We’re heading into the home stretch of 2017. That means contractors have some important decisions to make. First and foremost, how can you finish out the year as financially profitable as possible? But, nearly as important, what strategies should you consider to ensure your income tax payment obligations don’t adversely affect cash flow? Now is a good time to start planning.
Charts and trend lines
Although the primary goal of year-end tax planning is to minimize your 2017 tax liabilities, it’s important to look ahead to 2018 as well. Start by charting your gross cash revenues by month. This ought to show you how your cash revenues are trending. You can then use this data to estimate your 2017 total billings and ultimately add your construction costs to the chart.
Adding a trend line can help you see how your construction costs vary with the revenues. It may also be helpful to chart the gross profit percentage at this point. Your office and other general expenses will be relatively flat and can usually be taken as fixed costs. Once you’ve calculated your projected cash revenues and expenses for 2017, you can estimate your tax liability (depending on your business structure) and, hopefully, identify some savings opportunities. (If your company uses more advanced revenue recognition techniques, your CPA should help you estimate your tax liabilities.)
Regardless of who’s responsible for upcoming tax payments — whether the construction business itself or you and any other owners — try to set aside funds throughout the year for this purpose. Depending on your business structure, you can code future payments as either income tax expenses or owner distributions.
The numbers matter
When it comes to accounting methods, the cash method typically produces a greater tax advantage. It’s limited, however, to companies with consistent annual revenues under $5 million.
If your construction business is eligible for the cash method, it should strongly consider using it for two other reasons. First, the cash method saves time and money because it’s less complicated to account for and more straightforward. Second, the cash method helps you avoid traps that may trigger accelerated revenue recognition. Standards for revenue recognition in both the financial accounting and tax accounting spheres create uncertainties for contractors who use more advanced techniques.
All that said, both cash- and accrual-method companies may be able to defer income (and reduce taxes) by making contributions to certain qualified retirement plans. Depending on the type of plan offered, you may be able to deduct contributions made this year as long as they’re made by the extended due date of your 2017 tax return. Ask your CPA and benefits advisor which retirement plans qualify for this treatment, as well as for help setting one up should you decide to pursue this strategy.
The percentage is yours
To account for long-term contracts, many construction businesses use the percentage-of-completion method, which recognizes revenues and expenses as a job progresses. This method is almost always preferred when the cash method is unavailable, because it’s an industry standard on the financial reporting side.
As mentioned, it’s important to set aside enough cash to pay your construction company’s income taxes. Estimating tax liabilities when using the percentage-of-completion method, however, can be exceedingly complex. So be sure to keep your CPA involved and informed over the course of the year and particularly at year end.
Changes may lie ahead
These are but a few general ideas to ponder as year end approaches. The right strategies for a construction company can depend on a number of factors — including your business size and entity choice, the scope and dollar value of your projects, and, of course, just how profitable a year it’s been.
Also bear in mind that, as of this writing, various tax law reforms are under consideration in Washington. Check with your CPA on the latest, as well as for assistance in making the best tax planning decisions going forward for your construction company.