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SuraLink(This article is based on our annual year-end tax planning letter but has been modified to include aspects pertaining specifically to the construction industry. For the full tax planning letter, see Other Publications and Posts below.)
As the end of 2019 approaches, you are likely considering year-end tax planning strategies. Winter is almost here, and an election year approaches. Those factors mean House Republicans and the Trump Administration are talking taxes, specifically a new tax cuts plan informally known as Tax Cuts 2.0. Realistically, Tax Cuts 2.0 will be a 2020 legislative process and, if passed, may not be effective until 2021. For 2019 tax planning, we must deal with the here and now.
Most traditional income tax planning strategies focus on several key areas:
- Planning the timing (deferral or acceleration) of particular items of income or deductions, to the extent that they can be shifted from one year to another in order to take advantage of possible differences in the effective tax rate for the current year and succeeding year(s), limitations on deductions, or other factors that may differ year-to-year;
- Maximizing, within overall general planning, the character of income (for example, qualified dividends and capital gains) that is subject to preferential, lower tax rates than ordinary income; and
- Taking advantage of special incentive provisions of the Internal Revenue Code when available such as Section 179 expensing, bonus depreciation, various credits related to different business or personal activities, and Qualified Opportunity Fund investments.
As always, tax planning requires a combination of multi-layered strategies, taking into account a variety of possible scenarios and outcomes. There are various income and deduction items to consider and we recommend finding a trusted tax advisor to assist you in order to determine the most beneficial approach to take.
The Tax Cuts and Jobs Act (TCJA) did away with many familiar long-standing tax rules and introduced a host of new ones for 2018 and 2019. Below are the measures from the tax reform act that could have the most impact on individuals for 2019:
- The suspension of most itemized deductions;
- The near doubling of the standard deduction;
- The $10,000 cap on the state and local income and property tax deduction for individuals;
- The suspension of personal exemptions;
- The Section 199A deduction for pass-through business owners;
- The increase of alternative minimum tax (AMT) exemptions for individuals; and
- The new individual income tax rates and brackets.
The most talked about change for individuals has been the 199A deduction (also known as the Qualified Business Income (QBI) Deduction or the 20% deduction). For tax years beginning after 2017, taxpayers, other than corporations, may be entitled to a deduction of up to 20% of their qualified business income. For 2019, if taxable income exceeds $321,400 for married filing jointly, or $160,700 for all other taxpayers, the deduction may be limited based on whether the taxpayer is engaged in a service type trade or business (such as law, accounting, health, or consulting), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business.
One change that hasn’t been discussed as much, but could potentially have a large impact on your business, is the change to the simplified accounting method requirements. Prior to 2018, small businesses with average annual gross receipts for the three previous years of $10 million ($5 million if a C Corporation) or less were eligible to use the cash method of accounting for tax purposes. Under the TCJA, that threshold has been raised to $25 million for all taxpayers. This means that taxpayers with average gross receipts between $10 million and $25 million may elect to use the cash basis of accounting for tax purposes.
Small construction contractors and subcontractors with average gross receipts between $10 and $25 million have an additional tax planning opportunity. Prior to 2018, contractors with average gross receipts over $10 million were required to use the percentage of completion method for their long-term contracts. However, that threshold has also been increased to $25 million, opening the door for small construction contractors to elect to use other, more favorable, long-term contract methods for tax purposes. Two of these more favorable methods are cash and completed contract. Under the cash method, taxes are paid on income when payment is received. Under the completed contract method, taxes are paid on revenues only when the contract is complete.
When considering which tax method to use, the possibility of being subjected to alternative minimum tax (AMT) should not be ignored, as doing so may negate certain year-end tax strategies. While certain provisions of TCJA mean fewer individuals will be subjected to AMT, the tax does still exist. An AMT exemption is allowed; however, the exemption is phased out as taxpayers reach high levels of alternative minimum taxable income (AMTI).
C Corporations continue to face double taxation, with taxes paid once at the entity level and again when dividends are paid to shareholders. With the TCJA, the C Corporation tax rate was reduced to a rate of 21%. While this reduced rate may look appealing, it is important to take into consideration the double taxation of C Corps and the potential QBI deduction afforded to pass-through entities when looking at which entity type to choose.
The TCJA increased the bonus depreciation deduction for businesses. A depreciation deduction equal to 100% of the basis of qualifying property is available in 2019. In order to be eligible for bonus depreciation, qualifying property can be new (first-time use) or used tangible property. Any qualifying property acquired and placed in service after September 27, 2017 and before January 1, 2023 is eligible for bonus depreciation. The deduction will then phase out gradually through December 2026.
Another great tax planning opportunity is the Code Section 179 depreciation. Code Section 179 property includes new or used tangible personal property that is purchased to use in an active trade or business. Under the enhanced expensing, for 2019, businesses can expense up to $1,000,000 in qualifying expenditures with no reduction unless expenditures exceed $2,500,000.
BMSS understands that these changes and the general complexity of the tax law can make year-end tax planning overwhelming, but it is a necessity. If you want to learn more about tax planning opportunities for your unique situation, we encourage you to reach out to a BMSS professional at (205-982-5500) or visit bmss.com.