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.
Key Tax Provisions for 2021 Planning
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.
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.
Additional Planning Steps for 2021
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.
- Keep up on tax changes: Accounting firms are monitoring the political environment closer than ever before to help keep their clients informed of important legislative and regulatory changes. Construction companies should stay connected with their tax advisors in 2021 to keep up on tax changes and avoid any surprises.
- Don’t expect Congress to help: Despite the ongoing effects of the COVID-19 pandemic, there is no guarantee that Congress will pass additional legislation similar to the Payroll Protection Program. Businesses should not wait for Congress to act but should instead plan for 2021 under the assumption that there will not be further stimulus legislation.
- Consider succession plans: Owners of construction companies with closely held ownership structures should also consider their succession plans. In response to campaign proposals to reduce the estate and gift tax exemption, owners should consider whether to transition their company through a gift now to take advantage of the current $11.7 million exemption. Owners should also consider whether to transition their business through a buy-sell agreement and allow the next generation to use current low interest rates.
- Focus on business basics: After a tumultuous 2020, many contractors are focusing on the basic business practices that have made them successful in the past. The term “cash is king” is truer than ever. Companies are spending more time monitoring jobsites, reviewing legal contracts, and scrutinizing bond and insurance costs. They should also prioritize tax planning for 2021 as part of this process.
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.