Taxes are tricky, aren’t they? Most of us understand the basics of our personal income tax returns, but business taxes add more complexity to an already stressful activity.
When people make mistakes, it is often in the direction of being too conservative in taking tax credits and deductions. Other times, the error is in how a company or employee is classified.
Here are seven tax mistakes construction contractors make that could be costing them a significant amount of money.
Failing to depreciate new equipment correctly
Equipment depreciation is a key aspect in calculating business taxes. The Protecting Americans from Tax Hikes (PATH) Act was recently made permanent and retroactive to January 1, 2015. Two sections apply directly to construction.
- Section 179 allows an immediate tax depreciation deduction of the entire cost of equipment and machinery in the year it is placed into service. All construction machinery purchases are allowed but the total property, plant, and equipment purchases must be less than $2 million to receive the full depreciation of $500,000 (the deduction limit for 2016).
- Section 168k is a provision for “bonus” depreciation that allows an immediate 50% tax depreciation expense in the purchase year of certain property, plant, and equipment purchases.
Both of these are depreciation schedules that you may not be taking full advantage of. However, there are some restrictions on equipment depreciation.
You are limited in the amount of depreciation you can take for SUVs and trucks used at the jobsite. This limitation extends to any four-wheeled vehicle with a gross vehicle weight rating of 6,000 pounds or less AND is manufactured for primary use on public streets and highways.
These limitations can bring your depreciation deduction down to $3,500 or less in the year of purchase. In addition, these types of vehicles are not eligible for the Section 179 provision. Additionally, these types of vehicles can take much longer than the typical five to seven years to depreciate fully, which can cause problems with year-end tax planning that must span multiple years.
Failing to use the fuel tax credit
Just as an FYI, tax credits are worth more than tax deductions, so skipping these really hurts. Tax credits are a direct decrease in your tax liability. Who wouldn't want that?
The fuel tax credit is a credit on federal taxes paid on fuels. This can be as much as 18 to 25 cents per gallon of fuel purchased. It applies to a variety of fuels but for a contractor generally means off-highway business use of gasoline in machinery and trucks and the use of undyed diesel fuel.
You have to keep close track of your fuel usage throughout the year because the credit is based on the total number of gallons used.
Overlooking the domestic production activity deduction
That’s a mouthful, isn’t it? The DPAD is a method of decreasing taxable income. It doesn’t apply to all industries but it does apply to construction. The deduction is based on 9% of “qualified production activities income” from U.S. based operations.
Errors in selecting cash vs. accrual accounting methods
This one depends on how your company is organized.
If you are organized as a corporation, average company revenue must remain below $5 million during the previous three-year period for you to use cash as your method of accounting. If you are organized as an S-corporation that maximum rises to $10 million.
You probably started using the cash method when you started the business but as your company grows, you need to keep in mind the ceilings for these corporations, so you know when to begin using the accrual accounting method.
You have a good motivation to remember this. The IRS charges substantial penalties if it determines you should have been using the accrual method instead of the cash method.
Errors in converting from an accrual accounting method to cash
Yep, mistakes are made going the other direction, too. The rules for conversion include:
- Ensuring your average revenue of the past three years is under the ceiling for the entity your company is organized under $5 million for a corporation and $10 million for an S-corporation.
- Completing a calculation known as the 481a adjustment, which is designed to reveal the gain or loss from the conversion. Any gain or loss must be put into the tax return of the year of conversion.
But wait, there’s more. Losses stemming from conversion can be taken in full in the year the conversion takes place. Gains, however, may be spread out over a period of four years and keeps you from having a large tax hit in the first year.
Failing to track work in progress
While this is more about financial reporting than taxes, it still has an impact on your return. All job costs must be accounted for correctly when you try to get a bond or a loan.
A work in progress schedule shows all of your ongoing jobs and their costs at a particular point in time. You can set up internal statements to capture the direct costs of materials, direct labor, and subcontractors. However, some contractors forget to include the expenses for:
- Contractors insurance
- Payroll taxes
- Equipment rental costs
- Other “indirect” job costs
If you don’t include all losses, direct and indirect in the cost of goods sold, your company’s balance sheet will be inaccurate. It also impacts your profit and loss statements. Your company’s financial health is determined by these statements and directly impacts your ability to get loans and bonds.
Misclassifying employees as independent contractors
It looks very attractive to classify a worker as an independent contractor instead of an employee. After all, this could eliminate up to 20% of the cost of wages in payroll taxes and unemployment insurance.
DON’T DO IT! If the IRS finds out about the misclassification, whether it is willful or by mistake, it will cost you big time. It will definitely cost more than you save by misclassifying in the first place. As in, up to hundreds or thousands of dollars per employee.
It all boils down to who has control over the work, the employer or the worker. An independent contractor is someone who is hired independently of the rest of your workforce to perform a specific job. It can’t be a job one of your employees already does. The IC controls how and when the task is performed and completed.
Tax time never rolls around; it leaps right up at you. Check out these seven areas to see if you can get significant savings on your taxes and to make certain you are doing it legally.