The Tax Cuts and Jobs Act that was signed into law last December is the most sweeping U.S. tax reform legislation in more than 30 years. It includes a number of provisions that are beneficial to U.S. businesses — and construction firms, in particular.
Lower Tax Rates and More
For starters, the tax reform act replaces the graduated corporate income tax schedule — which featured a top rate of 35 percent — with a flat tax rate of 21 percent. This means construction firms structured as C corporations will pay corporate taxes at a flat rate of 21 percent.
However, many construction firms are structured as pass-through entities, such as S corporations, sole proprietorships, partnerships and limited liability companies (LLCs). The tax reform includes a new 20 percent deduction of qualified business income for these construction firms, subject to certain limitations. This deduction is effective for tax years 2018 through 2025.
In addition, the tax reform act repeals the 20 percent corporate alternative minimum tax (AMT). This tax required construction firms to maintain two separate sets of books, which was both cumbersome and costly. The repeal of the corporate AMT will greatly simplify accounting and bookkeeping for many construction firms while lowering these associated costs.
Beneficial Depreciation Changes
Many construction firms rely heavily on new and technologically advanced equipment in order to remain competitive. The tax reform act makes significant changes to how equipment is depreciated that will be beneficial for many construction-related businesses.
Specifically, the deduction for first-year bonus depreciation has been doubled from 50 percent to 100 percent for qualified assets placed in service after September 28, 2017, and before January 1, 2023. After this date, bonus depreciation will phase out until it vanishes in 2027. Importantly, bonus depreciation is now available for both new and used assets. Previously, it was only available for new assets.
Also, Section 179 expensing — which allows eligible construction firms to deduct the entire cost of new or used depreciable property in the first year — has been nearly doubled, from $510,000 to $1 million for property placed in service in tax years beginning in 2018. This increase is permanent, and the amount will be indexed for inflation in future years.
More Provisions to Note
Before tax reform, the taxable income from long-term contracts was generally determined using the percentage of completion accounting method, but there was an exception for construction firms with $10 million or less in average annual gross receipts in the preceding three years. Such firms could use the completed contract method for contracts that were expected to be completed within two years.
Now, this $10 million exception threshold has been increased to $25 million. If your firm has $25 million or less in average annual gross receipts in the preceding three years, you can use the completed contract method of accounting or any other permissible exempt contract method you choose. This change is effective for contracts entered into after December 31, 2017.
The tax-free status of private activity bond financing has been retained by the tax reform act, which will generally benefit the public construction sector. Energy-related and exploration tax credits, such as the wind sector’s production tax credit and a tax credit for the purchase of electric vehicles, were also retained.
Unfortunately, the domestic production activities deduction (DPAD) has been repealed. Before tax reform, businesses performing construction-related activities in the U.S. could deduct 9 percent of the income from these activities. However, this deduction is no longer available, effective for tax years beginning after December 31, 2017.
Please contact us if you have more questions about how tax reform could affect your construction firm.