The end of the year is always a great time to think strategically about your current tax situation. In light of recent tax reform, taking stock is even more important this year since you can potentially identify strategies that allow you to benefit from your share of $1.5 trillion in tax cuts. This certainly could apply to construction contractors, so this article discusses eight year-end tax considerations they can potentially take advantage of in 2019.
Consideration #1: Evaluate your method of accounting for long-term contracts
Tax reform opened up several new methods of accounting for contractors with no more than $26 million in average annual gross receipts. For example, a contractor using the percentage of completion method of accounting for book and tax may be able to switch to the completed contract method, which defers all of the income associated with open jobs until those jobs are complete. If you don’t know what method of accounting you are using for your long-term contracts, or you haven’t evaluated the method in light of tax reform, now would be the perfect time to evaluate your method.
Consideration #2: Evaluate the terms of leases
Rental activities can be considered business activities or investment activities for tax purposes. Prior to tax reform, the distinction wasn’t meaningful; you probably didn’t think much about tax issues when you entered into those leases. Following tax reform, the determination is significant in computing the 20% Section 199A deduction and the business interest limitation, among other items. In light of tax reform, you should evaluate the terms of leases.
Consideration #3: Evaluate your policy for employee use of company vehicles
Many construction companies allow employees to use company trucks for business reasons. Did you know that the value of any personal use of the vehicles must be included in the employee’s W-2? Creating a formal policy for employee use of company vehicles can protect the company in the event of an audit and allow for use of favorable valuation methods. For example, there is a special rule that treats the value of commuting in a company vehicle as $3 per day—regardless of actual mileage.
Consideration #4: Create formal loan agreements and charge interest on related party loans
From time to time you might lend money to your construction business or vice versa. Prior to the year’s end is a great time to ensure advances made during the year have been appropriately memorialized in a formal loan agreement with interest being charged. A loan agreement calling for interest reduces the risk that the IRS and courts will treat the loan as a contribution to capital or distribution rather than a loan.
Consideration #5: Maximize retirement contributions
No year-end tax strategy conversation would be complete without talking about retirement saving options. You may want to consider increasing your retirement plan contributions since it offers two potential benefits: you can obtain a tax deduction and set aside money for your future. In some cases, retirement plan contributions must be made by year-end (e.g., elective contributions to a 401(k) plan) and in other cases the contributions can be made after year-end (e.g., IRA contributions).
Consideration #6: Accelerate equipment purchases
Following tax reform, you can immediately write off the cost of new and used equipment purchases. Keep in mind that just because a tax deduction is available doesn’t mean you should do it, but if you are planning to invest in equipment in early 2020, you might want to consider accelerating the purchase so you can deduct the expense on your 2019 tax return.
Consideration #7: Defer capital gains by investing in an Opportunity Zone fund
Tax reform also added three incentives for reinvesting capital gains in economically distressed areas—referred to as “Opportunity Zones”—through a qualified opportunity fund (“QOF”):
- Deferral of gain invested in the QOF until the earlier of:
- The day the QOF is sold or exchanged, or
- December 31, 2026.
- Permanent exclusion of up to 15% of the deferred gain if the QOF is held for at least seven years.
- Permanent exclusion of post-investment appreciation in the QOF if the investment is held at least 10 years.
If you generated capital or net Section 1231 gains during the year, you should consult with your CPA to evaluate whether a QOF investment is available and right for you.
Consideration #8: Update your partnership agreement for the new partnership audit rules
For 2018 and later years, the procedures applied by the IRS in conducting partnership audits changed significantly. The new rules allow the IRS to assess and collect tax on understatements of income at the partnership level and grant a partnership representative sole authority to act on behalf of the partnership in an audit. If your partnership agreement was in effect prior to 2018, it might refer to a “tax matters partner” and include certain other language that should be updated to reflect the new rules. For example, the agreement should designate the partnership representative and require the representative to notify partners of developments in an audit, among other items.
How we can help
Are you interested in taking advantage of those $1.5 trillion in tax cuts? Our tax professionals have the knowledge to devise a personalized year-end tax plan that accounts for the above considerations and more, all for the sake of helping you take advantage of potential opportunities.