The New Tax Law & Your Construction Business
The Tax Cuts and Jobs Act (TCJA) brought the most significant changes to our country’s tax law in over thirty years when it was signed into law on December 22, 2017. Most of the changes in the new law first applied to 2018 tax returns, so it’s our first chance to really see its impact. Since December of 2017 there have been several notices and regulations clarifying the new tax law, but further guidance is still needed in many areas. In this article, we’ll take a look at some of the key issues impacting businesses, particularly those businesses in the construction industry.
Qualified Business Income (QBI) Deductions Clarified
TCJA introduced a new deduction under IRS Code Section 199A for up to 20% of an eligible taxpayer’s qualified business income (QBI). Final regulations clarifying Section 199A were released in late January. The deduction, which is not available to C corporations, is calculated based on the qualified business income of each trade or business, subject to limitations based on wages and fixed assets. If the individual taxpayer’s taxable income is under $157,500 ($315,000 married filing jointly), the taxpayer is not subject to these limitations.
The final regulations added the option to aggregate at the entity level, reducing the reporting obligations of the taxpayer. This is welcome news for many contractors, as it is common in the construction industry to have multiple entities for different geographic regions or service lines.
Aggregation can also be done at the individual level, allowing a taxpayer to combine activities that would otherwise be limited from taking the deduction. This individual level of aggregation now allows a taxpayer to combine wages and assets to maximize the QBI deduction. This aggregation will also simplify the new tax return disclosures required under the Tax Cuts and Jobs Act.
Assuming the individual taxpayer’s taxable income is in excess of the thresholds, the 20% deduction is limited based on a percentage of the entity’s wages and/or fixed assets. The final regulations also allow the entity to include wages of common law employees paid by another entity. This could be a significant benefit for related entities that may have differing ownership or those who use staffing companies, certainly something seen often in the construction industry.
It’s also important to carefully analyze other planning opportunities and pitfalls. It will generally be beneficial for partners to take distributions in lieu of guaranteed payments since guaranteed payments don’t qualify for the 20% deduction. Also, entities will need to monitor the level of any consulting or other specified service income within an otherwise qualified trade or business. Specified service income over thresholds could cause an entire trade or business to be disqualified.
Bonus Depreciation and Section 179 Changes
Most owners of construction companies can never have enough equipment! Many of these businesses are smart and buy new equipment for economic reasons and not for tax reasons. If it’s necessary to buy new equipment to grow your company, some changes in bonus depreciation can really pay off. In fact, we’ve seen an increase in activity in the buying and selling of construction companies because this same rule applies to equipment acquired when you buy a new construction business.
The TCJA expanded accelerated depreciation, increased the Section 179 limits, and allows for 100% bonus depreciation on both new and used property. There are not any limits on the amount of bonus depreciation that can be taken, but Section 179 is still limited by the asset acquisitions of the taxpayer as well as taxable income. Qualified Improvement Property, a new class of property, includes nonresidential improvements to the interior of a building. Qualified Improvement Property is eligible for Section 179 depreciation, but currently is not eligible for bonus depreciation due to technical oversights when the TCJA was drafted.
Meals and Entertainment Deductions: Not What They Used to Be
In the past, taxpayers could deduct 50% of the costs of business-related meals and entertainment expenses. The new tax law has eliminated any deduction for entertainment-related expenses. In general, the 50% deduction remains for most business-related meals, and the 100% deduction for employee social and recreational meals still exists.
Ohio Municipal Income Tax: Easier Filing
Beyond the federal tax law changes, there have also been significant changes to Ohio municipal income taxation. This was the first filing season allowing business taxpayers to file a single, combined municipal income tax return instead of filing separate returns for each city. This is a welcome change for contractors working in communities across Ohio, eliminating the need for potentially dozens or maybe hundreds of separate filings. Before a business can begin filing a combined return, it must first make a one-time election and notify each of the cities within 60 days of the beginning of their tax year. Businesses with a December year end would have had to file the election by March 1, 2019 in order to be able to file a combined 2019 return.
The application of the new tax law can be complicated for both individuals and businesses. It’s safe to say we can expect to see more clarifications from the IRS in the months ahead. While the Tax Cuts and Jobs Act simplified tax filing for some of the most basic tax returns, many taxpayers and businesses are likely to struggle to digest and apply the new law now and for some time to come.
CPA Mary Jo Pitzen contributed this article. It was also published in the May 2019 edition of the CFMA Northwest Ohio Ledger, the organization's online newsletter. Mary Jo is a senior tax manager at Gilmore Jasion Mahler, LTD. She is a member of the firm’s Construction & Real Estate Specialist Team. Mary Jo is also a member of the Northwest Ohio chapter of the Construction Financial Management Association (CFMA) and the Toledo chapter of The National Association of Women in Construction (NAWIC).
Established in 1996, Gilmore Jasion Mahler, LTD (GJM) is the largest public accounting firm in Northwest Ohio, with offices in Maumee and Findlay. Locally owned, GJM offers cloud-based accounting and provides comprehensive services including assurance, business advisory, tax, risk advisory, healthcare management and outsourced accounting. The Firm’s professionals specialize in industries including construction & real estate, healthcare, manufacturing & distribution and utilities.