Many of the provisions in the recently passed Tax Cuts and Jobs Act will save contractors money, as well as provide some great opportunities to accelerate deductions and defer taxes to later years.

The rate reduction for C corporations to 21 percent from the previous top rate of 35 percent is one of the most heralded changes. The previous graduated rate scale was reduced to just a single rate of 21 percent. This lower rate will be a blended rate for fiscal year companies, giving them the benefit of part of the lower rate for the part of their fiscal year that is in 2018. 

Contractors that can accumulate earnings will be able to do so at this fixed, lower rate. Even owners of C corporations that cannot retain earnings at that lower rate will have the benefit of lower personal tax rates for payments from their company as dividends or compensation. 

In addition to a lower top tax rate, the law eliminates the alternative minimum tax (AMT) for C corporations. 

Owners of S corporations will have several layers of tax savings, as the legislation added a new 20 percent deduction calculated at the company level for the pass-through income that will pass to the owners’ personal tax returns where the top rate was decreased to 37 percent from the prior 39.6 percent. 

Owners who are not in the top bracket also will generally have lower rates for their tax calculation. While the AMT was not eliminated for personal tax returns, it is likely that many contractors will still experience that tax, which acts as a pre-payment of tax for contractors using deferral methods, such as the completed contract method (CCM) or the cash or accrual method.

IRC 199A

The new 20 percent deduction, the Internal Revenue Code (IRC) section 199A for pass-through businesses, is similar to the 9 percent domestic production activities deduction of IRC 199, which the new law eliminated after 2017. 

Previously, the 9 percent deduction was available to most construction contractors, both C and S corporations, depending on the contractor’s type of work, but the new 20 percent deduction of IRC 199A is only for pass-through businesses, such as S corporations and partnerships. 

These two parts of the IRC sound similar, have some similar types of calculations and limitations, but are in fact two very different sections of the code. 

SALT Deductions

The new law does cause some inequities between the treatment of state and local taxes (SALT), such as income taxes, on construction companies’ earnings. 

For example, if a C corporation had state income taxes of $100,000, that were fully deductible by the company under both the old and the new law. The new law limits the SALT itemized deduction on personal returns to $10,000. The SALT income tax on the earnings of an S corporation will not have that same full deduction as a C corporation. 

Many states already are planning possible changes to their state tax systems to bypass this limitation, such as an entity-level tax on S corporations rather than the current pass-through.

PCM, CCM and Cash Method

Contractors are required to use the percentage of completion method (PCM) for long-term contracts when their average annual gross receipts (AAGR) exceed a specified dollar amount. This AAGR, which is based on the prior three years, used to be $10 million, but the new tax law increased it to $25 million, making the CCM and other methods once again available for long-term construction contracts entered into after 2017. 

Contractors that previously exceeded the $10 million threshold, but are under the $25 million level, will now be able to easily return to their prior tax accounting method and the benefits of the CCM, the cash method or an accrual method.

Previously, $10 million was the threshold for the required use of the PCM for long-term contracts. A contractor also will have an accounting method for all its other income, including income from contracts that do not meet the definition of being a “long-term” contract. It could be the cash method or an accrual method.  

The prior law had dollar limits on the use of the cash method, which also have been raised to the new $25 million threshold. 

For example, under prior law, a C corporation contractor with AAGR exceeding $10 million was required to use the PCM for its long-term construction contracts and an accrual method for other income. If that contractor had a contract that was not long term, which may have completed in December and billed in January, that January billing would be income in the prior year, which ended in December. Under the new law, that contractor could elect, or revert to, the cash method and in the future defer that January billing to the next year. 

Equipment Investments

Previously, contractors could exclude the gain on the trade of equipment. For example, if a fully depreciated excavator valued at $50,000 was traded for a new one, the $50,000 tax gain was not recognized in the trade transaction. 

The new law removes the benefit of that exclusion on all trades except for real estate so the new equipment can be fully expensed. This full expensing produces the same net benefit of the prior deferred gain on the trade and the expensing of new equipment as the net benefit of the new rules on a taxable trade with the new equipment fully expensed. 

For example, if the fully depreciated excavator with a value of $50,000 was previously traded for a new one priced at $250,000, the net difference of $200,000 could be expensed or depreciated. Under the new tax law, the traded excavator will have a taxable gain of $50,000 and the new one can have a write-off of $250,000, producing the same net result. 

The law expands expensing compared to the prior rules. The 50 percent expensing under Section 168(k) of new equipment has been expanded to 100 percent for most equipment, whether new or used, if it was not previously used by the same company, such as with a prior lease. 

Section 179 expensing, previously limited to $500,000, has been increased to $1 million. These expanded percentages and limits will allow contractors to write off most, if not all, equipment in the year it is acquired and placed in service.

Net Operating Loss Carryback

Not all the news is good news considering the cyclical nature of the construction industry. The new tax law eliminates the net operating loss carryback, which was extremely helpful for many contractors to recover prior tax paid during the recent economic downturn. 

The new law eliminated the carryback and expands the carryover to an indefinite number of years. The loss carryover is also limited to 80 percent of the income in those future years. This provision of the law may not be attractive to contractors when the economy turns down again in the future.

Other changes that may not be significant, but are certainly noteworthy, are the elimination of the deduction for entertainment costs and the 80 percent deduction for contributions to colleges if the donation is tied to the right to purchase seating at events. 

Still, the overall benefits of the new tax law will greatly outweigh the loss of some deductions for many contractors.