Tax planning tips for the construction industry
Numerous tax strategies are available to construction companies and can provide tremendous value. However, these strategies are only beneficial if adequately planned and used. Considering the ongoing impact of the pandemic and recent legislation, taking a step back to plan is more important than ever since it could potentially identify new construction tax strategies that will save money. This article will discuss 11 strategies, credits, and deductions that could be advantageous for construction company owners.
tAX Credits & Deductions
1. Minnesota Income Taxation at the Business Level
A significant change for 2021 taxes is the deductibility of Minnesota taxes at the business level without being limited to $10,000 like individuals. On July 1, 2021, the Minnesota legislature approved the bill to allow pass-through entities (S-corporations, LLCs, and Partnerships) to tax Minnesota income at the business level and receive a deduction on the federal return for the taxes paid.
Note: For cash basis businesses, the tax payments must be made before December 31 to benefit the 2021 tax year. The tax savings will vary based on business income and ownership structure.
2. Qualified Business Income (QBI) Deduction
Introduced as part of the Tax Cuts and Jobs Act, Qualified Business Income from pass-through entities are generally eligible for a 20% deduction. The deduction is limited to specified services or trade businesses. 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 individually, so it is essential to discuss it with a tax advisor as it could be irrevocable.
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 credit has been extended until December 31, 2025.
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. Click to view a complete list of the targeted groups.
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 deduction of $1.80 per square foot 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 Tax Credit
The Energy-Efficient Homes Credit has been retroactively extended for 2018 through 2021. This credit is a tax incentive allowing builders to claim a credit of $2,000 per qualified dwelling unit. An eligible 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 70% of wages paid to employees during the COVID-19 crisis. The credit applies to wages paid from January 1, 2021, through December 31, 2021.
The maximum amount of wages eligible for the credit is $10,000, with the maximum credit for any employee equal to $7,000, per quarter for the first three quarters of 2021. This credit could be claimed if the business experienced a government order limiting commerce, travel, or group meetings, or more than a 20% drop in quarterly sales when comparing the 2021 income with the 2019 year.
The credit is applied against the employer portion of social security taxes and may be claimed immediately by reducing the amount of payroll taxes.
Note: Employee Retention Credit Ending Early
The Infrastructure Investment and Jobs Act signed into law on November 15th, 2021 eliminates the Employee Retention Credit (ERC) for 4th quarter of 2021. It was originally scheduled to continue through the end of 2021. Businesses that were eligible to claim the ERC for any of the first three quarters of 2021, but have not already filed to take the credit, are still eligible to claim the credit on an amended return.
7. Research & Development (R&D) Tax Credit
The R&D tax credit is a federal tax credit for increasing research and development activities during the tax year. Many construction businesses often overlook this credit because they do not think they qualify. The IRS definition for qualified research is that it “must be undertaken for discovering information that is technological in nature, and its application must be intended for use in developing a new or improved business component of the taxpayer.” Within this definition, an improved business component counts as R&D, not just new components.
The credit amount ranges based on various factors, but can be up to 20% of the company’s R&D expenditures. There are also state-level R&D credits for many states, including Minnesota. Expenses can be used in the calculation of both federal and state credits in many cases.
The qualified expense categories include:
- Payroll expense
- Experimental supplies cost
- Contractor research expenses
- Qualified educational institute research costs
Other Tax Planning Strategies to Consider
8. 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 to manage 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.
9. 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 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.
10. Change Accounting Method
The 2017 Tax Cuts and Jobs Act allows businesses with average annual gross receipts of less than $25 million to adopt the cash basis method. An eligible company can take advantage of cash basis reporting by deferring tax liability on income that is earned but not received before year-end. They may also expense items purchased before year-end even if they are not consumed during the year.
11. Contribute Toward a Retirement Plan
Contributions made to an employee’s company-sponsored retirement plan count as a tax deduction for the company. Contribution limits change based on the type of retirement plan. Maxing out a 401k or Self-Employed Retirement Plan (SEP) will reduce tax liability now and help save toward a financially stable future.
If it is a lower-income year, consider contributing to a Roth IRA. Roth IRAs allow contributing post-tax money into the plan. These already taxed dollars and the earnings grow tax-free and can be removed at 59 1/2. The 2021 Roth maximum income amounts are $208,000 for married filing joint filers and $140,000 for single filers.
HOW CAN WE HELP?
With proper planning and consultation with a tax advisor, construction companies can benefit from these strategies and, in many cases, use them to reduce tax liability. Contact us today to work with a qualified advisor to help 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.