Copyright © 2013 by the Construction Financial Management Association. All rights reserved. This article first appeared in CFMA Building Profits. Reprinted with permission.
BY CORY BUNYARD
Capitalizing on New Laws & Deductions: Year-End Tax Strategies for Contractors Opportunities remain for contractors to save on taxes for the 2013 tax year. Capitalizing on those opportunities requires being aware of new tax rates, tax benefits specific to 2013, and other tax-saving options that can be implemented before 2014. Investing time now for tax planning can pay dividends later. The remainder of 2013 gives contractors an opportunity to evaluate whether projected year-end compensation levels could place individuals in higher tax brackets, including the new 39.6% tax rate. (See Exhibit 1 on the next page.)
New Taxes for the 2013 Tax Year The Patient Protection and Affordable Care Act (PPACA) of 2010 and the Health Care and Education Reconciliation Act of 2010 included two new taxes that took effect for the 2013 tax year: the Additional Medicare Tax and the Net Investment Income Tax. Both were included in the PPACA and amended by the Health Care and Education Reconciliation Act. The impact of those taxes hinges upon the types and levels of income earned by contractors.
is deemed to be nonpassive and subject to self-employment tax is likewise subject to the Additional Medicare Tax, which must be paid via quarterly estimated tax payments. The final months of 2013 offer the opportunity to determine whether underpayments or overpayments have been made on that tax and make adjustments accordingly. Net Investment Income Tax
The Net Investment Income Tax is addressed by Internal Revenue Code (IRC) §1411. The tax took effect on January 1, 2013; imposes a 3.8% tax on certain types of income that exceed specified thresholds; and must be paid by individuals, estates, and trusts. The IRS defines investment income to include:
• Interest • Dividends • Capital gains • Rental and royalty income • Nonqualified annuities
Additional Medicare Tax
• Passive income
The Additional Medicare Tax of 0.9%, effective January 1, 2013, applies to W-2 (earned) and self-employment income. The threshold amounts on which the tax is due are:
• Income from businesses involved in trading of financial
• Married filing jointly: $250,000
Investment real estate and gains from the sale of interests in partnerships and S corporations may also be subject to the Net Investment Income Tax.
• Married filing separately: $125,000 • Single: $200,000 • Head of household (with qualifying person): $200,000 • Qualifying widow(er) with dependent child: $200,000 In many instances, the Additional Medicare Tax for 2013 has been paid via payroll deduction since January 1, 2013. However, business owners (such as a partner in a partnership who receives a guaranteed payment via a K-1) need to pay the Additional Medicare Tax whenever a quarterly estimated tax deposit is made. Also, income from a pass-through entity that CFMA Building Profits November/December 2013
instruments or commodities
Planning for this new tax is imperative. There should be an open line of communication between your company’s tax advisor and financial planner/stockbroker (if separate individuals). The broker has significant control over investment income and could possibly realize losses or switch investment strategies (e.g., income fund to growth fund) to minimize realized investment income and keep a taxpayer’s net investment income below the following applicable thresholds:
tax
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for dollar until it is fully phased out for entities with $2.5 million or more of purchases.
• Married filing jointly: $250,000 • Married filing separately: $125,000 • Single: $200,000 • Head of household (with qualifying person): $200,000 • Qualifying widow(er) with dependent child: $250,000 Favorable 2013 Tax Provisions While new taxes were introduced in 2013, favorable legislation for the construction industry was also enacted. Those provisions include an enhanced IRC §179 deduction and bonus depreciation. Each of these provisions can substantially reduce or eliminate a taxpayer’s tax liability. If used together, they can create considerable tax benefits and assist cash flow by minimizing tax liability. Enhanced IRC §179 Deduction
The IRC §179 deduction can also be applied toward used property, enabling construction companies to purchase valuable items at a lower cost (e.g., used equipment from an auction sale) while still realizing the benefits of that deduction. Eligible items include:
• Equipment and machinery purchased for business use • Tangible personal property purchased for business use • Business vehicles with a gross vehicle weight greater than 6,000 pounds
• Off-the-shelf software Ineligible items include:
• Real property, including land, buildings, permanent structures, and components of permanent structures
The American Taxpayer Relief Act of 2012 was passed by Congress on January 1, 2013. The act included enhanced IRC §179 deduction limits for the 2012 (retroactive) and 2013 tax years. The enhanced IRC §179 deduction allows a company to immediately deduct up to $500,000 from the cost of equipment purchases made, rather than having to claim depreciation over a much longer timespan. The deduction applies to equipment purchases of up to $2 million made between January 1, 2013 and December 31, 2013. For purchases in excess of $2 million, the $500,000 deduction reduces dollar
• Most heating and air conditioning equipment • Property acquired from related parties • Property that is not considered to be personal property The IRC §179 limitations are scheduled to decrease from $500,000 in 2013 to $25,000 in 2014. That is a substantial drop, and a contractor considering making large capital expenditures in 2014 may wish to make those purchases now to capitalize on that 2013 expensing limitation. While the §179 deduction can be used to reduce a taxpayer’s tax liability to zero, it cannot be used to put a taxpayer in a net loss position for income tax purposes.
