It’s not a matter of if, but when, the next recession will hit, experts suggest. What are you doing to better prepare your business for an economic downturn? In part two of Jobsite’s two-part interview with Eve Dreyfuss, partner and CPA at Moss Adams, she discusses how construction companies can best manage cash flow and prepare for potential tax liabilities in the future.
Jobsite: How can companies better manage cash flow to help ensure they are able to pay previously deferred tax liabilities?
Eve: The most important thing to remember is the current environment isn't going to last forever. Contractors are often flush with cash when they’re working. It’s during those times that they stand to benefit the most from preparing for a downturn by paying down debt and future tax liabilities.
Contractors generally win big and lose big, which means they can sustain substantial losses in a downturn.
Contractors generally win big and lose big, which means they can sustain substantial losses in a downturn. In the past, contractors were able to handle this by carrying back those losses. For example, if a contractor sustained a $2 million loss, this loss could be carried back to prior years to recoup taxes that were previously paid, putting a significant amount back into the company’s balance sheet.
Tax reform removed this provision, which means contractors can’t carry back losses anymore—they can only carry them forward.
There’s also the excess business-loss provision, which enacts a $500,000 limit on how much of a business loss can be used to offset other income. For example, a contractor sustains a $2 million loss. The contractor can only offset wages and portfolio income up to $500,000, even though $2 million was lost.
There are some strategies for working with this limitation. For example, a lot of closely held businesses can set wages, which may come from various sources. Ensuring those wages don’t exceed $500,000 can help prevent the need to pay tax when there’s an overall loss.
Additionally, there’s the business-interest expense limitation, which limits the amount of deductible business interest to 30 percent of adjusted taxable income. Generally, contractors may not have a lot of debt right now, and their adjusted taxable income is pretty high. In a downturn, however, contractors may have to borrow more money when they may have lower taxable income. With the limitation, they may not to be able to deduct the interest expense they’re incurring on a business line of credit.
Ultimately, there are strategies that can help mitigate the effects of these provisions. Talking to an advisor who can help make those elections, and determine a strategy that accounts for the fact that tax-reduction provisions are going to sunset while other provisions won’t, can help set a contractor up for success.
Jobsite: How do like-kind exchanges contribute to increased tax liabilities for contractors—both in economic growth and recession?
Eve: A like-kind exchange allows a contractor to defer the tax liability when he or she sells an asset with a gain. For example, assume a contractor paid $1 million for an asset that’s now worth $3 million. If the contractor sells it, he or she would have to pay tax on the $2 million gain. With a like-kind exchange, the contractor can roll that gain into a similar piece of property and defer the tax payment.
Tax reform removed the provision that allowed for like-kind exchanges of construction equipment.
Tax reform removed the provision that allowed for like-kind exchanges of construction equipment. This means that contractors who previously could have entirely deferred gains on equipment through the purchase of new equipment can no longer do so. Instead, a contractor who sells a $500,000 piece of equipment that has depreciated to zero now has to pay tax on the entire $500,000. One strategy to avoid this result is to use the 100 percent bonus depreciation mentioned earlier in the article on the new property, which could offset the taxable gain on the sale of the first property.
Jobsite: Do you have any big takeaways for readers?
Eve: I have two big takeaways. In 2018, contractors generally are paying less tax, but there’s potential that those lower taxes will sunset while other provisions won’t—potentially hitting contractors in a downturn and increasing their tax burden. To help avoid this scenario, start strategizing now. Strategies may include: saving cash now to pay future tax liabilities, paying taxes now and forgoing deferrals, not taking 100 percent bonus depreciation, and paying down debt.
The other takeaway is about the economy. Construction lags one or two years behind the real estate market, which has started to show more caution. Legislation, such as California’s SB 1, may be repealed in November 2018. If it isn’t, approximately $5.5 billion will be poured into California infrastructure over the next 10 years, which will help bolster the construction industry. If it gets repealed, however, contractors will want to be prepared.
Eve Dreyfuss has practiced public accounting since 1991. She specializes in tax planning and structuring of complex transactions for privately held companies, partnerships, flowthroughs, and individuals in the construction, real estate, manufacturing, and high-tech industries. She can be reached at (408) 558-3201 or firstname.lastname@example.org.
Assurance, tax, and consulting offered through Moss Adams LLP. Investment advisory services offered through Moss Adams Wealth Advisors LLC. Investment banking offered through Moss Adams Capital LLC.