As the fourth quarter is in full swing and the end of the year quickly approaches, it is traditionally the time for business owners to meet with their advisors and discuss year-end tax planning. This year, those conversations will be heavily influenced by legislation currently pending in Washington. While the bill(s) are yet to be finalized, here are six high-level considerations every construction professional should incorporate into those conversations:
- Investment in Infrastructure – According to the White House, the Bipartisan Infrastructure Framework will allocate roughly $1.2 trillion in federal funding for investment in "clean transportation infrastructure, clean water infrastructure, universal broadband infrastructure, clean power infrastructure, remediation of legacy pollution and resilience to the changing climate." For construction professionals in these fields, there are tremendous opportunities for further growth (in other words… there is going to be a lot of work to be done). As companies take advantage of these newfound opportunities, their individual tax situations will shift. On a grander scale, such a large investment in infrastructure is going to necessitate changes in federal tax policies to provide funding for these improvements.
- Reduction of the QBI Deduction for High-Income Taxpayers – One of the most significant proposals for construction companies is the limitation on the deduction for qualified business income (QBI), specifically for high-income individuals. The proposed provision would amend Section 199A and set a maximum allowable deduction at $500,000 for joint-filers and $400,000 for single-filers and would be effective after 2021. This has the potential to significantly increase the tax burden for high-income taxpayers.
- Deductibility of R&D Expenses – Under current regulations, taxpayers can deduct 100% of their research and development (R&D) expenditures in the year they are incurred. This provision was set to expire after the 2021 tax year, at which point these expenses would need to be amortized over 5 years. The Biden proposals would push back the timeline to tax years beginning after 2025. With the pending infrastructure bill, R&D costs could become a significant expense as construction companies explore new methods of building a modernized and sustainable infrastructure.
- State & Local Tax Considerations – To fund these spending bills, Congress has recognized the need to scale back certain deductions included in Biden's original proposals. One example is the $10,000 limitation on deducting state and local taxes. Originally proposed to be repealed, it now appears that the limitation will remain in place in some capacity. While it remains to be seen exactly what the deduction will look like, it is safe to say that taxpayers will not be able to fully deduct their state and local taxes. In response to the original limitation dating back to the Tax Cuts and Jobs Act of 2017, a litany of states enacted pass-through entity taxes aimed at circumventing this cap. All construction companies organized as pass-through entities should determine their eligibility and weigh the pros and cons of these regimes to possibly take advantage of tax savings opportunities.
- Shifting S Corp Benefits – Currently, construction owners have found S Corporation status to be a tax advantageous entity structure, as net income from S Corporations is shielded from the 15.3% self-employment tax. Among the Biden proposals is a provision to bring all pass-through entities onto a level playing field by subjecting S Corporations to self-employment tax. This proposal, along with the Biden administration's plan to subject all pass-through income to the 3.8% Net Investment Income Tax for high income taxpayers, could result in a large tax increase for certain S Corporation shareholders. Owners should continue to monitor entity choice as these developments take shape to determine whether their current structure is still best equipped to fit their changing needs.
- Everything with the plan is subject to change – As of the writing of this article, no final legislation has passed regarding both the infrastructure plan and the corresponding tax plan. As such, everything in this article (much like everything in life over the past 19 months) is subject to change. The only certainty at this time is more change is coming, which will present opportunities to work closely with your tax advisor to find the most advantageous opportunities for your situation.