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Minimizing Your 2014 Tax Liability: 8 Simple Questions To Think About Now


1/23/14

When is it best to begin the tax planning process? Many business owners tend to only think about tax credits, deductions, and other planning issues at the end of the year, and in relation to that year’s tax filings. Tax planning should be a 12-months-a-year exercise. Even though business decisions are not based on tax consequences alone, they are an important component of maximizing cash flow and profitability.

Take time now to look ahead and consider addressing the following questions early in the year.  This could help minimize the tax bite of 2014 tax filings.

1. What will I spend on equipment, including repairs and maintenance?

As of this writing, the fate of bonus depreciation for 2014 and beyond is still in play. This lucrative tax benefit has become one of the political footballs commonly referred to as “tax extenders.” Regardless of whether and when it is extended, remember that you can claim bonus depreciation for any equipment placed in service in 2013.

Looking forward, routine repairs and maintenance on existing fleets of equipment also present opportunities to write-off expenses in the current year. With its final repair regulations, effective January 1, 2014, the IRS attempted to bring to an end years of uncertainty and controversy over the distinction between a capital improvement and a deductible repair. The rules are complex and full of nuance, so construction companies with fleets of vehicles and equipment will want to look carefully at the new regs to determine whether a change in income tax accounting method is warranted.

Deductible Repair or Capitalized Improvement?

Under the finalized repair regulations, replacing the engine of a road grader with the same type of engine may qualify as routine maintenance, and thus be treated as a deductible repair. If the engine is replaced with a more powerful and/or efficient one, it does more than return the property to its ordinary and efficient operating condition. Therefore, it must be capitalized.


The final repair regulations also allow a taxpayer to deduct rather than capitalize the acquisition cost of tangible property up to a specified threshold. For businesses with audited financial statements, that threshold is $5,000 per invoice or per item substantiated by the invoice. For companies without audited financial statements, the threshold is $500. Keep in mind that the company must have a written capitalization policy in place at the beginning of the year in which the property was placed in service to qualify for this safe harbor.

2. Have I bought or am I considering buying a heavy SUV or truck?

When considering a vehicle to purchase for business use, keep in mind that depreciation deductions for so-called “luxury autos” are capped. For example, if you placed a business vehicle in service in 2013, the combined depreciation and expensing deduction could not exceed $11,160 regardless of the cost of the car. However, if this was a truck or a sport utility vehicle (SUV) with a loaded weight that is more than 6,000 pounds, but not greater than 14,000 pounds, up to $25,000 of the cost can be expensed and annual depreciation deductions can be claimed for the balance of the cost.  Many common full-size pickup trucks with cargo box areas of at least six feet in length are not subject to the “luxury autos” or “heavy SUV” depreciation limits and can yield even greater tax deductions.

However, be forewarned that if business use of the vehicle does not exceed 50% of total use, the SUV or truck is not eligible for expensing and must be depreciated on a straight-line method.

Under the finalized repair regulations, replacing the engine of a road grader with the same type of engine may qualify as routine maintenance, and thus be treated as a deductible repair. If the engine is replaced with a more powerful and/or efficient one, it does more than return the property to its ordinary and efficient operating condition. Therefore, it must be capitalized.

3. Am I investing in research and development (R&D)?

Considering that the industry involves constant innovation, too few construction contractors take advantage of federal and state research and development (R&D) tax credits. Another perennial “extender,” the federal R&D credit was introduced to encourage innovation and business growth. Recent court decisions have loosened the “discovery test” restrictions and documentation requirements to make it more business-friendly.

Activities that qualify for the federal R&D tax credit include those aimed at developing the construction process for a specific job or improving the efficiency of overall process performance. While design/build, value engineering, and LEED projects present the greatest opportunities for innovation, pre-construction planning and development of means and methods for plan-spec and hard-bid jobs also can qualify. The bottom line: If your company has invested time, money, and resources toward the advancement and improvement of designs and processes, then you likely meet the requirements for the R&D tax credit.

R&D Credits Reduce Contractor’s Tax Bill by $325,000

A construction company with annual sales of $25 million developed the means and methods to improve two boilers and associated piping for a medical center. Because the hospital needed the boilers to be operational at all times, the contractor designed a temporary system and associated piping to enable continuous functionality during the replacement of the system. These developments, which improved the efficiency of the building, qualified for more than $325,000 in federal R&D tax credits.


