Year-End Tax Planning for the Construction Industry
With the holiday season fast approaching, many of us are gearing up for family gatherings and a return to normal life post-pandemic. However, plenty of headaches remain. Businesses are dealing with sky-high inflation not seen in the last 40 years. There is a potential recession on the horizon. And in the construction industry, labor shortages abound.
Here are several items we advise our construction clients to keep in mind for 2023 planning and beyond.
Employee Retention Tax Credit
Businesses can no longer pay wages to claim the Employee Retention Tax Credit, but they have until 2024 (and in some instances 2025) to look back on their pandemic payroll to retroactively claim the credit by filing an amended tax return.1 Businesses have until April 15, 2024, to file amended returns for Q2, Q3, and Q4 of 2020, and until April 15, 2025, to file amended returns for Q1, Q2, and Q3 of 2021.
An eligible employer could potentially qualify for a total credit of $26,000 per employee for the last three quarters of 2020 and the first three quarters of 2021 combined (there is a $5,000 maximum per eligible employee in 2020 and a $7,000 maximum per eligible employee for quarters 1-3 in 2021).
Bonus depreciation allows business taxpayers to deduct additional depreciation for the cost of qualifying business property, beyond normal depreciation allowances. It’s intended to spur capital purchases by all business taxpayers, small, mid-sized, and large.2 Under the Tax Cuts Jobs Act (TCJA), businesses can deduct 100% of cost of acquiring a qualified property between September 28, 2017, and December 31, 2022. It will be limited to 80% in 2023 and 60% in 2024 until it fully sunsets at the beginning of 2027.
Research and Development Expenses
The Tax Cuts & Jobs Act (TCJA) of 2017 required any research and development costs incurred after 2021 to be amortized ratably over five years, rather than deducted in the year the costs are incurred (or amortized over five or 10 years at the election of the taxpayer, subject to specific requirements).3
Meal and Entertainment Deductions
Beginning January 1, 2023, meal and entertainment deductions will revert to tax rules under the TCJA. The passing of the Consolidated Appropriations Act of 2021 temporarily changed these deductions for tax years 2021 and 2022. For tax year 2023, many of the meal and entertainment deductions will be reduced from 100% deductibility to 50% deductibility.
Net Operating Losses
When projecting losses in 2022, it is important to note that the net operating loss rules under the TCJA are back in effect beginning with tax year 2021. Most taxpayers no longer have the option to carryback a net operating loss (NOL) — most, NOLs arising in tax years ending after 2020 can only be carried forward. The two-year carryback rule in effect before 2018 generally does not apply to NOLs arising in tax years ending after December 31, 2020. The Coronavirus Aid, Relief, and Economic Security (CARES) Act provided for a special 5-year carryback for taxable years beginning in 2018, 2019, and 2020. Also, losses arising in taxable years beginning after December 31, 2020, are limited to 80% of the taxable income.
Excess Business Loss Limitation
Non-corporate taxpayers such as individuals, trusts, and estates are not allowed to claim a deduction for any excess business loss. Any disallowed excess business losses are treated as net operating losses for the current year, and this informs any NOL carryover to subsequent tax years. The at-risk limits and passive activity limits are applied before calculating any excess business loss. An “excess business loss” is the excess of the taxpayer’s aggregate trade or business deductions (determined without regard to the limitation of the provision), over the sum of the taxpayer’s aggregate gross trade or business income or gain, plus the threshold amount which for 2022 is $540,000 for joint returns and $270,000 for any other filing status.
Section 163(j) Business Interest Deduction Limit
A taxpayer’s deduction of business interest expense paid or incurred for the tax year is generally limited to the sum of:
- The taxpayer’s business interest income for the tax year for which the taxpayer is claiming the deduction (not including investment income) and;
- Thirty percent of the taxpayer’s adjusted taxable income (ATI), but not less than zero.
Pass-through Entity Tax Election
The TCJA limited individual taxpayers’ state and local tax deduction to $10,000. In response, many states (more than half, as of now) have enacted some form of ”workaround” to minimize the limitation’s impact on self-employed (Schedule C) individuals and taxpayers who own pass-through entities.
The pass-through entity tax (PTE) allows partnerships and S-corporations to elect to be taxed at the entity level for state income tax purposes. If the entity makes this election, the partner or shareholder is usually allowed to claim a credit on their state individual income tax return for the amount of their distributive share of the pass-through entity tax paid by the partnership or S-corporation. This election also allows the partner or shareholder to not report their distributive share of income on their personal state income tax return.
Inflation Reduction Act
The Inflation Reduction Act of 2022 was officially signed into law by President Biden on August 16, 2022. The bill has significantly expanded two key federal tax incentives to promote energy efficiency: the 179D deduction and 45L tax credit.
The 179D Deduction
The 179D deduction is permanent within the law, allowing government-owned building owners to allocate special tax deductions to their architects, engineers, and contractors who design the building’s energy-efficient systems. This deduction had a maximum of $1.88 per square foot in 2022. The bill includes significant changes in four main areas:
- Starting in 2023, the maximum deduction will rise to $5 per square foot if prevailing wage and apprenticeship requirements are met.
- It significantly expands the list of eligible buildings to include other tax-exempt entities such as religious and educational entities, and other nonprofits. This potentially expands the tax savings opportunities for professionals in the design and construction industries who may not have been involved in public-owned property in the past.
- The bill updates the calculation methodology, replacing the partial deduction with a more favorable sliding scale. This may yield more benefits when the maximum deduction is not obtained.
- This deduction is available to architects, engineering firms, and contractors when they are considered primary designers.
45L Tax Credit
The existing 45L tax credit program allowed up to a $2,000 tax credit per eligible dwelling unit, which typically impacted single-family and multi-family developments. The 45L program expired at the end of 2021, but the bill includes significant changes in these areas:
- Extends the 45L tax credit retroactive to the beginning of 2022 through the end of 2032.
- Increases the maximum tax credit to $5,000 per dwelling unit starting in 2023 (the max is still $2,000 for 2022).
- Aligns some program criteria with other government energy programs. This can expand eligibility to other residential developments beyond multifamily projects of four stories or less.
This tax credit is abatable to home builders and multifamily residential developers. For multifamily developers, the tax credit is reduced to $500 or $1,000 per unit if strict energy efficiency rules are not followed.5
As we approach year-end, it is important that business leaders review current finances to identify opportunities for efficient tax planning in 2023 and beyond. Consult your Marcum tax professional for assistance in developing the appropriate strategies for your particular situation.