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.
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
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.
What are we hearing from our construction industry clients?
As this crisis continues to bring uncertainty to the economic landscape, the construction industry is feeling the impact. To assist contractors during uncertain times, the Smith Schafer Construction Experts are providing a list of the Top 10 Questions we hear in the industry.
1. What are the top three concerns we hear from our construction industry clients?
Canceled contracts – even with a substantial backlog heading into 2020, our clients have seen contracts get canceled or delayed since March.
Reduced bidding opportunities – the combination of shrinking backlog and decreasing opportunities to bid on new work has significantly impacted the 2020 and 2021 outlook.
Restrictions on job sites – the safety of the workforce currently on job sites is most important. However, delays and lower headcounts are hurting existing job margins, reaching milestones, and extending the overall timeline of jobs.
2. How has the pandemic affected our construction clients?
We have seen a complete 180 as far as worker and job availability. Prior to the pandemic, there was a tight labor market and now there are not enough active projects to keep the workforce utilized.
3. What have we advised clients to do to lessen the impact on their businesses?
We have advised our clients to think long-term. This is a drastically different situation from 2008 or other economic downturns. We can still weather the storm with proper planning and tough decisions. We recommend preparing a 14-week cash flow forecast.
The Payroll Protection Program and other assistance have helped ease the pain or delay the tough choices, but we need to plan for additional shelter in place orders, shutdowns, and shortages. It is crucial to be aware of alternate funding sources, such as SBA loans or other federal or state programs.
4. Are other construction clients taking advantage of the CARES Act, and its accompanying Payroll Protection Program to keep their workforce employed?
Many clients have taken advantage of the Payroll Protection Program (PPP). The immediate goal of the PPP is to help employees. However, if job sites cannot be operational to keep employees on payroll and the loan is not forgiven, it is still a low-interest loan.
5. What options are available to construction businesses who may not survive an economic downturn?
These difficult times have taken a toll on businesses. Some owners are considering selling their business or consolidating. While negotiating a merger or business sale, it is helpful to conduct a valuation. There is more to business value than simply your balance sheet today. Your goal should be to make sure you are getting the best purchase price, even during the current crisis. We also recommend consulting with an attorney and contacting lenders and vendors.
6. Will there be an impact from COVID-19 on construction business retirement plans?
After several years of improving funding statuses of defined benefit plans (pensions), we may see a steep decrease in value, which could possibly result in financial improvement plans and surcharges costing participating employers more in the future.
7. How have the Financial Accounting Standards Board (FASB) changes to revenue recognition impacted our construction clients?
Change orders have come under more scrutiny under the new revenue recognition standard. After a bumpy year of implementation, the hope is that revenue recognition will once again ‘normalize.’
8. How are construction businesses adjusting to workforce changes and increase demand?
One of the most significant issues continues to be an extremely tight supply of skilled workers. Before COVID-19, work was being bid at higher margins to account for the required overtime or weekend pay. Many construction companies were trying to work with industry associations and local technical schools to help get more people into the workforce.
9. What trends have you seen construction firms using to achieve prompt payment?
In the current environment, filing and maintaining construction lien rights will become even more critical—plan to expedite billings and collections on all jobs. Identify contracts you expect might delay payment and include this information in your cash flow forecast.
10. What advice do you have for construction firms to protect their businesses and financial systems from phishing, data breaches, and cyber intrusions?
Training, training, and more training. Many services will send phishing emails to your employees and track how many open the links or attachments. Most claim they would never fall for such an attack, but those are often the same people who open a link, which is better to be done on a test email than an actual phishing email.
The long-term impacts of the COVID-19 pandemic are unknown, but will likely include additional job site safety measures, including health screening and limiting headcounts on sites. We recognize your construction business may be facing decisions you have never had to face, and we are here to help.
labor shortages amid a nearly fully employed national economy have plagued
construction companies across the sector in recent years, limiting the level of
construction investment and volume of new projects. According to the latest Job Openings and Labor Turnover Survey, the
level of job openings within the construction sector reached a record-breaking
monthly average of 276,000 positions open in 2018, the highest level since
tracking began in 2007.
construction industry must rethink strategies to attract and retain
well-trained and experienced workers. Smith Schafer has been a part of the
construction industry since 1971. Here are a few ideas to navigate the
construction industry labor shortage.
Encourage youth to return to the
industry. Some construction
companies are establishing trade schools or college internship and
apprenticeship programs. These can serve to create a new perception of the
construction industry, one that includes a long-term career with management
Expand efforts to recruit from outside
of the traditional candidate. Many construction companies have increased their outreach to military veterans.
Not only are veterans dedicated and disciplined, but they can work under
pressure and are often committed to seeing projects through to success.
Veterans often have difficulty finding and keeping employment, so construction
companies interested in hiring veterans should offer training programs that
make it easier for them to secure work and establish careers.
