Adopting Changes in Tax Laws & Practices: What Construction Contractors Need To Know
Even though we have entered 2021, there are still many construction firms and contractors that are dealing with the downtime and damage caused by the COVID-19 pandemic. Since we are approaching the end of the financial year 2020-2021, it is extremely important that contractors must spend some time working on the tax plans and get over any financial issues while ensuring a better practice for their business in 2021.
Though consulting with tax and accounting experts is a good idea, it is equally important for contractors to understand the situation by looking at the changes made to accounting methods, Presidential and Congressional changes, and other important updates.
Changes in Accounting Methods
When it comes to the construction industry, we talk about big budgets. This simply makes contractors work on different practices that can help them to pay the least amount of taxes while helping them sustain the perfect financial position to retain cash flow and liquidity for their future interactions with banks.
Usually, the tax code is designed in a manner that allows contractors to record two portions of the dollar earned, each to be kept for IRS and Bank, respectively. This needs accountants to keep two sets of books for keeping the records and it is completely a legal process.
However, this needs contractors to ask their accounting teams to adopt the percentage-of-completion method for their financial reporting process, while working on tax returns can be done by following the Cash method, Accrual, or Accrual method with excluded retainage. Also, the long-term contracts that need to stick with changing tax practices can opt for accounting methods that begin in one year and end in another. These include Completed Contract, Percentage of Completion, Tax Percentage of Completion, and Percentage of Completion (Capitalized Cost Method).
Since contractors are required to create a request before IRS at the end of a financial year, choosing the right method to work on tax calculations could help overcome the burden of tax while meeting the general requirements of the tax process.
Presidential and Congressional Changes
Usually, contractors when submitting tax reports try to hold some amount of their total collected receivables in order to defer taxes, while pushing that extra income into the deposits for the upcoming tax year. However, another way that can help contractors to reduce tax liabilities is by adding to the total expenses made during a particular year. This can be done by making major purchases, clearing all the invoices and bills before December 31st, or maybe paying a bonus to all the employees.
Though most construction contractors have their own tax advisory teams or tie-ups, paying out the taxes in the U.S. for the year 2020 would be a little different with changes announced to the tax plan by recently elected President, Joe Biden. With the implementation of the end-of-year strategy, a 7 percent increase in corporate income tax rate is expected taking the numbers to 28 percent while the individual tax rates are also very likely to raise for firms that are earning more than $ 4,00,000 a year. To work on this plan could impact shareholders who have passed their ownership to other entities and are having personal returns on the business.
This has made many contractors and tax experts think of accelerating their income or tax liabilities for the financial year 2020 in order to deviate from the impact of increased tax rates that might happen in 2021 under the Biden administration. As a part of the strategy to prepare for the increased tax rates in 2021, contractors can even postpone major business purchases to next year as an offset to high tax rates. In other words, contractors concerned about high tax rates could plan to pay more in 2020 but a lower amount on the increased tax rate that might come into effect for the tax year 2021.
CARES Act and PPP Ramifications
The spread of coronavirus brought the biggest business downtime to the construction industry. However, to help people find the necessary aid and relief, Congress rolled out CARES Act or (Coronavirus Aid, Relief, & Economic Security Act) in March 2020. CARES Act was not only meant to provide financial aid to businesses and workers but also offered some tax benefits for the contractors. Some of these include:
- A refundable payroll tax credit equal to 50 percent of qualified wages.
- The employer portion of social security deferrable to 2021 and 2022.
- Opportunities to carry net operating losses back to previous tax years.
- The ability to deduct more business interest
- Qualified improvement property eligible for 100% bonus depreciation retroactive to 2017.
(Note: the above statements and benefits are derived from the statements of Warren Hennagin, Marcum’s California construction services leader. ProjectPro is not liable for any amendments or differences in the reported data.) Besides this, the CARES Act also brought the idea of the Payroll Protection Program to the front via Small Business Administration. Under this, if the business spent the loan amount on qualified expenses like payroll, equipment rent, and other essential utilities, the loans provided under PPP will be forgivable. However, any amount used to make other expenses other than qualified payments must be returned at an interest rate of 1 percent. But still, according to some IRS guidelines, the expenses that come with forgivable terms are not deductible with tax and will eventually lead contractors to pay bigger bills. The need to overcome those deductible expenses would require congress to work on some legislation that can address the issues.
Research and Development Credit
Since the pandemic has caused enough disturbance to the business, the construction companies are now eligible for tax credits for the federal research and development they make on creating products and processes. Also, the general business credit of 6 percent to 12 percent can be considered as qualifying expenses and contractors could use that data to get cash savings that can help with growth practices and reinvestment. Conversely, there are many construction firms who are investing time in innovative R&D and are eligible for qualified credit by IRS but are uninformed of the process due to poor information availability and misconceptions. However, some of the activities or research tasks that can help contractors enjoy an exemption on taxes include:
- Research or development of improved and more reliable construction processes and techniques.
- Improvements made to energy-efficient projects or LEED.
- Development of new and efficient assembly techniques.
- New and sustainable building materials
- Development of construction equipment
- Additional Testing and Certifications achieved for Projects.
Concluding it all
All in all, the ultimate decider that can help contractors find the best process for their tax practices is their cash position. For instance, for contractors who are short on finances to work their payroll before the end of the tax year, deferring invoice collection for the upcoming tax year would be of no benefit to the business.
Fortunately, the beginning of 2021 is currently seen as of greater value to the construction industry bringing chances of better project-related opportunities. On the other hand, there is both type of firms i.e. those with shrinking backlogs and those with lost project opportunities. Moreover, the vulnerability of the construction industry and uncertainty of the situation has been carried to 2021 from the previous year making it more crucial for firms to work on cash preservation.
If you are a construction firm or a contractor struggling with cash retention and tax process, the only thing that can save the day is having construction accounting software like ProjectPro that brings you real-time project data to picture cash flow and work on your tax goals.
For more information on how you can manage your payroll, invoice, and billing process for better tax control with ProjectPro, reach our experts today!