By: Bryan Porter
While it may seem late in the year for planning, there are a few simple, yet often overlooked, tax and cash flow planning opportunities that are available to most contractors that allow you to preserve the company’s balance sheet and conserve your cash position. It is important to be aware of and evaluate those opportunities now, as they are easy and important ways to set the company up for financial success in 2016.
Here are a few key tax and cash flow considerations that may add value to your company’s financial position as you begin a new year.
In recent years, the government has offered significant tax benefits related to accelerating depreciation on equipment purchases and capital improvements. Historically, Congress has not passed the “extender” legislation on bonus depreciation or increased section 179 benefits until late in the year, leaving a contractor very little time to plan and react to the incentives and purchase new equipment. The same holds true this year, which is why contractors exploring significant purchases during the first quarter of 2016 should consider making these purchases in 2015 in case legislation is passed to provide an increased tax deduction. The potential tax savings would need to be analyzed with any financial reporting and cash flow implications for 2015 and future periods.
Contractors should also revisit and update tax projections and related cash requirements based on the most current financial data available to assess the projected tax liability of the company and its business owners. Contractors who are projecting significant taxable income for 2015 should consider the tax benefits of pre-paying 2015 projected state income tax liabilities in December 2015 and should formulate a cash flow plan to assess any significant cash outflows for remaining federal tax liabilities in early 2016.
Contracts Less Than 10% Complete
Contractors should perform a detailed review of their work-in-progress schedules and identify any contract that has started by December 31, 2015 and is less than 10% complete at year-end. The IRS allows the gross profit from contracts less than 10% complete to be excluded for income tax purposes even if the company’s contract accounting method is traditional percentage of completion.
Home and Residential Construction Projects
Now is a good time for contractors to talk to their CPA about opportunities to defer profit and the related tax liabilities on construction projects directly or indirectly related to home or residential construction projects. While the rules are complicated, there may be significant tax savings available to both general contractors and subcontractors who participate in these types of contracts and the company may be able to defer all or a portion of taxable income until substantial completion of the contract. Deferring tax liabilities on these contracts will conserve cash that can be crucial to beginning new projects or investing in the infrastructure of the company.
Large contractors may receive a current tax benefit through a concept known as the “look-back” method. The IRS requires large contractors to revisit contracts that were in progress in prior years to make sure they recognized income (and paid tax) as it was earned on a project. For example, if a project was 80% complete at December 31, 2014 and was projected to result in $100,000 of profit at completion, then $80,000 should have been included in taxable income at December 31, 2014. If the contractor completed the project in 2015, but only earned $70,000 of profit due to unforeseen costs, then the company would be entitled to interest related to the overpayment of taxes in 2014. It is important to note the calculation also works in reverse and could result in additional tax liabilities on under-reported income.
Given the current demands and ever-changing construction marketplace, it is crucial that business owners and executive management teams have knowledge of available tax benefits that can be used to increase the company’s financial strength. A qualified, industry-savvy CPA can provide you a level of confidence in understanding the tax code and help you accomplish the financial goals set for your company in 2016.
BRYAN C. PORTER, CPA, MS, is a Principal in the Audit, Accounting and Consulting Department of Ellin & Tucker (www.ellinandtucker.com) in Baltimore, MD, where he advises privately held businesses in various industries including manufacturing, wholesale distribution, construction, technology and not-for-profit. Bryan is also a member of the firm’s Audit and Accounting Technical Standards Committee, which oversees programs designed to educate the firm and its clients on current accounting and business topics.