President Trump signed the Tax Cuts and Job Act ("Act") in December 2017 affecting how construction companies account for contracts, inventory and other expenses. Construction companies are already feeling the impact from the new federal tax law.
Here’s an overview of 8 key ways the new tax law will impact the construction industry.
1. Accounting for long-term contracts – Construction companies that have average annual gross receipts of $25 million or less in the 3 prior tax years are permitted to use the completed-contract method (or any other permissible exempt contract method). The $25 million gross-receipts threshold will not apply if more than 35% of the losses from the business are allocated to owners who are not active in the business. The threshold is also indexed for inflation after 2018. Use of this Percentage of Completion Method (PCM) exception for small construction companies applies to contracts for construction or improvement of real property if the contract is expected to be completed within two years of commencement of the contract. This exception is applied on a cutoff basis for all similarly classified contracts entered into after 2017.
Unfortunately, the Act did not change the requirement to compute income from long-term contracts under PCM for alternative minimum tax ("AMT"). Therefore, companies will still need to calculate the income for all contracts under PCM for AMT purposes even if they meet the new $25 million gross receipts threshold. The AMT exemption amount for individuals was, however, increased under the Act, and the phase out of the exemption will also now not start until AMT taxable income exceeds $1 million for joint returns and $500,000 for all other taxpayers.
2. Utilizing the cash method for overall accounting - The Act expanded the list of entities that are eligible to use the cash method of accounting for tax years beginning after Dec. 31, 2017. The $5 million average gross receipts threshold for corporations and partnerships with corporate partners that are not allowed to use the cash method of accounting would be increased to $25 million.
3. Accounting for inventory and uniform capitalization rules - Construction companies with receipts less than $25 million can elect for tax purposes to account for inventory as materials and supplies or to conform with the financial accounting treatment. Companies that meet this gross receipt threshold are also exempt from capitalizing specific administration and general costs to inventory for tax purposes as well. Both are applicable to tax years beginning after Dec. 31, 2017 and are a change of accounting method.
4. Increased depreciation expensing limits - For property placed in service in tax years beginning after Dec. 31, 2017, the maximum amount a taxpayer may expense under Code Sec. 179 is increased to $1 million, with the phase-out threshold amount increased to $2.5 million. For qualifying assets acquired and placed in service after Sept. 27, 2017, 100% bonus depreciation can be utilized. Bonus depreciation can now be used on either new or used assets and is scheduled to start phasing out after 2022.
5. Domestic Production Activities Deduction/Section 199 repealed - The Act repealed the 9% Domestic Production Activity Deduction for years after 2017 which will impact nearly the entire construction industry.
6. Limitation of business interest expense - Business interest is limited to 30% of the company's adjusted taxable income for tax years beginning after Dec. 31, 2017. Companies that meet the aforementioned $25 million gross receipts test, however, are exempt from this limit.
7. Entertainment expense limitation - Starting in 2018, deductions for entertainment expenses are disallowed, and the current 50% limit on the deductibility of business meals is expanded to meals provided through an in-house cafeteria or otherwise on the premises of the employer.
8. Like-Kind exchange limited to real property - The Act limits the nonrecognition of gain for like-kind exchanges to real property that is not held primarily for sale. Therefore effective Jan. 1, 2018, any gain from the trade-in of personal property (i.e. equipment and vehicles) will be taxable. However, under a transition rule, the pre-Act like-kind exchange rules apply to exchanges of personal property if the taxpayer has either disposed of the relinquished property or acquired the replacement property on or before Dec. 31, 2017.
Another key point to consider is whether you should convert your company from an S corporation to an C corporation or vice versa given the new corporate and individual tax rates included in the Act. Each company's facts are different so there is no one answer that will fit all companies.
For specific questions on any of the changes listed above or how the Tax Cut and Jobs Act may impact your construction business, please contact your MarksNelson Advisor at (816) 743-7700.