Presented By: Grassi Advisors & Accountants
Grassi Shows Construction Pros How to Maximize Tax Incentives, Cash Flow Strategies
Grassi Advisors & Accountants has been providing accounting and consulting services to the construction industry for more than 40 years. The Commercial Observer Partner Insights team spoke with Grassi’s Construction Practice Leader, Carl Oliveri, about key tax planning strategies for the construction industry.
Commercial Observer Partner Insights: What are some of the most overlooked tax incentives in the construction industry?
Carl Oliveri: One overlooked credit for the construction industry is related to research and development. When most people hear the term R&D, there is this preconceived notion of white lab coats. But R&D credits, which are wage-based, could be applicable for any company that is innovating their deliverable. For a construction contractor, investments in ways to build better could qualify for R&D credits. And as a credit, it is a dollar-for-dollar reduction of the contractor’s income tax liability.
Another common oversight is not electing the appropriate accounting method for income tax purposes. The Internal Revenue Code has specific guidelines for the construction industry. Based on the nature and length of the construction project, a contractor could have the opportunity to elect the most advantageous method on a project-by-project basis, as compared to an overall reporting method. Exploring this concept with a tax professional could help the contractor develop a proactive income tax deferral strategy.
How do tax strategies differ for larger contractors versus smaller contractors?
Gross receipts will dictate the income tax reporting method options for a contractor and, subsequently, the income tax deferral strategies we recommend.
For larger contractors, we will determine whether they should use a blended method. For example, if the contractor’s method is percentage of completion, we would look to elect the “10% method,” which allows the contractor to defer the gross profit for any project that is less than 10 percent complete. By contrast, a smaller contractor may be on the cash basis, in which case, we will help them manage their cash receipts and disbursements to maximize their income tax position.
What are the current tax incentives for green building?
First and foremost, any innovation that the construction company undertakes to incorporate green building into their processes should be looked at for R&D credit opportunities.
In addition, the Consolidated Appropriations Act (CAA), passed in December 2020, made the Section 179D deduction permanent. This is good news for contractors who make energy-efficient improvements to federal buildings, including lighting, HVAC and the building envelope, as they could qualify for this deduction of up to $1.80/sf ($0.60 each/sf).
What COVID-related tax incentives can contractors take advantage of, even if their projects were deemed essential during the pandemic?
The Coronavirus Aid, Relief and Economic Security Act (CARES Act) introduced us to several tax incentives to help businesses through the thick of the pandemic, including the well-publicized Paycheck Protection Program.
Two provisions of the CARES Act that construction companies may not have taken advantage of were the option for companies to defer their share of 2020’s Federal Insurance Contributions Act (FICA) tax, half of which is due Dec. 31, 2020, and the balance by Dec. 31, 2021); and employee retention credits, which are refundable credits against the contractor’s share of social security tax.
The original provisions of the CARES Act were amended by CAA, making these credits more accessible and valuable to contractors. If a construction company with less than 300 employees has experienced a 20 percent decline in gross receipts in the first and second quarters of 2021 as compared to 2019, they should consider this credit.
How does a contractor’s choice of accounting method affect their tax savings potential?
Determining what income tax reporting method a construction company is on could be governed by the Internal Revenue Code. For example, if a contractor’s average annual gross receipts for a three-year period is more than $26 million, the company can no longer be on a cash-basis method; it automatically changes to an accrual-basis method (more likely than not, percentage of completion).
However, a construction company could have more than one method based on each type and length of the contract. Proactively planning what method(s) to adopt is the first step in developing a proactive income tax deferral strategy. And the real power lies in forecasting how projects are going to finish so that the contractor can plan when to unwind the deferral. This process, performed in conjunction with cash flow forecasting, will empower the construction contractor to maximize the balance sheet.
What is your advice on structuring a construction company for maximum tax benefit?
The first step is to collaborate with a CPA or tax professional to understand the different methods available and marry those methods to the contractor’s long-term strategy. Most start-up companies are going to start on a cash basis, but if they expect explosive growth within the first couple of years, the contractor may want to consider an accrual basis to start maximizing income tax deferrals.
What strategies best address the cash flow challenges that contractors face?
The tried-and-true financial management tools, such as cash flow forecasting on a project-by-project basis, are essential to understanding and preparing for fluctuations in cash flow. The purpose of this process is to identify the peaks and valleys of each project’s cash cycle. With this knowledge, the contractor’s financial management team can identify when cash flow, either project-specific or company-wide, will be in the red, and can proactively mitigate this with the luxury of time.
How can a cost segregation study reduce a contractor’s tax liability?
This comes into play when a contractor owns real estate. A cost segregation study allows the contractor to segregate the cost of the building among its components, such as the structural steel, windows, doors, electric, HVAC, etc. Under the Internal Revenue Code, each of those components has a different useful life.
So, rather than depreciating the cost of the property over 39 years, a cost segregation study breaks down the components of the property, assigns monetary values, and enables the owner to accelerate depreciation on the property over the components’ useful lives, typically shorter than 39 years.
How do contractors take advantage of the bonus depreciation aspects of the CARES Act related to qualified improvement property?
The CARES Act cleaned up some of the language in the Tax Cuts and Jobs Act on what qualifies as a leasehold improvement and can be depreciated over 15 years. For interior, non-structural improvements, a contractor can file a Form 3115 and change the depreciable useful life from 39 to 15 years. Once that election is made, these qualified property improvements can also qualify for bonus depreciation.
Individually, how can construction company owners make the most of the depressed economy and plan for additional tax savings?
For years, construction company values have been high. The recent changes in the economy have brought lower valuations, which can be used for estate planning purposes. By gifting shares of the company to whomever the contractor wants to see as future ownership (a trust, children, the spouse, etc.) when values are low, the contractor can maximize gifting assets out of their estate under the lifetime gift tax exemption, which is currently $11.7 million.
Is there anything else you’d like to address that we have not yet discussed?
Contractors do not go out of business because they don’t have work. They typically go out of business because they don’t have cash flow. I cannot emphasize enough the value of tried-and-true financial management tools, such as project-by-project cash flow forecasts and budgeting. These tools were developed to help contractors identify where their business is going to be profitable, or where it could be in trouble. The more information they have, the stronger and more prepared they will be for whatever is around the corner.
Carl Oliveri, CPA, CCIFP, CFE, MBA is the construction practice leader at Grassi and can be reached at email@example.com.