The Tax Cuts and Jobs Act (TCJA) made sweeping changes to how businesses and owners involved in construction, contracting and real estate development are taxed. Taxpayers are advised to strategically evaluate the new provisions associated with the TCJA to ensure their goals are realized and aren’t negatively affected by the new law.
Limited Interest Deduction
Large contractors and developers need to be mindful of the impact of Internal Revenue Code (IRC) Section 163(j) on the deductibility of interest. Under the TCJA, interest expense is limited to 30 percent of the taxpayer’s adjusted taxable income. This limit on interest applies when taxpayers have greater than $25 million of gross receipts. Conceptually, this wouldn’t seem to apply to many taxpayers; however, in practice—due to the required control group testing—the gross receipts of related businesses are taken into account in determining the $25 million gross receipts test.
For example, interest expense for a real estate holding company might be limited where there is common ownership with a contractor that has gross receipts in excess of $25 million.
Meals & Entertainment Changes
Under the TCJA, the deductibility of meals and entertainment has changed. Under the new rules, entertainment-related expenses are generally nondeductible. Business meals are generally allowed a 50 percent deduction except for certain employee appreciation activities such as company picnics or holiday parties, which are still fully deductible. The real burden associated with the new provisions is related to bookkeeping and the creation of additional expense accounts to allow for separate tracking of entertainment and meals, as these expenses were traditionally grouped together.
Prior to the TCJA, taxpayers with gross receipts in excess of $10 million were required to recognize income using the percentage of completion method of accounting for long-term nonresidential contracts. The TCJA increased this threshold to $25 million, allowing more contractors to adopt other, more taxpayer-friendly accounting methods.
The TCJA expanded the application of 100 percent bonus depreciation and §179 (immediate expensing provisions) related to capital expenditures. This means 100 percent bonus depreciation can now be taken on both used and new equipment purchases. In addition, §179 provisions under the TCJA were permanently increased to $1 million (as adjusted for inflation) and assets eligible for §179 now include certain improvements to nonresidential real property such as roofs, HVAC, security and fire systems.
Qualified Business Income (QBI) Deduction
While the TCJA eliminated the domestic production activities deduction that most contractors and trade-related businesses were accustomed to claiming, it was replaced with the QBI deduction. This new provision allows for individuals to claim a deduction of up to 20 percent of QBI earned from pass-through entities. This provision comes with various potential limitations and requires a complicated analysis. It also requires additional information to be reported to the owner of the pass-through entity. The QBI deduction is unavailable to corporate entities (those taxed as C corporations).
Choice of Entity Structure
Although corporate taxpayers are not afforded the advantages of the QBI deduction, the decrease of corporate tax rates to a flat 21 percent can make the C corp structure attractive to businesses that want to retain and grow equity within the entity. It’s advisable to revisit and evaluate the overall entity structure to determine if flow-through status continues to be tax-advantageous.
As a result of the TCJA, taxpayers have more options to consider when developing their overall tax strategy. Because of the additional complexity and flexibility, tax planning has never been more important. Reach out to your BKD trusted advisor or submit the Contact Us form below if you have questions.