Increase compensation. A seemingly easy solution, but not
always practical, especially with small profit margins. Compensation does
matter, and it is important for construction companies to review their
compensation plan periodically to ensure it has kept place with the marketplace
Track safety performance closely. This should be checked regularly to
ensure all staff are following defined rules and regulations. A company who
takes care of their employees is more likely to retain them.
Conduct ongoing training and
development. Initiatives such as mentorship programs, career coaching and educational
seminars may help employees widen their knowledge base and feel like a valuable
member of the team.
Review performance management. Many construction companies conduct
annual performance reviews for in-office staff, but may do so less frequently
for field workers. Consider a
company-wide performance management program that includes regular reviews and
goal-setting for everyone.
Choose projects carefully. Labor shortages present an opportunity
for construction companies to be selective about the projects they accept.
Construction companies have the power to invest their resources in the
highest-paying projects. A thinner bidders’ market lets them come in with
Use technology. Smart technologies may reduce costs and speed
up project schedules. Investing in the right technology can free up time for
the experienced workers, allowing them to focus on other vital tasks.
is not a simple solution to overcome the labor shortage in the construction
industry and each company needs to take an individualized approach that makes
sense for their size, market and specialty. Our Construction & Real Estate
Group, comprised of numerous professionals, is committed to serving over 800 Minnesota construction and real estate entities.
Contact us today to learn business strategies that will help you grow and save
it is dealing with labor shortages, collecting retainage or preparing for the ever-changing
regulatory landscape, those in the construction industry never seem to have a
lull in the action. This audit and accounting resource guide supplies insights
and reference material for your construction business and reviews some of the
recent changes in the industry.
Revenue recognition is finally here!
After years of threats and changes to the standard, revenue recognition is now in effect. For construction companies issuing Generally Accepted Accounting Principles (GAAP) basis financial statements, this new accounting standard will change their financial statement presentation and possibly the timing of revenue recognition. This standard introduces a five-step approach to recognizing revenue and requires construction companies to make more estimates, examine contracts for variable consideration and revisit change orders to determine if they should be a new contract or modification of an existing contract. The new standard completely replaces the existing standards.
After revenue recognition, construction companies still have leases to contend with in 2021. Many off-balance sheet lease agreements will be added to balance sheets, which will result in an increase in both debt and asset balances. Construction companies need to be aware of the ramifications this will have on their total financial health and bank or bonding covenants.
Current liabilities will increase and if banks opt not to remove this new liability from covenant calculations or change the benchmark, a historically easy ratio to obtain may become an impossible hurdle. The lease standard will also require estimates of how many extensions of a lease will be exercised and, based on wording in the lease, expenses like operating costs and real estate taxes may be included in the newly recorded liability. Construction companies should review their lease agreements and current footnotes to determine the impact of this change, prior to implementation.
Assess the need to continue using GAAP reporting
GAAP has been the gold standard for accounting basis, some would argue, forever. However, with the recent changes occurring or pending, including the above mentioned revenue recognition and lease standards, GAAP may no longer be the answer for many small or privately held construction companies. When a reporting framework becomes too difficult to maintain or not beneficial to the users of the financial statements, it may be time to change. Construction companies could shift to tax or cash basis of accounting or a similar version of either and instantly simplify this function. Another option, as developed by the American Institute of Certified Public Accountant, is the Financial Reporting Framework for Small and Medium Sized Entities (FRF for SME). This framework was very similar to GAAP 10-15 years ago and has removed many of the larger changes (revenue recognition, leases and fair value reporting) that has made current GAAP so complex. Any switch in accounting basis cannot be made lightly and needs to be discussed and understood by the users of the financial statements, including banks, owners, bonding companies and future users of the financial statements. Although these alternatives are valid and widely used, there are exceptions.
1: If a construction company’s
goal is to sell to a large, publicly traded company, switching away from GAAP
is not the solution.
Example 2: If obtaining bank financing is an issue or switching banks is being planned, it may not be the best time to transition. Discuss options with your bank prior to making a transition away from GAAP.
When the U.S. Supreme Court changed course on nexus determination and no longer required a physical presence for sales tax remittance, the online retail industry was not the only one affected. States quickly reacted to the ruling and have implemented a variety of different laws. Before taking a contract of shipping goods out of state, be sure to review the possible sales tax implications.
Technology drives the construction industry
The 2019 Construction Technology Report by JBKnowledge offers insights into the market and allows you to compare your company to others in the industry in terms of technology usage, IT expenses and research and development costs. As in most industries, technology drives efficiency, improves productivity and is constantly changing. The report is driven by a survey of industry members.
Although not an industry specific problem, the construction industry has been hit hard by a shortage of qualified employees. Union benches are empty and accepting under-motivated or under-qualified applicants is the new normal as projects and proposals are still available. If this continues, construction companies will need to look at expanding benefits to keep or attract employees. Companies need to look at production and backlog and consider if higher production, at the expense of overtime and other additional costs, is worth the margin gained on the work. This is especially important if contracts require specific deliverables or have a specific date for completion. Most construction companies have a difficult time passing on a proposal, but increasing margin or extending dues dates when responding to the proposal could improve workflow and counteract the effects of overtime.
