Year-end Tax Planning for Construction Companies

It’s time for the snow to fly in Montana, which also means it’s a good time to proactively review year-end income and deductions for your construction company and do some planning before the New Year arrives. Owning your own construction business provides the opportunity for numerous deductions, but you also need to make sure you don’t become a target of the IRS.

Construction company owners face a myriad of challenges in today’s marketplace. Like many small business owners, you must deal with self-employment taxes and income taxes. Using an assumed federal income tax rate of 15%, a state income tax rate of 5%, and the actual self-employment tax rate of 13.3% yields a combined rate of 33.3%. Personal exemptions, standard deductions, and credits may help, but many small business owners also need to plan and save for taxes. In most cases, they must also pay quarterly estimated taxes. A good rule of thumb is to save at least one out of every four dollars for taxes. Work with your CPA or tax preparer throughout the year to plan for your current tax bill. And if you’re extending your line of credit, make sure your bank has budgeted for taxes.

As a best practice, consider reviewing your year-end tax rates and projecting what your tax rate may be next year. In some cases, it may be worth accelerating your income to capture a lower tax rate. This may be especially true with capital gains, as many taxpayers believe rates could be headed higher in the coming years.

Although the deduction for expensing equipment has been significantly reduced this year, it’s still worth considering. The 179 deduction for equipment purchases in 2012 is $139,000, which is down considerably from $500,000 in 2011. Watch for year-end changes in the law, as Congress may be willing to increase the 179 limit to stimulate the economy. Bonus depreciation for brand new equipment is 50% of the cost. While there are further limits on cars and trucks, making a purchase before year-end can still make sense, especially a truck or other SUV that is used in the business and has a GVW over 6,000 pounds. While equipment purchases can significantly reduce your current year tax burden, be careful not to spend your money just to avoid a tax bill. Only invest in equipment if it’s truly needed for your construction business.

One of your best purchases may be a new computer and software. The size of your business will largely determine the hardware and software needed. QuickBooks® for Construction Companies is an excellent software package if your business is small to medium-sized. Consider computerizing your bookkeeping system and using computerized checks. There are some interesting applications available that have been specifically developed to assist with your record keeping on the fly. If your construction business is larger, there are other excellent software packages to choose from, such as ComputerEase and Timberline.

Another excellent tax deduction is planning for an SEP-IRA or other retirement contribution. This is one way to soften the bite from your income tax bill; be aware, however, that it does not lower your self-employment tax.

As a construction contractor, review your independent contractor status. To avoid paying payroll taxes, some companies make the mistake of hiring “independent contractors” who technically qualify as employees. While many individuals work in the construction industry as independent contractors, you need to ensure the person qualifies for this status. While no two situations are alike, the amount of control, level of expertise, and other important facts will determine whether you have an employee or an independent contractor. Your CPA can offer guidance on how to determine whether someone qualifies as an independent contractor.

Finally, some thoughts on the type of business entity you should have. Currently, many attorneys are recommending LLCs or LLPs. However, don’t overlook a C Corporation as the next step from operating as a sole proprietor. I like C Corporations for net value up to $250,000. C Corporations offer ways to legitimately limit payroll taxes, and they have deductions other operating entities can’t offer. The big drawback of the C Corporation is that earnings may be double-taxed upon liquidation. If you have questions, consulting with your CPA or tax professional is a must.

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