In December 2017, the Tax Cuts and Jobs Act (TCJA) was passed and resulted in sweeping changes to the tax code. Within this immense overhaul are two critical changes that all construction companies need to know about in order to stay ahead in their businesses. Some rules and planning strategies that worked in the past to limit taxable income are no longer available, while new regulations and guidelines have come out for tax years 2018 and beyond.
1.Threshold amount for reporting using the percentage-of-completion method versus the completed contract method
One change that takes affect for small- to medium-size contractors is the change in the threshold to report using the percentage-of-completion method versus the completed contract method. Before 2018, if the taxpayer’s average annual revenue was more than $10 million, they were required to file using the percentage-of-completion method. Going forward, the threshold to report using the percentage-of-completion is increased to $25 million.
The shift to a higher threshold will allow more taxpayers to defer revenue into later years because under the completed contract method, the taxpayer will recognize only the income (and the associated costs) for projects that are substantially complete. With the percentage-of-completion method, taxes are calculated on the portion of the contract that is complete, regardless of the stage of the project.
It is important to note that this change applies to contracts entered into after December 2017 and the average annual gross receipts test is calculated based on the prior three tax years. Therefore, if the taxpayer meets the $25 million average annual revenue test in 2017, they can still file under the completed contract method for 2018.
2.Elimination of the Domestic Production Activities Deduction
Another change that will have a significant impact on tax planning is the repeal of the Domestic Production Activities Deduction (DPAD). This deduction, which lowered taxable income by the lesser of 9 percent of net income or 50 percent of W-2 wages, has been eliminated and replaced by two separate changes.
- For Flow-through Entities (non-C Corporations), a new 20 percent deduction is calculated based on qualified business income. This deduction may be limited depending on a taxpayer’s taxable income. If the taxpayer has less than $157,500 of taxable income as an individual filer ($315,000 married filing jointly), they can deduct a straight 20 percent from the income. Above those income thresholds, there is a phase-out window that is used to calculate the total deduction based on the greater of 50 percent of W-2 wages or 25 percent of W-2 wages plus 2.5 percent of depreciable assets.
- C Corporations are not eligible for the above deduction; it is applicable only to pass-through entities. C Corporations are now taxed at a flat 21 percent, meaning many of those entities will see substantial tax savings.
For an outlook for residential and commercial builders, please see my article, .Construction Industry Outlook: What to Expect in 2018
For help with planning for the changes in 2018 and guidance about which new tax laws will have the most effect on your business, please reach out to me or another member of Yeo & Yeo’s Construction Services Group.