Effective planning for your construction business not only includes understanding the items that impact your operations but also the results that taxation on your profits will have on your net post-tax income. Many provisions in the Tax Cuts and Jobs Act (TCJA) expire by December 31, 2025. However, there are a handful of provisions expiring as early as the 2022 and 2023 tax years that are crucial to understand when tax planning for your business and personal estimated taxes.
Research and Development Expenditures
For taxpayers that incur costs relating to the development or improvement of a product, a significant change occurred in the reporting of these costs that went into effect on January 1, 2022. Prior to this rule change, taxpayers were allowed to expense 174 costs in the year incurred, receiving an immediate tax deduction. For tax years beginning after December 31, 2021, taxpayers are now required to capitalize and amortize 174 costs over five years for domestic expenses and 15 years for foreign expenses.
Meals and Entertainment
During the COVID-19 pandemic, a temporary benefit was introduced to incentivize businesses to spend money at restaurants. A 100% deduction was allowed for business-related food and beverages that were purchased at a restaurant in tax years 2021 and 2022. Beginning January 1, 2023, the deduction rate for business-related meals will revert back to the original 50%.
Bonus Depreciation
The TCJA increased bonus depreciation from 50% to 100% starting in 2018, which provided immediate tax deductions and savings for construction companies. Starting in 2023, bonus depreciation will begin to phase out as follows:
- December 31, 2023 – 80% bonus depreciation
- December 31, 2024 – 60% bonus depreciation
- December 31, 2025 – 40% bonus depreciation
- December 31, 2026 – 20% bonus depreciation
Being aware of the above phase-out rules is essential for tax planning and should result in increased consideration for the timing of capital expenditures.
Interest Deduction Limitation
In general, your construction company may be eligible to deduct interest expense that was paid during the taxable year. However, beginning in tax year 2018, the interest may have been subject to the Section 163(j) business interest limitation—30% of adjusted taxable income (ATI) for businesses with aggregated gross receipts over the small business exception threshold (approximately $26 million in gross receipts).
For tax years 2019 and 2020, the deduction limit was temporarily increased from 30% to 50% of ATI. This temporary support provided by Congress is no longer available, and the ATI limitation reverted back to 30% for tax years 2021 and forward. Additionally, starting in tax year 2022, depreciation, amortization and depletion can no longer be included in the ATI calculation. This change increases the potential for deferred interest expense deductions.
Underpayment Interest Rates and Changes
For the 2023 tax year, the IRS has increased interest rates, which could have a significant impact on your tax cost. For individuals, the present annual rate for tax overpayments and underpayments is 7%. Therefore, the cost of underpayment of estimated tax payments will have more of a cash burden.
Maximize Your Retirement Contributions
Maximizing your retirement contributions may be a useful tool in lowering your taxable income. While there are income limitations, you can increase your contributions to your 401(k) or other retirement plans to achieve this goal. In 2023, $22,500 can be deferred by taxpayers through their 401(k). Additionally, taxpayers 50 years or older are allowed a catch-up contribution of $7,500.
Considering the changes in the tax law will allow you the ability to better manage your cash at the individual and business levels. Knowledge of the amendments will also benefit you in successful tax planning.
For more information on tax law changes and other tax considerations, you may contact Shawn Layo at slayo@dmcpas.com or visit www.dmcpas.com.