2013 Income Tax Rates For year-end planning, construction company shareholders and executives should consider the following income tax thresholds:
Tax Rate
Individual
Married
(single filer)
(filing jointly or qualifying widow(er))
10%
$0 to $8,925
$0 to $17,500
15%
$8,925 to $36,250
$17,500 to $72,500
25%
$36,250 to $87,850
$72,500 to $146,400
28%
$87,850 to $183,250
$146,400 to $223,050
33%
$183,250 to $398,350
$223,050 to $398,350
35%
$398,350 to $400,000
$398,350 to $450,000
39.6%
Over $400,000 (New Bracket)
Over $450,000 (New Bracket)
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Bonus Depreciation
The act also extended a 50% bonus depreciation rate for qualified property placed in service from January 1, 2013 through December 31, 2013. The bonus depreciation offers several benefits not included in the enhanced §179 deduction provisions. A construction company does not have to report net income to apply the bonus depreciation. So, a contractor can claim the 50% depreciation while also reporting a net operating loss (NOL). The bonus depreciation also does not include the $2 million cap associated with the §179 deduction, which means 50% bonus depreciation can be claimed for much larger purchases and utilized by much larger entities. A Fortune 500 company, for example, generally would have too many capital expenditures and would not be eligible for the §179 deduction. However, this company could still benefit from the 50% bonus depreciation. Bonus depreciation applies to qualified property with a recovery period of 20 years or less, qualified leasehold improvements, certain computer software, and water utility property. Qualified leasehold improvements generally are made under a lease to the interior part of a building and placed in service more than three years after the building was first placed in service. Unlike the §179 deduction, bonus deprecation can only be applied toward new, original use property and not used property. Bonus depreciation, much like the §179 deduction, cannot be applied to tax-exempt property, tax-exempt financed property, or property used outside the U.S. Also, since states set their own income tax provisions, this particular deduction may not be available in every state.
heavy machinery and work trucks, that enable them to capitalize on like-kind exchange opportunities more often than many businesses in other industries. IRC §1031 offers provisions that enable a construction company to defer capital gains tax if the proceeds from the sale of property are reinvested in similar property within a relatively short time span – six months or less. Like-kind exchanges are available to individuals, C corporations, S corporations, general or limited partnerships, limited liability companies, trusts, and other taxpaying entities. A §1031 exchange may be a simultaneous swap of properties or a deferred exchange. With a deferred exchange, one property is disposed of, with the proceeds used to subsequently buy one or more like-kind properties. A deferred exchange is more complex, but both a simultaneous swap and a deferred exchange must be based on disposition and acquisition activities that are mutually dependent upon each other. In other words, a taxpayer cannot simply use the proceeds from a property disposition to purchase another property. For a construction company, a number of scenarios arise where a like-kind transaction might be worth pursuing. A company’s current facility may need to be replaced by a similar facility in a different location. Two companies could make a like-kind exchange involving such facilities. Disposing of equipment that is no longer needed to acquire more essential equipment might likewise be arranged through a like-kind transaction. However, the following are some items that might be excluded from §1031 exchanges:
• Inventory or stock in trade • Stocks, bonds, or notes • Other securities or debt
Other Tax Incentives to Consider
• Partnership interests
Other tax-saving options that contractors should consider before the end of 2013 include:
• Certificates of trust
• Like-kind exchanges
There are several other issues a company must consider when conducting a like-kind exchange:
• IRC §199 domestic production activities deduction (DPAD) • Retirement plan contributions and bonuses Like-Kind Exchanges
Construction companies have so much equipment, including
CFMA Building Profits November/December 2013
• The seller of a relinquished property has 45 days from the date of the sale to identify potential replacement properties. Identification of those properties must be stated in writing and delivered to the person involved in the exchange.
tax
• The identification of each property needs to include a street address or distinguishable name.
• The property to be purchased in the exchange must also be received within 180 days of the sale of the exchanged property. The replacement property received must be substantially the same as the property originally identified following the sale of the relinquished property. §199 DPAD
IRC §199 DPAD is another tax benefit that is particularly relevant to the construction industry and most contractors perform work that qualifies for that deduction. §199 DPAD offers qualifying construction companies a 9% tax deduction for the 2013 tax year. The deduction is based on the lesser of:
• Qualified production activity income (QPAI) • Taxable income • 50% of the Form W-2 wages that are deducted in
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cosmetic in nature and cannot be capitalized to the land, unless they are performed in conjunction with qualifying construction
• Services that physically transform land (such as grading, excavating, and demolition of structures), unless they are associated with activities that involve erection or substantial renovation of real property Calculating the appropriate IRC §199 deduction can be either simple or complex, depending on the nature and structure of the construction business. The IRS defines QPAI as all income derived from qualified production activities. If a company has more than one line of business and engages in nonqualified activities, then calculations are needed to determine which gross receipts qualify. If less than 5% of gross receipts are regarded as nonqualifying, then a de minimis rule applies and all gross receipts qualify.
