By Justin Gipp and Jason Dudas, CPA
In December 2017, Congress signed the Tax Cuts and Jobs Act. There are many changes in the new tax bill that will cause varying effects on businesses and individuals. As the dust starts to settle on the new tax bill, most businesses expect their income tax expense to decrease. However, a general understanding of the new tax law is necessary to effectively make tax planning decisions for your business. Business owners can start strategizing their plan by reviewing the five most significant changes that are expected to affect construction contractors.
1. Reduced Individual and Corporate Tax Rates
The first major change from the recent tax bill is the reduction in individual and corporate income tax rates for tax years beginning after December 31, 2017. The new individual tax brackets have been reduced to 10, 12, 22, 24, 32, 35, and 37 percent and are applicable to tax years 2018 through 2025. All tax rates for years following 2025 may be subject to subsequent legislation.
|2018- 2025 Income Tax Brackets|
|Rate||Individuals||Married Filing Jointly|
|10%||Up to $9,525||Up to $19,050|
|12%||$9,526 to $38,700||$19,051 to $77,400|
|22%||38,701 to $82,500||$77,401 to $165,000|
|24%||$82,501 to $157,500||$165,001 to $315,000|
|32%||$157,501 to $200,000||$315,001 to $400,000|
|35%||$200,001 to $500,000||$400,001 to $600,000|
|37%||over $500,000||over $600,000|
The corporate tax rate has been reduced to a flat 21% rate for tax years beginning after December 31, 2017. Businesses should be evaluating their current tax structure in response to the reduced corporate tax rates.
It is imperative that businesses conduct a complete analysis of the tax law to determine if a change in entity type is beneficial. Making the change from a pass-through entity (S-Corporation, Partnership or Sole Proprietors) to a C-Corporation is an alternative to consider. Typically, C-Corporations are being taxed at a lower rate than pass-through entities. Keep in mind that C-Corporations are still subject to potential double taxation of dividends paid to shareholders. A cost-benefit analysis should be completed before deciding to make the switch.
2. Pass-Through Entity Income Deduction
A lot of business owners may have a knee-jerk reaction to the reduced corporate tax rate and decide to convert their business to a C-Corporation. However, not all hope is lost for pass-through entities. A second key change in the tax bill is the new Section 199A pass-through entity deduction. For tax years starting after December 31, 2017, a 20% deduction will be allowed for taxpayers who have qualified business income from an S-Corporation, Partnership or Sole Proprietor, subject to limitations.
The 20% pass-through deduction is limited to the lesser of 20% of their pass-through business income or the greater of the following two options – Option A is 50% of his/her share of W-2 Wages paid with respect to qualified business income and Option B is the sum of 25% of his/her share of W-2 Wages plus 2.5% of the unadjusted basis of qualified property. The wages or wages plus capital limitation do not apply to taxpayers with taxable incomes below $315,000 (joint filers) or $157,500 (other filers). Taxpayers eligible to claim the full 20% deduction on qualified business income will incur a maximum effective tax rate of 29.6% on qualified business income.
3. Small Contractor Exemption
Another currently active change is an increase in the exempt amount for small contractors. Previously, companies with gross receipts under $10 million were exempt from using the percentage of completion method for recognizing taxable income on long-term construction contracts. Starting 2018, this exemption amount has been increased to $25 million. Also note that long-term construction contracts that started prior to December 31st, 2017 and all commercial contracts regardless of start date are required to apply the percentage of completion method for alternative minimum tax purposes. Although the alternative minimum tax was repealed for C-Corporations, it was not repealed for pass-through entities that flowed down to the individual levels.
4. Accelerated Depreciation Changes
The new tax bill also includes changes to bonus depreciation and Section 179 expensing. Taxpayers are now allowed 100% bonus depreciation on qualifying business assets placed in service after September 27, 2017 through December 31, 2022. Previously, this rule was limited to bonus depreciations of 50%. With 100% bonus depreciation in affect for assets after September 27, 2017 and Section 179 expense being limited to $510,000 for the 2017 tax year, it may be most advantageous to Section 179 expense fixed assets. Under this circumstance, assets purchased after September 27, 2017 can be bonus depreciated 100% to maximize depreciation expenses for the year. Nevertheless, it is recommended that business owners perform a full review of their assets and discuss with their trusted advisor before taking advantage of Section 179 expensing or bonus depreciation.
Following tax year 2022, 100% bonus depreciation will be phased down and will decrease to the following:
- 80% in 2023
- 60% in 2024
- 40% in 2025
- 20% in 2026
Additionally, starting 2018 the new tax bill increases Section 179 expensing limit to $1,000,000 with the phase out limitation starting when total asset purchases exceed $2,500,000. Also note that the new tax bill now limits like-kind exchanges of real property that is not primarily held for sale. This may have an impact on contractors that typically exchanged equipment or trucks in prior years.
5. Net Operating Losses
One change in the new tax bill that could have an adverse effect on construction contractors is the treatment of net operating losses. Prior to the new tax bill, taxpayers were allowed to carryback net operating losses for two years and carryforward losses for twenty years. The new tax bill now disallows the carryback of net operating losses. It however allows for indefinite carryforward of those net operating losses. Effectively managing cash flow is very important in the construction industry. The inability to carryback current year losses against prior year taxable income could prove costly to cash management.
These are just a few of the many changes in the tax bill that will have an effect on construction contractors. It is time for contractors to assess the effects and strategize how to incorporate a new tax plan for their businesses. The tax and construction team at Ryan & Wetmore, P.C. is well-versed in the new law and happy to assist with any tax planning needs.
Peter Ryan, CPA, MBA (firstname.lastname@example.org) and Jason Dudas, CPA (email@example.com) both specialize in the construction industry. For questions regarding the Tax Cuts and Jobs Act please contact Peter and Jason directly.
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