LUTZ BUSINESS INSIGHTS
2020 + year of change and uncertainty for contractors
jonathan patent, tax manager
For many obvious reasons, 2020 has been one for the history books. The current, ongoing, and future impact of the year’s events are at the forefront of everyday conversation, from the global pandemic, social justice, or the presidential election. The same goes for the world of taxation. The combination of recently passed and speculative future legislation has made tax planning more important than ever for businesses and individuals in the construction industry.
With the passing of various relief bills in response to the COVID-19 global pandemic came several tax law changes, both temporary and permanent. We will address some of the most substantial updates, primarily focusing on changes relating to income taxation. However, the importance of the changes to payroll and employment taxes should not be understated.
Paycheck Protection Program (PPP)
PPP is a program administered by the Small Business Administration (SBA) designed to make capital available for payroll and other vital business expenditures. If funds were used for qualified purposes, forgiveness of the debt is available. The primary goal was to keep individuals employed by businesses in a time when shrinking revenues were to be expected.
When it comes to income tax implications, this has been a large area of uncertainty and discomfort. When originally presented, the PPP indicated that the receipt of funds and forgiveness of the debt would be excluded from gross income. Subsequently, the IRS issued a publication indicating that the expenses paid for with the funds received from the PPP would be nondeductible on income tax returns. Recently, the IRS issued Revenue Ruling 2020-27, which essentially confirms the nondeductible treatment and states the adjustment should be reported on the tax return for the year in which a “reasonable expectation of forgiveness” is reached.
Qualified Improvement Property Correction
The Tax Cuts and Jobs Act of 2017, in an attempt to simplify tax depreciation rules, unintentionally omitted language needed to apply a 15-year depreciable life to Qualified Improvement Property (QIP). It was long expected that Congress would eventually issue a Technical Correction to fix the problem, and that correction was built into the CARES Act and was retroactively applied back to 2018. QIP type assets, such as tenant improvements, are now depreciable over a 15-year life and eligible for bonus depreciation.
Net Operating Losses/Sec. 461(l) Loss Limitations
In an effort to help taxpayers monetize current and prior year taxable losses, Congress delayed the effective date for Sec. 461(l) loss limitations to 2021 and retroactively eliminated for 2018 and 2019. This may mean that amended returns for 2018 may be required to free up losses that may have been previously limited. In addition, net operating losses for 2018, 2019, and 2020 may be carried back for up to five years, resulting in potential cash refunds.
Sec. 163(j) Interest Expense Limitation
Previously, a taxpayer had been able to deduct business interest expenses up to 30% of adjusted taxable income. The CARES Act changed that threshold to 50% for 2019 and 2020. However, some complications exist in how that is treated depending on the taxpayer’s entity structure (i.e., partnership vs. S-Corporation).
CHANGE IN THE OVAL OFFICE
It appears that Joe Biden will be the next President of the United States. With that, the President-elect’s tax plan becomes something to pay great attention to as it departs significantly from the revisions enacted by President Donald Trump. Among the substantial changes, we could see the following come our way:
- The top individual federal income tax rate will be returned to 39.6% from the current 37%.
- Capital gains and qualified dividends to be taxed at ordinary rates for individuals with income in excess of $1 million.
- The corporate federal income tax rate would be increased from the current flat 21% to 28%. Also, a potential 15% minimum tax could be applied to corporate book income. This would come into play if income reported for financial reporting and income tax have significant differences. The most obvious culprit, especially, but not only for the construction industry, is accelerated depreciation expense.
- Additional Social Security taxes could be applied to wages earned in excess of $400,000.
- Estate tax lifetime exemption could be reduced by approximately 50%, leading to higher taxes paid by decedents estates.
- Step-up in basis for appreciated inherited assets to be repealed. That means, if an heir inherits an asset that has seen its value increase in the hands of the decedent, the deferred tax would transfer to the heir.
Although none of the above-mentioned potential changes apply exclusively to the construction industry, they could nonetheless have a significant impact on the amount of tax paid by businesses and individuals. It far too soon to know when exactly these changes could potentially go into effect, but consideration of the timing of taxable income and estate planning needs to be near the top of the year-end checklist.
TRIED AND TRUE STRATEGIES
The 100% bonus depreciation on the purchase of eligible new and used assets is still currently set to be in place through the tax year 2022. Any equipment placed in service prior to the end of the year could be deducted entirely on the corresponding year’s tax return.
If a business has average gross receipts over the three preceding tax years of $25 million or less (indexed for inflation), there may be flexibility on the method of accounting used to report taxable income. Among the possibly preferential methods available are the overall cash basis method, and the completed contract methods for long-term contracts. If certain circumstances exist, these methods may lead to greater deferral of income. However, whether that is a benefit or not needs to be determined on a per taxpayer basis. If gross receipts levels exceed the $25 million threshold, there is less flexibility, but options still exist. Different forms of the percentage of completion method may make sense for certain taxpayers if there is a heavy concentration in certain types of projects or retainage is an overwhelming portion of the contract amount.
As you can see, tax planning in 2020 will be vital to ensure a tax-efficient future. Each individual’s situation is unique and needs specific attention. Please contact us for more information on how we can assist in making the rules work in your favor.
ABOUT THE AUTHOR
JONATHAN PATENT + TAX MANAGER
Jonathan Patent is a Tax Manager at Lutz with over six years of experience in taxation. He provides tax compliance and consulting services to clients with a focus on the construction and real-estate industries. In addition, Jonathan provides tax research and multi-state tax compliance services.
AREAS OF FOCUS
- Tax Consulting & Compliance
- Construction Industry
- Real-Estate Industry
AFFILIATIONS AND CREDENTIALS
- American Institute of Certified Public Accountants, Member
- Nebraska Society of Certified Public Accountants, Member
- Certified Public Accountant
- BSBA in Accounting, University of Nebraska, Omaha, NE
SIGN UP FOR OUR NEWSLETTERS!
We tap into the vast knowledge and experience within our organization to provide you with monthly content on topics and ideas that drive and challenge your company every day.