by Conor Flanagan
Now that 2015 has come to an end, contractors would do well to keep a few tips in mind as they prepare their end-of-year tax figures.
Tax Tip No. 1: Understand your income tax reporting method. A contractor is required, under Internal Revenue Code (IRC) Section 460(b), to use the percentage of completion method for the tax reporting of long-term construction contracts. However, this section only refers to specific long-term contracts rather than the contractor as a whole.
This is an important distinction, as the ability to account for individual contracts differently opens up the options for contractors. So even though the taxpayer is required to report long-term contracts under this method, the contractor can use different tax methods to report other exempt construction contracts.
A company with large receivable balances made up of service contracts and short-term contracts (contracts that are started and completed within the same year) should elect to use the cash method as the overall accounting method for tax reporting since all receivables and payables for those jobs are not recognized until they are received or paid. The cash method gives the taxpayer the most flexibility when it comes to tax planning.
For those contractors using the cash method of accounting, be sure to review the projected balances in deferral accounts (accounts receivable, accounts payable, accrued expenses); determine the current year tax deferral based on the projected balances and compare against the prior year deferral; consider using your line of credit to finance the acceleration of certain deductions or to finance the growth of receivables.
Tax Tip No. 2: Consider additional fixed-asset acquisitions. An extender deal has been reached (Editors Note: The PATH Act signed into law, expands the Section 179 deduction limit to $500,000). Included in the deal are several tax provisions that would become permanent; chief among them is the enhanced 179 deduction. As a result, contractors that have already purchased equipment, or are considering additional purchases, can take advantage of the accelerated cost recovery. With the enhancement, contractors would be able to write off up to $500,000 of the cost of qualifying asset acquisitions (with a phase-out beginning at $2 million). In addition, the bill includes an extension of the bonus depreciation until the end of 2017, creating even more cost recovery for qualified fixed assets.
Tax Tip No. 3: Review contracts for 179D deduction potential. Under 179D, the owner of a commercial building is entitled to a tax deduction for the reduction of energy and power costs. The 179D tax deduction specifically applies to those commercial buildings that notably reduce their interior lighting energy costs, heating, cooling, and building envelope.
A critical part of the 179D is that it allows government entities that wouldn’t be able to benefit from the tax deductions the right to transfer the tax deductions to certain contractors/designers/architects. This was another provision that was scheduled to be extended as part of the tax bill.
Tax Tip No. 4: Review activity that could qualify for the R&D Credit. Another provision that is scheduled to become permanent on the current tax bill is the R&D credit. For years, the United States Federal Credit for Increasing Research Activities has been underutilized. Some of the best candidates for the R&D credit include construction, manufacturing, tool and die, and engineering companies. The ability of construction companies to take advantage of this is due to a variety of reasons — the first being the expanded application within the federal tax law. Another influencing factor has been all of the changes within the construction industry itself since the economic downturn in 2009.
Tough economic conditions have increased competition and forced contractors bidding on contracts to focus their company’s resources on developing more-efficient methods of performing the contract or more-efficient ways of implementing the contract to help stay ahead of decreasing margins. These upfront costs could possibly qualify for the R&D credit.
In addition, the increase of more design-build contracts and the use of new and improved technology on these contracts have led to more R&D credit opportunities. These new industry behaviors can be qualifying activities for R&D credit purposes. With the current rate of construction in the United States continuing to climb, 2016 could prove to be the best year contractors have seen yet since the economy rebounded.
By following the outlined tax tips, contractors will be well positioned to take the most advantage of all the opportunities 2016 has to offer.
Conor Flanagan is tax manager at KAF.