4. Are the government buildings I have designed energy efficient?

If a construction company was the primary designer of a government-owned, energy-efficient building, there may be an opportunity to claim the 179D Energy Efficient Commercial Building Deduction (assuming that it is extended). The Energy Policy Act of 2005 enacted Section 179D, which provides a deduction of up to $1.80 per square foot to owners of energy-efficient commercial buildings.

When a government agency owns the building, however, the tax benefit can be transferred to the primary designer of the building. The primary designer is the person who creates technical specifications for installation of energy-efficient commercial building property including an architect, engineer, contractor, or environmental consultant. Note that installation, repair, or maintenance of property does not meet this definition.

To qualify for the 179D deduction on a government-owned building, the designer must secure a letter that assigns the tax benefits from the government agency to the contractor. If more than one entity is responsible for creating the technical specifications of the building, then the building owner can either determine which designer is the primary one or allocate the deduction between the designers. The significant tax benefits of this provision mean that it might be worthwhile to bring it to the attention of the building owner, architect, or engineer.

5. Do I withhold significant retainage from my subcontractors?

In addition to tax credits and accelerated depreciation deductions, contractors also stand to improve their tax efficiency through alternate methods of accounting. In particular, contractors with significant retainage payable can defer taxable income into future years. This only applies if a business has taxable income and significant retainage payable and a Form 3115 Application for Change in Accounting Method must be filed. Because IRS approval can take months, talk to a tax advisor now about the potential tax-saving opportunities of a change in accounting method. Also, keep in mind that changing the method of accounting without filing a Form 3115 requesting permission to change accounting methods is not permitted. Be sure to secure IRS approval first.

6. Am I properly accounting for employees’ expenses and reimbursements?

While the above points explore opportunities to lower your tax bill, another important component of tax planning involves avoiding penalties and interest by ensuring compliance with all applicable federal, state, and local tax laws.

One perennial area for IRS scrutiny is how the business reimburses employees’ expenses. Some contractors use a “nonaccountable plan” to reimburse travel and entertainment expenses. This means that the construction company allocates to an employee a certain amount (say $200 per week) to cover travel expenses. However, the company owner may not realize that unless the employee submits receipts to account for those expenses, that income is taxable.

Another common (and incorrect) approach is the “tool allowance” where the construction company allocates a certain amount each week to reimburse specialized employees for use of their personal tools. Unless the worker is being reimbursed for a specific tool or equipment purchase, that income will be considered taxable.

7. Are my contract workers really employees?

Worker classification continues to prove a confusing area of the law – and a potentially expensive one. If the IRS determines that a worker who was designated an independent contractor is actually an employee, the employer will owe back payroll taxes, potential interest and penalties. Soon, that employer may also owe stiff penalties under the Patient Protection and Affordable Care Act (PPACA) if those reclassified employees push the company into the “large employer” category.

The determination of whether a worker is an independent contractor or an employee generally turns on the degree of control the employer has over the worker. It is advisable to consult a labor lawyer to ensure best practices are followed with regard to classifying workers.

8. Have I expanded my operations into new states?

Contractors also can get tripped up when their operations cross state lines. One common area of confusion involves sales and use taxes. Generally, a contractor is deemed to be the end user of materials purchased in the construction of a building. Therefore, the contractor is responsible for paying sales and use taxes. One problem occurs when the materials are shipped to a location in one state and then delivered to a different state. Depending on the states involved, the contractor will likely owe sales and use taxes in both jurisdictions. If sending people or materials across state lines, ensure compliance with the state and local tax rules in each state.

What Does CohnReznick Think?
Remember that tax planning should be an ongoing process. Once you have wrapped up your 2013 tax filings, keep a focus on the future. In particular, pay attention to Congressional activity regarding the “tax extenders”— including bonus depreciation, the R&D tax credit and 179D. Most important, maintain a continuous dialogue with a tax advisor to identify ongoing opportunities to grow business in the most tax-efficient way.

Contact

For more information, visit our Construction Industry Practice webpage and contact Joseph Tighe, Partner, at 973-618-6243, or Jack Callahan, Partner and Construction Industry Practice Leader, at 732-380-8685.


Circular 230 Notice: In compliance with U.S. Treasury Regulations, the information included herein (or in any attachment) is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of i) avoiding penalties the IRS and others may impose on the taxpayer or ii) promoting, marketing, or recommending to another party any tax related matters.

This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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