Since Congressional passage of the Tax Cuts and Jobs Act, much of the tax-savings attention has centered on a lower tax rate for C-corporations. The top tax rate for this category of business was slashed from 35 to 21 percent, in most cases producing a savings windfall for these companies, like construction companies, to redeploy in various ways.
But other business structures can get a bite at the TCJA tax reduction apple, too. Businesses organized as pass-through entities (as many construction companies are) can feast on the new 199a deduction described below. Other changes in the tax reform law mean companies can immediately expense more of the cost of certain business property. And many are now able to write off most depreciable assets in the year the assets are placed into service.
Here are just a few of the tax-saving benefits that construction companies will be enjoying as they file their 2018 return.
Section 179 and IRC 168k depreciation
Section 179 depreciation has been a popular tax deduction over the years that has helped numerous construction companies immediately expense investment in equipment. Under tax reform, this benefit only got better.
The new rules increase the dollar amount to expense from $500,000 to $1,000,000. And the investment limitation is increased from $2,000,000 to $2,500,000. The TCJA also expanded the definition of qualified real property eligible for section 179 expensing to include certain improvements to nonresidential real property. These new deduction rules are effective for assets purchased after December 31, 2017.
Changes to IRC 168k (known as bonus depreciation) increased the first-year depreciation from 50% to 100%. The new rules now allow bonus depreciation on the purchase of used as well as original use property. This is effective for assets purchased after September 27, 2017, and is available through 2022, when a phasedown period commences.
So how might these two expanded rules apply to an eligible construction company?
Let’s use the fictitious Acme Construction Co. as an example. Acme is set up as an S-corporation – company profits are passed through to the owner, whose personal income is taxed at the 30% federal tax rate.
In 2018 the company purchased $800,000 in qualified construction equipment and spent an additional $200,000 in qualified leasehold improvements to its headquarters.
Under the old rules, the Company would be able to immediately deduct $500,000 of section 179 depreciation and half of the remaining $300,000 ($150,000) for a total tax depreciation expense of $650,000. The leasehold improvements would not be deductible immediately but instead depreciated over a period of time.
Under the expanded rules of the TCJA, the company can now claim a total section 179 depreciation expense of $1,000,000, representing the total of qualified equipment plus improvements. (Had Acme purchased any additional qualified equipment, it could have been deducted under the expanded 168k rule at 100% of the cost).
So the company’s total depreciation expense has effectively jumped from $650,000 under the old rules to $1 million. With this added depreciation expense of $350,000 to deduct, the tax-savings value to Acme’s owner at the 30% personal tax rate is a cool $105,000.
Cash Basis Tax Returns
Many companies may remember being forced to convert from a cash basis accounting method to an accrual basis method simply because their average gross receipts over the prior 3 year period exceeded $10 million. The rule of conversion still stands, however, the average gross receipts test under the TCJA has now risen to $25 million.
This significant increase will allow many companies to remain as cash basis taxpayers rather than converting to the more complex accrual method. For those that did convert, they now have the option of reverting back to the simpler cash basis method.
Even for companies that exceed $25 million of average gross receipts over the three prior years, there are planning techniques that help to simplify accounting and reporting methods, especially if the business is set up as a partnership.
Although the new tax plan eliminates the 199 domestic production activity deduction (DPAD), it gives us something in its place – the 199a. This pass-through income deduction allows an individual taxpayer to deduct up to 20% of qualified business income (QBI) from a partnership, S corporation, sole proprietorship or trust.
The QBI is determined for each qualified trade or business of the taxpayer. This means that if the taxpayer has three qualified businesses, he has the opportunity to take up to a 20% deduction on the QBI of each trade or business. There may be limitations for certain taxpayers with taxable income over $315,000 and this deduction ends after 2025.
To illustrate, let’s go back to the owner of Acme Construction Co. Let’s say that after Section 179 depreciation deductions are applied, he is left with $200,000 in profit or QBI. After adding other sources of income to his form 1040, his total taxable income remains under $315,000.
So the first 20% ($40,000) of income from the S-corporation would be deducted from total QBI, leaving $160,000 of S-corporation income to be taxed. At a 30% tax rate, Acme’s owner will enjoy a $12,000 tax savings under the new 199a rule.
Be aware that there are various limitations that come into play if the owner’s total income is over $315,000 and there are rules to know if your business is a fiscal year-end in 2018. Consult your tax advisor for which of these special rules apply to your situation.
Of course here in the U.S., tax policy reform is never really finished. With Congress already considering new legislation to extend some expiring tax breaks as well as correcting technical problems of the TCJA, expect more tax code changes down the road.
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