Note: Interested in learning benchmarks and key performance indicators for your specific industry? Reach out to a Smith Schafer professional. We work with over 800 Minnesota construction and real estate entities and have access to industry reports.
Tax law changes offer opportunities
Tax reform simplified some aspects of the tax code, but also made it much more complicated. Construction company owners need to ensure they have fully examined the opportunities allowed within tax reform, including, maximizing the tax benefits of their basis of accounting and increasing the 199A deduction. These decisions cannot be made without a full review of both the ownership group and the company in general.
Industry knowledge and close collaboration are instrumental in providing our construction clients with the insight and awareness to make the best business decisions and seize growth opportunities. Smith Schafer is a recognized leader in providing accounting and consulting services to the construction industry since 1971. We have a team of experts, focused on working with the construction industry, and committed to helping our clients succeed. If you have questions about improving your business model, implementing an accounting practice or tax planning strategies to improve operations, Smith Schafer can help. For additional information, click here to contact us.
The Internal Revenue Code Section 199A Qualified Business Income
(QBI) Deduction allows a deduction equal to 20% of business income for owners
of pass-through entities. When the law was passed, there was confusion about whether
owners of rental real estate businesses would be eligible for the deduction.
When the regulations were finalized, the IRS released Revenue Procedure
2019-38, which was intended to help these rental real estate businesses assess
whether they are eligible for the QBI Deduction. This helps to clarify
confusion by allowing a “safe harbor” for rental businesses who do not
necessarily qualified as a trade or business, to qualify for the deduction.
What types of entities qualify for the safe harbor?
The safe harbor rules define a rental real estate enterprise as
an interest in real property existing for generating rents. If the taxpayer
owns several different real estate enterprises, they have the choice to either
treat each one of the rental properties individually or as a group. Properties
would be divided into groups for residential real estate and commercial real
estate if a grouping election is made.
What are the requirements to qualify for the safe harbor?
The taxpayer, their employees, agents or independent contractors must perform at least 250 hours of rental services annually with respect to the enterprise.
Items qualifying as rental services:
Advertising for the rental of the properties
Performing repairs and maintenance
Supervision of employees or contractors
Processing tenant applications
Negotiation or execution of leases
Items not qualifying as rental services:
Making investment or financing decisions
Managing long-term capital improvements of the property
Hours spent traveling to or from the rental properties
Separate books and records must be maintained to track income and expenses of each rental real estate enterprise, either individually or by group if electing to form a multiple property enterprise.
Taxpayer must maintain records proving who performed the services, hours of all service performed, description of the services performed and the dates on which the services were performed.
What could disqualify a taxpayer from the safe harbor?
A taxpayer cannot use the safe harbor if they use the real estate property as a residence at any point during the year.
Real estate property leased using a triple net lease would not qualify for the safe harbor.
The safe harbor rule is not the only way to qualify for the
Section 199A deduction. This deduction can be quite powerful so contact us today
to discuss how to qualify. It is important to review your tax strategies to
ensure you are in the best position possible.
Smith Schafer is a recognized leader in providing accounting, auditing and consulting services to the construction and real estate industry. Our Construction Group, comprised of numerous professionals, is committed to serving over 800 Minnesota construction and real estate entities. Click below to schedule a free 30-minute consultation.
Smith Schafer is proud of our clients. Our success is the direct result of our client’s success. We are an award-winning public accounting and business consulting firm offering a proactive advisory relationship to business clients.
Industry knowledge and close collaboration are instrumental in providing construction companies with the insight and awareness to make the best business decisions and seize growth opportunities. We demonstrate our value by anticipating client needs rather than reacting to their requests. The following construction industry client case study is just a sample of Smith Schafer’s results. For more information about our approach to client solutions, visit our services pages.
Below is a case study of how we have helped one of our Twin Cities construction clients – Steve Kucera, CFO, Schoenfelder Renovations.
Q: How long have you worked with Smith Schafer?
A: Schoenfelder Renovations has worked with Smith Schafer for five years.
Q: What services does Smith Schafer provide for Schoenfelder Renovations?
A: The Smith Schafer Team helps us with audited financials, Sage 50 and all-around accounting support. Having our financials audited annually and Tim Pass, a Smith Schafer Audit Principal, as a member of our Board, brings immense knowledge and industry expertise to the conversation.
Q: Can you describe a time when Smith Schafer really came through for Schoenfelder Renovations?
A: A few years ago, we changed our accounting staff. Smith Schafer Principal, Tim Pass, and Smith Schafer IT Advisor, Tim Jewell, reviewed our accounting system and assisted us in creating best practices going forward to help grow the company.
Q: What are the most important reasons you stay with Smith Schafer?
A: Their willingness to help the company grow and the team’s knowledge and expertise.
Schoenfelder Renovations is a nationwide general contractor offering hotel, multi-housing and box store renovations. With years of experience in commercial work, they can help property reach its fullest potential. Check out their website for more details: www.schoenfelderrenovations.com