By not considering the tax implications of certain decisions, you may be leaving valuable tax deductions and credits on the table.
By Vincenzo Botta, CPA, CGMA
Rucci, Bardaro & Falzone PC
It’s a familiar scenario. On a day-to-day basis, owners and managers of contracting firms do what they need to do to keep the business running. Whether it’s purchasing a new piece of equipment to replace an outdated one, or hiring extra help to handle a brand new project, they tend to focus on “taking care of business” now and put off thinking about the tax consequences until later.
But doing so often comes at a cost. Here are four tax mistakes that contractors commonly make, some that can leave serious money on the table – or worse, land you in trouble with the tax authorities.
1. Failing to depreciate new equipment correctly
Depending on the whims of Congress, this could be a two-part opportunity to decrease taxable income by a significant amount in 2015. One tax provision – Section 179 – is currently in force; the other – Section 168k – expired last year but may be extended by Congress before year-end.
Section 179 allows for an immediate tax depreciation deduction of the entire cost of equipment and machinery in the year it is placed into service. Although not all property, plant and equipment purchases are included, all construction equipment and machinery purchases are allowed. Total purchases must be less than $200,000 to receive the full benefit of $25,000. Anything over $200,000 in purchases is a dollar-for-dollar decrease in section 179 tax depreciation expense.
However, this provision should be monitored as the year goes along. Congress has the option to extend the 2014 amounts of $500,000 in total section 179 depreciation on up to $2,000,000 in purchases, which would certainly result in even bigger tax savings in 2015.
Another tax benefit that should be monitored this year is the revival of Section 168k or “bonus depreciation” provision. Until the end of 2014, this allowed for an immediate 50% tax depreciation expense in the year of purchase on certain property, plant and equipment purchases. As mentioned, Congress has the option to extend this provision into 2015, just as it did a year earlier when it voted to keep it in force for another year.
2. Overlooking the fuel tax credit
Many contractors miss out on this one. Either they are unaware that it exists, or are unsure if they qualify for it. But the tax savings can be substantial. More valuable than a tax deduction, a tax credit of any kind is a direct decrease of your tax liability.
This particular credit is for federal taxes paid on fuels. The credit applies to various types of fuels, but the two that normally pertain to contractors are 1) the off-highway business use of gasoline in machinery and trucks, and 2) the use of undyed diesel fuel.
To take advantage of the fuel credit, your company’s use of these two types of fuels should be tracked throughout the year. The credit is based on total number of gallons used and can range from 18 – 25 cents per gallon.
3. Overlooking the domestic production activity deduction
“DPAD” is a little-known method to decrease taxable income that doesn’t pertain to all industries; however construction companies are one of the few that do often benefit. The deduction is based on 9% of “qualified production activities income” from U.S. based operations.
To make sure the credit is taken accurately, it is generally a good idea to invest some effort ahead of time to have the proper cost accounting mechanisms in place. These will help you distinguish between qualified and non-qualified production activities. Proper tracking of revenue from various construction services (and the expenses that go along with it) is critical.
If the deduction is taken on non-qualified activities, a restatement of taxable income may be required in future years, and the additional taxes due may also be subject to penalties and interest.
4. Mis-classifying employees as independent contractors
Should the people working on your jobs be issued a w-2 or a 1099? This question causes confusion for employers across the board, but especially for those in the construction trades. Many contractors would understandably like the answer to be the latter in order to avoid paying the employer portion of taxes, unemployment insurance and w-2 filings, costs which when combined can approach 20% of wages.
Unfortunately the decision is not based on what the employer would like to save or what the employer believes the person may be. The decision must be made according to (among other things) who has “control” of the employee or independent contractor for the work that the individual is performing. A 1099 individual (independent contractor) has control over the work they do. They are hired independently of the company’s own workforce to perform a specific job, and they – not the employer – control the completion of that task.
A 1099 independent contractor must also perform work that is “outside the usual course of business” of the employer. No individual who perfoms the same work as the employer’s own workers can be treated as an independent contractor.
Still, some companies decide to classify what should be a w-2 employee as a 1099 employee under the mistaken belief that the consequences for mis-classification are minimal. Not true. If an employee qualifies as a w-2 employee by law but is not paid that way, the penalties for the improper filing can run into the hundreds and sometimes thousands of dollars – per employee.
Although the up-front cost savings of issuing a 1099 rather than a w-2 is certainly tempting, the potential penalties in the long run – including increased scrutiny by federal and state tax authorities – are just not worth the risk. That’s why it pays to take the correct steps at the beginning of a worker’s engagement with your company to ensure that he or she is classified properly.
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Vinny Botta is a principal in the Boston-area CPA and business advisory firm Rucci, Bardaro & Falzone, PC. Through the firm’s Construction Business Services Group, he offers tax planning advice and services to the owners and managers of contracting firms of all sizes. For a complimentary copy of “Employee vs. Independent Contractor: 7 Tips for Business Owners,” contact Mr. Botta at 781-321-6065 or firstname.lastname@example.org.