By: Bryan Porter
The following article appeared in the January 2016 issue of CMFA Bottom Lines. To view the article online, please visit Tax & Cash Flow Considerations for Contractors on CFMA’s website.
As the new year begins, here are a few key tax and cash flow considerations that can potentially preserve your company’s balance sheet, conserve its cash position, and accomplish a contractor’s long-term goals.
Contractors should take time to 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 owners. Contractors that are aware of significant taxable income from 2015 should formulate a cash flow plan to assess any significant cash outflows for remaining federal tax liabilities in early 2016. In addition to cash flow planning, considering common tax reduction strategies (e.g., accelerated depreciation on equipment acquisitions and special treatment of home and residential projects) can help ensure that you accurately project the ultimate tax liability.
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.
The current interest rate environment allows contractors that are considering transferring their business to the next generation some planning opportunities to do so in a cash- and tax-efficient manner. Successful family-owned businesses that have a capable next generation might be able to enter into a long-term note at a favorable fixed rate (must exceed the current Applicable Federal Rate as published by the IRS) with terms that allow for a balloon payment at a date 10 years or more in the future. The sale of a non-controlling interest in a growing company can help the business owner preserve his or her lifetime gift exclusion and motivate the next-generation buyer to continue to grow the company. With proper planning, business owners have the benefit of current low interest rates and retaining control of their company while working toward their eventual exit from the company.
Contractors should also consider the tax and cash flow benefits of a trust when discussing estate planning with their CPA or legal advisor. When structured correctly, an irrevocable trust can reduce the impact of significant estate taxes after death. Proper planning will ensure beneficiaries of the trust will receive significantly more value of your accumulated wealth (as opposed to receiving the assets directly from your estate). Irrevocable trusts are designed in many ways, and contractors should consider all benefits and conditions before opting to utilize this structure.
Given the current demands and ever-changing construction marketplace, it is crucial that business owners have knowledge of available tax benefits that can be used to increase the company’s financial strength and retain accumulated wealth. Consult with your CPA for assistance in understanding the tax code and accomplishing the financial goals set for your company in 2016 and beyond.
Bryan is a highly motivated and service-minded Director in Ellin & Tucker’s audit, accounting, and consulting department. He provides high quality audit, accounting and advisory services to many of the firm’s construction industry clientele. Bryan’s exceptional knowledge of industry technical trends has solidified his reputation as a well-respected member of the firm’s Construction Services Group.