The Tax Cuts and Jobs Act made sweeping changes to how businesses and owners are taxed in construction, contracting and real estate development. Taxpayers are advised to strategically evaluate the new provisions associated with the act to ensure their goals are realized and aren’t negatively affected by the new law.
Here are six items for business owners in the construction, contracting and real estate development industries to consider.
1. Limited interest deduction.
Large contractors and developers need to be mindful of the impact of Internal Revenue Code Section 163(j) on the deductibility of interest. Under the act, interest expense is limited to 30% of the taxpayer’s adjusted taxable income. This limit on interest applies when taxpayers have greater than $25 million of gross receipts. Conceptually, this wouldn’t seem to apply to many taxpayers; however, in practice – due to the required control group testing – the gross receipts of related businesses are taken into account in determining the $25 million gross receipts test.
For example, interest expense for a real estate holding company might be limited where there is common ownership with a contractor that has gross receipts in excess of $25 million.
2. Meals and entertainment changes.
Under the act, the deductibility of meals and entertainment has changed. Now, entertainment-related expenses are generally nondeductible. Business meals are generally allowed a 50% deduction, except for certain employee-appreciation activities, such as company picnics or holiday parties, which are still fully deductible. The real burden associated with the new provisions is related to bookkeeping and the creation of additional expense accounts to allow for separate tracking of entertainment and meals, as these expenses were traditionally grouped together.
3. Accounting methods.
Prior to the act, taxpayers with gross receipts in excess of $10 million were required to recognize income using the percentage of completion method of accounting for long-term nonresidential contracts. This threshold is now increased to $25 million, allowing more contractors to adopt other, more taxpayer-friendly accounting methods.
4. Depreciation changes.
The act expanded the application of 100% bonus depreciation and section 179 (immediate expensing provisions) related to capital expenditures. This means 100% bonus depreciation can be taken on both used and new equipment purchases. In addition, section 179 provisions were permanently increased to $1 million – as adjusted for inflation – and assets eligible for section 179 now include certain nonresidential property improvements, such as roofs, HVAC, security and fire systems.
5. Qualified business income deduction.
While the act eliminated the domestic production activities deduction that most contractors and trade-related businesses were accustomed to claiming, it was replaced with the qualified business income deduction. This new provision allows for individuals to claim a deduction of up to 20% of QBI earned from pass-through entities. With various potential limitations and requiring a complicated analysis, it also requires additional information to be reported to the owner of the pass-through entity. The QBI deduction is unavailable to corporate entities taxed as C corporations.
6. Choice of entity structure.
Although corporate taxpayers are not afforded the advantages of the QBI deduction, the decrease of corporate tax rates to a flat 21% can make the C-corp structure attractive to businesses that want to retain and grow equity within the entity. It’s advisable to revisit and evaluate the overall entity structure to determine if flow-through status continues to be tax-advantageous.
As a result of the act, taxpayers have more options to consider when developing their overall tax strategy. Because of the additional complexity and flexibility, tax planning is critically important.
Nathan Fitzgerald is a senior manager at BKD LLP. He can be reached at firstname.lastname@example.org.
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