and is expected to have a notable impact on the construction industry. The framework changes the way contractors recognize revenue from rework, warranty work, tasks outside project scope, and other items. For example, materials acquired for a project but not yet installed get classified as contractor inventory, not contract revenue.
The new regulations “take much of the flexibility out of what accountants do in reporting income…because in some cases in the past, income recognition has been overstated,” Hoffman said. “These new standards are a very, very, very big deal… If accountants are doing their job, they will have more conversations with contractors about what is really happening with each contract.”
In the midst of this strong economy, finance professionals insist that now is the time for contractors to exercise prudent financial management.
“There is a really horrible disease out there called tunnel vision,” Hoffman said. “People do things without thinking through how it could impact them.”
Contractors, Gentry said, should bank enough money to cover any potential tax obligation before buying new equipment. Companies and individuals should work now, while interest rates are low and work backlogs are large, to eliminate their debt, Hoffman said.
Finally, contractors need to closely track their expenses, adjust their prices and resist the urge to grow quickly, Hoffman said. “There have been bankruptcies of big construction companies in the past two years. All of those companies grew too quickly because the economy was so good.”