Tax planning tips for the construction industry
Planning throughout the year is essential to reduce the tax owed on your construction company’s 2020 return. In light of the ongoing impact from COVID-19 and recent legislation, taking a step back to plan is more important than ever since you could potentially identify new construction tax strategies that will save you money. This article will discuss nine strategies, credits, and deductions for construction company owners to potentially take advantage of in 2020.
Credits & Deductions
1. Qualified Business Income (QBI) Deduction
Introduced as part of the Tax Cuts and Jobs Act, Qualified Business Income from pass-through entities (sole proprietorships, partnership, or S-corporations) are generally eligible for a 20% deduction. The deduction is limited for specified services or trade business. These include any companies where the principal asset is the reputation or skill of its employees. Businesses involved in the construction industry should be able to utilize this deduction fully.
Tax Planning Tip: QBI is determined by many factors, including payroll levels. A company should determine if there are enough wages paid out, so the QBI deduction is maximized. Alternatively, determine if additional money should be invested in equipment or machinery.
Aggregation is determined on an individual level, so it is essential to discuss with your tax advisor as aggregation could be irrevocable.
2. Empowerment Zone Employment Credit
The Taxpayer Certainty and Disaster Tax Relief Act of 2019 renewed the Federal Empowerment Zones, which had previously expired at the end of 2017. The Empowerment Zone Employment Credit is retroactively extended for qualified zones wages paid or incurred in 2018, 2019, and 2020. This credit provides an incentive to hire individuals who live and work in a federally designated empowerment zone. This is a wage credit of up to $3,000 for each employee.
3. Work Opportunity Tax Credit (WOTC)
The WOTC is a federal tax credit available to employers for hiring individuals receiving government assistance and reintroducing them into the workforce. The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) retroactively allows eligible employers to claim the WOTC for all targeted group employee categories that were in effect before the enactment of the PATH Act, if the individual began or begins work for the employer after December 31, 2014, and before January 1, 2021.
Depending on the target group an individual belongs to, the credit per new hire can range from $2,400 to $9,600. Target groups include: Qualified IV-A Recipient, Qualified Veteran, Ex-Felon, Summer Youth Employee, and many more.
The value of this tax credit is determined by the target group under which the employee qualifies, the number of hours worked, and the wages earned in the period of employment applicable to that target group.
4. Section 179D Energy-Efficient Commercial Property Deduction
This deduction allows construction company owners to claim an amount based on the square footage of a new building construction remodel. The incentive provides a $1.80 per square foot deduction of energy-efficient space. This deduction can be divided into three energy-efficient categories:
- HVAC & Hot Water Systems
- Building Envelope
Each of these can obtain a $0.60 deduction. To qualify for this deduction, a building must be modeled by a qualified third-party individual (as defined by IRS Notice 2006-52) and compared against a reference building designed following ASHRAE Standard 90.1-2007 using IRS-approved software.
5. Energy-Efficient Homes Credit
The Energy-Efficient Homes Credit has been retroactively extended for 2018, 2019, and 2020. This credit is a tax incentive allowing builders to claim a credit of $2,000 per qualified dwelling unit. A qualified dwelling needs to be modeled by an independent individual and compared against a reference building designed to meet the International Energy Conservation Code of 2006. It can be a single-family home, a unit in an apartment complex, or a senior living community. Each separate rental unit may qualify for the $2,000 credit. However, each unit must be eligible on its own (i.e., an entire building cannot be certified with one model). This credit may be claimed on any open tax year.
6. Payroll Tax Credits & Deferral
The Coronavirus Aid, Relief, and Economic Security (CARES) Act provides a refundable payroll tax credit for 50% of wages paid to employees during the COVID-19 crisis. The credit applies to wages paid after March 12, 2020, and before January 1, 2021.
The maximum amount of wages eligible for the credit is $10,000, with the maximum credit for any employee equal to $5,000. If the business experienced a government order limiting commerce, travel, or group meetings, or there was more than a 50% drop in quarterly sales compared to the prior year, this credit can be claimed. When the business sales exceeded 80% of sales in the same quarter in 2019, it no longer qualifies for the credit at the end of that quarter.
The credit may be claimed immediately by reducing the amount of payroll taxes. The credit is applied against the employer portion of social security taxes.
Other Tax Planning Strategies to Consider
7. Succession Planning
The succession planning process is often overlooked until it is too late. Tax planning is an integral part of the succession planning process. It would be best if there is a plan for managing the tax liability generated by the influx of income upon a potential sale or other methods for the transfer of the business ownership. When negotiating the terms of a transaction, it is crucial to keep taxes in mind. The last thing you want is to give the government more taxes than is necessary due to poor tax planning.
8. Cost Segregation Study
The purpose of a cost segregation study is to identify assets and their costs related to a real estate purchase or reconstruction and classify those assets for federal tax purposes. When taxpayers purchase or construct a building, it is typically depreciated, often over 39 years. However, a cost segregation study identifies costs related to real property that can be reallocated to a shorter-life for depreciation. These studies are among the most valuable tax-saving strategies for commercial real estate owners, leaseholders, and others.
9. Revenue Recognition
The main goal of Accounting Standard Codification (ASC) 606 is to create a similar revenue recognition policy and calculation across all industries. The construction industry, which has historically had its own guidance and industry practices, is no exception. ASC 606 replaces virtually all accounting standards related to revenue recognition. It had been required for non-public entities to implement for years beginning after December 15, 2018, resulting in many already undergoing implementation, but this has been delayed because of the COVID-19 crisis. It is now required for years beginning after December 15, 2019.
Note: early implementation of ASC 606 is allowed.
How can we help?
With several credits extended to the end of 2020, the construction industry has the opportunity to take advantage of tax incentives and reduce their next tax bill. Contact us today to work with a qualified advisor to help you leverage opportunities and make the best decisions for your construction company. Our Minnesota Construction Accounting Experts, comprised of numerous professionals, is committed to serving over 800 Minnesota construction and real estate entities. Smith Schafer has the experience and understanding of the construction industry to make a lasting positive difference in your future success. Please send us a message today.