arriving at QPAI IRC §199 DPAD was introduced in the American Jobs Creation Act of 2004, and included a 3% tax deduction for the 2005 tax year. That rate increased to 6% for 2007 and increased again in 2010 to the current rate of 9%. Construction activities in the U.S. that involve the building and renovation of residential and commercial properties qualify as domestic production activities. Section 199 DPAD is available to contractors, but not developers – unless the developer is also the contractor. Qualifying income is derived from activities associated with erecting or substantially renovating real property. Those qualifying activities encompass:
• The construction of commercial or residential buildings, including related architectural and engineering services
• The construction of oil or gas wells and similar structures • Infrastructure items, such as roads, sidewalks, sewers, utility lines, and railroad spurs
• Administrative activities directly connected to a construction project, such as secretarial and bookkeeping services
• Construction warranties, provided that the warranty is not separately stated from the amount charged for the construction and is not offered or bargained for separately with customers Nonqualifying activities include:
• Landscaping, painting, or other activities that are primarily
Standard Tax Deductions & Savings Each year brings tax code changes and provisions in effect for limited durations. Annual year-end tax planning for a construction company, though, should also take into consideration residual tax-saving concerns, including: • Deferring income to 2014, if possible: If cash flow and current income permit, defer income when possible. • Making additional charitable donations: Charitable contributions made before January 1, 2014, count as deductions for 2013. Such contributions may be cash, in-kind donations of materials, or a construction project itself. Be sure such donations are documented. • Writing off obsolete inventory: Damaged or obsolete inventory should be written off and disposed of to reduce carrying costs and garner tax deductions. • Writing off bad debt: The IRS allows self-employed individuals and companies to write off debt that cannot be collected. Supporting documentation (telephone logs, correspondence, contracts with collection agencies, etc.) should be maintained to prove reasonable efforts were made to collect that debt.
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Pass-through entities, such as partnerships and S corporations, must also ensure that costs and income are properly allocated among partners or shareholders.
Consult an employee benefits or tax professional for additional information regarding retirement and bonus planning.
Retirement Plan Contributions & Bonuses
The remainder of 2013 provides opportunities to address potential underpayments and obligations related to the new tax rates, the Additional Medicare Tax, and the Net Investment Income Tax.
Funding retirement plans and bonuses can reduce a construction company’s income subject to income tax while also providing a benefit to company shareholders and employees. For contractors, placing shareholder money into retirement plans provides an additional layer of liability protection in an industry where lawsuits are crucial risks. Construction companies also face difficulties in retaining key employees. Bonuses can serve as a retention tool for these employees. Company shareholders and employees may benefit from a variety of retirement plan options, including SEP, Keogh, and 401(k) plans. Implementing or providing additional funds to such plans reduces income tax burden, while also providing future benefits. Selecting the most appropriate plan depends on retirement goals, number of individuals to be included in the plan, and other factors. Benefits advisors and financial planners can provide additional information and insight. A company can also consider paying discretionary year-end bonuses as a means of reducing its tax obligation while also rewarding employees. Bonuses for 2013 may be deductible if they are paid within two and a half months of year-end (March 15 for businesses that base taxes on a calendar year). Such bonuses can be contingent upon reaching defined company goals related to sales revenue increases or other benchmarks. An S corporation may deduct bonuses for shareholders or owners who have any ownership stakes when the bonuses are actually paid, not accrued. A C corporation may only deduct bonuses for shareholders, or owners who have 50% or more ownership when the bonuses are paid.
CFMA Building Profits November/December 2013
Act Now to Save & Avoid Difficulties Later
While 2013 brought those new tax obligations, companies can also benefit immensely from the enhanced §179 deduction and bonus deprecation provisions. Other substantial tax savings opportunities can still be realized for 2013 as well, including the §199 deduction or a like-kind exchange tax deferral. In addition to those savings, there are items contractors should review at the end of each year to maximize potential savings, including writing off obsolete inventory and deferring income, if possible. (See sidebar) Acting now provides that savings and spurs thought as to what can be done to plan more effectively for the 2014 tax year, too. n CORY BUNYARD, CPA, is a Senior Manager in Tax and Strategic Business Services at Weaver in its Houston, TX office. He provides tax compliance and consulting services for corporations, partnerships, individuals, trusts, and estates in the construction and other various industries. Cory joined Weaver in 2007 upon graduating from Sam Houston State University, where he earned a BBA in Accounting. He is a member of CFMA’s Houston Chapter. Additionally, Cory belongs to the AICPA and Texas Society of Certified Public Accountants’ Houston Chapter. Phone: 832-320-3214 E-Mail: cory.bunyard@weaver.com Website: www.weaver.com