Construction is one of the most complicated industries to understand from a tax perspective. With over 10 different accounting methods to choose from, different rules for small and large contractors, and a myriad of tax credits with complex eligibility rules, proper planning is key to ensuring your company maximizes its tax-savings potential.
As we approach 2024, here are even more end-of-year income tax preparation strategies a contractor can utilize.
Bonus depreciation or Section 179 elections. Available for fixed assets placed in service in the current year, both allow you to deduct the cost of qualified additions. For tax years beginning in 2023, the maximum section 179 expense deduction is $1.16 million. This limit is reduced by the amount by which the cost of section 179 property placed in service during the tax year exceeds $2.89 million.
The rules allow 100% bonus depreciation for all qualified purchases made between September 27, 2017 and January 1, 2023. Bonus depreciation ramps down to 80% in 2023 and continues to ramp down in ensuing years as follows: 60% for 2024, 40% for 2025, 20% for 2026, and 0% beginning in 2027. There are no limits on bonus depreciation.
A common tool to maximize the deduction under current tax law is to bunch necessary purchases in the years with the most projected income.
Accounting method. It's also time to evaluate your accounting methods. Chose the allowable method to create maximum tax deferral. The most common methods are cash basis, completed contract and percentage of completion. The right method can create an income tax deferral for several years, leaving more daily cash on hand.
Also, be sure to evaluate the following opportunities:
1. Energy Efficient Home Credit (Section 45L). Eligible contractors who build or substantially reconstruct qualified new energy efficient homes can qualify for this credit. Starting in 2023, the maximum credit available for single and multifamily homes is $5,000 per unit. The height limitation of four above-grade floors has also been eliminated, expanding this credit to more contractors than before.
2. Fuel tax credit. The excise tax included in the cost of gasoline funds the maintenance of highways and roads.
The IRS offers a tax credit to contractors who purchase fuel for eligible off-highway business uses, such as stationary machines, bulldozers, earthmovers, etc.
The credit is computed by the rate per gallon that the IRS allows for each fuel type. Since this is a credit (not a deduction), it is a dollar-for-dollar reduction of your taxes. If you are equipment-intensive, this can be a big savings.
3. Research & development (R&D) credit. Commonly underutilized by contractors, the R&D tax credit can be applied to any new or improved business component whereby a process or product is created or improved, such as work performed on a structure to enhance construction performance, development of a new technique to increase efficiency, research of new construction methods due to site conditions, and creation of a new tool or part.
A four-part test determines eligibility:
- Permitted purpose: Have you improved the functionality, performance, reliability or quality of a product/process?
- Technological in nature: Does the activity fundamentally rely on science, technology, engineering or math?
- Elimination of uncertainty: Is there a level of uncertainty that the R&D is attempting to reduce?
- Process of experimentation: Have you evaluated solutions through modeling, simulation or trial and error, even if the experiment was unsuccessful?
A product or process that meets all four criteria likely qualifies as R&D. Like the fuel credit, this is a dollar-for-dollar reduction of taxes and can be a substantial year-after-year savings.
4. Employee retention credit (ERC). It is not too late to pursue COVID-19 relief through the popular ERC program. If your business has less than 500 employees and was partially or completely shut down during the pandemic or suffered more than a 20% revenue decline in 2021 (or 50% in 2020), don’t overlook this payroll tax credit. Combined, the 2020-Q4 and 2021-Q1-Q4 ERC can equate to up to $33,000 per employee. Even if these quarters have passed, you can still amend Form 941 and request refunds.
It’s never too early to start planning 2024 tax strategies. Contact Ronald Eagar of Grassi at email@example.com.