If you are like most construction contractors, you are currently in the midst of or getting ready for your financial statement preparation; and with that, especially at this time of the year, income tax planning stops as minds shift to preparation and filing. During this time, the construction contractor needs to be certain they have exhausted all income tax planning strategies to save or defer the payment of one of their largest overhead items, income taxes.
As part of this process, there are several income tax preparation strategies the construction contractor can utilize. For example:
- Bonus Depreciation or Section 179 elections – Available for fixed assets placed in service in the current year, both give the taxpayer the opportunity to deduct the entire cost of qualified additions. Since the Tax Cuts and Jobs Act, a common tax planning tool is to bunch necessary purchases in the years with the most projected income to maximize the deduction available.
- Income Tax Accounting Method – Was an allowable method chosen to create the maximum income tax deferral to a future date? Contractors have numerous methods that may be available. The most common are cash basis, completed contract and percentage of completion. By following the tax code, all may create an income tax deferral leaving more cash on hand for day-to-day operations. It’s important to see what method is allowed or required. It is also important to remember that a contractor’s accounting method can vary by contract.
Once the tax preparation phase begins, be aware of other income tax savings opportunities that remain available to contractors up until the day returns are filed – and some even retroactively after that. This tax season may be the perfect time for you to evaluate the following commonly overlooked tax credits and incentives:
Fuel Tax Credit. The excise tax included in the cost of gasoline is used to fund maintenance of highways and roads. The IRS offers a tax credit to contractors who purchase fuel for eligible off-highway business purposes. Common off-highway business uses of fuel by contractors include stationary machines (e.g. compressors, power saws and generators), bulldozers and earthmovers.
More valuable than a tax deduction, which reduces the amount of taxable income, a tax credit offers a dollar-for-dollar reduction of your tax obligation. The fuel credit is computed by the rate per gallon that the IRS allows for the type of fuel being used. For example, if a contractor purchased 10,000 gallons of undyed diesel fuel, which has a rate of .243, the credit would be $2,430. This may not seem like a large credit at one time, but its cumulative effect could be significant. Over 10 years, this example would multiply to nearly $25,000 of tax dollars saved.
These savings also yield a cost benefit because the burden on the taxpayer is light. The only things a contractor needs to do to claim the credit is to keep track of the gallons of fuel used and file Form 4136, “Credit for Federal Tax Paid on Fuels.”
Research & Development (R&D) Tax Credit. Contrary to popular belief, R&D activities do not have to be performed in a lab to be eligible for this valuable wage-based credit. The tax savings can be applied to any new or improved business component whereby you create or improve a process or product.
Examples of qualifying R&D activities in the construction industry include: work performed on a building structure to enhance construction performance, development of a new technique to perform the job more efficiently, research of new construction methods due to site conditions, and creation of a new tool or part.
A four-part test has been established to help taxpayers determine their eligibility for the R&D tax credit:
- Permitted purpose: Have you improved upon the functionality, performance, reliability or quality of a product or process?
- Technological in nature: Does the activity fundamentally rely on science, technology, engineering or math?
- Elimination of uncertainty: Is there a level of uncertainty, and is the R&D attempting to reduce it?
- Process of experimentation: In the process of the activity, have you evaluated solutions through modeling, simulation or trial and error? (The experiment does not need to be successful to qualify.)
If any of your processes or products meet all four of these criteria, they are most likely eligible for the R&D tax credit.
Section 179D Deduction. The Energy-Efficient Commercial Building Deduction (179D) was extended through 2020 at the end of 2019. This valuable tax deduction of up to $1.80 per square foot is achieved through the installation of energy-efficient HVAC, building envelope and lighting assets.
This deduction applies to both new construction and renovation of qualifying commercial buildings (retail, office, industrial or warehouse) and apartment buildings (four stories or more). It is available to building owners, as well as contractors and designers who worked on eligible government-owned buildings that were placed in service after December 31, 2005 and through December 31, 2020. Contractors must obtain an allocation letter from the government entity to get the deduction passed on to them.
Remember, it’s never too early to start planning your tax savings strategies for 2020 and beyond.