10 Tax Planning Strategies for Contractors to Reduce Taxes

AndrewRusso,CPA,MST

any provisions have been implemented under legislation in the past several years to help businessesandindividualsreducetheirtaxobligation. Herearetentaxplanningstrategies for contractors to consider:

UsetheRightAccountingMethod.Contractors shouldensurethatthetax reportingmethodforeach contractisappropriatebydeterminingwhichprojectsarenotconsideredlong-term(morethanone year). Most contractorsmust use the percentage-of-completionmethodfor long-termcontracts,but exceptions exist. For example, residential builders generally qualify to use a different tax reporting method.In addition, contractors may be eligiblefor other elections for pay-if-paid contract language, unit price contracts, GuaranteedMaximumPricecontracts,andretainagereceivable. UndertheTaxCuts&JobsAct(TCJA), tax accounting methods previously available only to smaller contractors can generally be used by contractors with average annual gross receipts of up to $26 million (adjusted for inflation).Choosingtheappropriatemethodforeachcontracttoreducetaxesis anoverlookedtaxplanningtool.

Qualify as a Real Estate Professional. Rental activities and income are largelyconsidered passive incomeunlesstheinvestorqualifiesasarealestateprofessionalfortaxpurposes.Thenitistreatedas non-passive income. Losses can be deducted if the real estate professional materially participates in the rental activity. More than 50% of the person’s time and 750 hours must be spent on real estate activities. Holding a real estate license is not required. Other rules apply. Generally, contractors qualify for this provision under the Internal Revenue Code.

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DepreciateProperties.According to the IRS, thelifespanofaresidentialbuildingis27.5years. Therefore, owners can deduct 1/27.5 of the property’s building value each year for the first 27.5 years they own the property.Capitalimprovementstothepropertycanalsobedepreciated.However,when theproperty is sold, the owner may owe taxes for “depreciation recapture” on profits they previously avoided paying taxes on through depreciation. Land cannot be depreciated or the costs of clearing, planting, and landscaping. Those activities are considered part of the cost of the land and not the buildings.Real estate investors that acquired renovated orbuilt a building should consider a cost segregation studytodetermineifthepropertyqualifiesforaccelerateddepreciation.Personal propertyacquired as part of a building may be eligiblefor immediate expensing under TCJA by claiming 100% bonus depreciation.

Take Advantage of the 20% Pass-Through Deduction. A TCJA provision allows small business owners todeduct20%ofdomesticqualifiedbusinessincome(QBI)fromapass-throughentity.Thededuction is taken on the net amount of qualified items of income, gain, deduction, and loss concerningany qualified trade or business of the taxpayer. The deduction cannot exceed taxable income. Rules apply.

Takethe Employee RetentionCredit(ERC).TheEmployeeRetentionCredit(ERC)canstillbeclaimed in 2022,even though the program ended last October. Employers can go back to March 13, 2020, and claim wages until October 1, 2021. This refundable tax credit can be taken against certain employment taxes. Federal income tax withholdings, the employee’s share of Social Security and Medicare taxes, and the employer's share of Social Security and Medicare tax can be claimed up to the amount of thecreditEmployer-paidhealthinsurancecostsmayalsobeeligible,eveniftheemployer has furloughed workers and is not otherwise paying wages. A maximum of $7,000 per employee per quarter for a total of $28,000 can be claimed by qualified employers in 2021,and $5,000 for the third andfourth quarters of 2020 foratotalof$33,000peremployee.Generally,businesses canqualifyfor the ERC even if they receivefunding through the Paycheck Protection Program (PPP).

Assess NOL Carryback vs.Carryforward. The CARES Act permits net operating losses (NOLs) to be carried back to obtain refunds of prior year taxes. While appealing, business owners should assess the implications of this tax provision before deciding to take an NOL carryback or carryforward. It is important to determine if it is more advantageous to take a carryback and refund in a year with a lower tax rate or have the NOL available for future years when income tax rates are expected to be higher. Evaluate current working capital needs and thecompany’s long-term financial stability before deciding.

Takeadvantageofbonusdepreciationchanges.TheCARESActincludesatechnicalcorrectiontoTCJA that permits 100% bonus depreciation for eligible Qualified Improvement Property (QIP) placed in service after December 31, 2017, and before January 1, 2023. Taxpayers who placed eligible QIP in service during 2018 and 2019 may be eligible to claim 100% bonus depreciation. REITs, manufacturers, and other businesses that own certain non-residential real estate improvements on leased land may also be eligible.

Take the Energy Efficient Building Deduction. The Consolidated Appropriations Act (CAA) of 2021 made the Energy Efficient Building Deduction (Section 179D) permanent. Business owners and government contractors can deductenergy-efficient improvements to commercial and government buildings.Atax deductionis availabletoneworexisting buildingownerswhoinstall interior lighting, building envelope, heating, cooling, ventilation, or hot water systems that reduce energyandpower costsby50%ormore.Anyaccruedtaxdeductionsfromthesebuildingscanbe carried back two tax years or forwardedfor up to 20 years. The Inflation Reduction Act (the Act) increases the value of the section 179D tax deduction to $5.00 (up from $1.88) per squarefoot. Contractors can qualify for the full deduction by designing and installing qualified energy-efficientsystems in certain buildings,

provided they meet prevailing wage and apprenticeship requirements.Certainnonprofit organizations,schoolsanduniversities,churches,andotherpublic entities are now eligible for this deduction under the Act. Eligible designers and builders (such as architects, engineers, contractors, environmental consultants, and energy service providers) can qualify for 179D under a special rule for public property.

Takethe45LEnergy EfficientHomeTax Credit. TheAct also expandsuponsection45LoftheInternal Revenue Code, where eligible builders of energy-efficient apartment buildings could receive a tax credit of up to $5,000 per dwelling unit.

Buyan Electric Vehicle.TheActincludes a $4,000taxcredittopurchaseused electric vehiclesandup to $7,500 in tax credits for new ones. These tax credits apply to any “clean vehicle,” including hydrogen fuel cell cars. In addition, the Act extends existing electricvehicle tax credits for 10 years until December 2032.

The InflationReductionAct introduces new renewable energytax credits andextends others.These include incentives to companies and consumers who make cleaner energy choices, a tax credit for energyefficiencyincommercialbuildings,andgrantsandloanstohelpcompaniesreducegas methane emissions from oil and gas. The Act also creates a $1 billion incentive program for energyefficientaffordable housing and $3 billion to improve roads.

Takingtaxcreditsinoneareaofthebusinessmayoffsetthebenefitsof another. So, it is important to take a holistic approach to tax planning. Contractors must weigh the costs versus the benefits of each credit or incentive beforeimplementing a strategy.

AbouttheAuthor Andrew Russo,CPA,MST,isthedirectoroftaxstrategiesfor McCarthy & Company. Andy helps clients by providing them with a strategic approach to tax planning to reduce their income tax liability. He can be contactedat610.828.1900orandrew.russo@mccarthy.cpa.

Andy Russo, CPA, MST