Preparing for Potential Tax Law Changes

A Guide for Construction Business Owners

As the expiration of several key provisions of the Tax Cuts and Jobs Act (TCJA) looms, construction business owners must brace for significant tax law changes. The TCJA, enacted in 2017, brought numerous benefits, but many of these are set to expire after 2025, potentially reverting to pre-TCJA levels. Here are the critical areas to watch:

1. Individual Tax Changes

Key individual provisions set to expire include:

  • Top Individual Income Tax Rate: Increasing from 37% to 39.6%, which could affect construction business owners’ personal tax liabilities.
  • Standard Deductions: The TCJA nearly doubled the standard deduction and eliminated personal exemptions. If the TCJA expires in 2025, the standard deduction for a married couple filing jointly in 2026 could substantially decrease from approximately $30,000 to $13,000 before being indexed for inflation. Meanwhile, the personal exemption is expected to increase to approximately $5,300 per individual. These changes could potentially increase taxable income, making itemizing deductions more advantageous.
  • Gift and Estate Tax Exemptions: Reducing significantly, impacting estate planning strategies for family-owned construction businesses.

2. Impact on Pass-Through Entities

The Section 199A deduction, which allows a deduction of up to 20% of qualified business income for pass-through entities, is at risk of expiration. If this deduction sunsets, small businesses will lose the deduction and face higher taxable income, leading to increased tax liabilities for owners of pass-through entities. The increase in the tax liability would require larger tax distributions for owners and thereby reduce the amount of capital available for reinvestment in the business, such as purchasing new equipment, hiring additional staff, or expanding operations.

3. Accelerated Depreciation

Bonus depreciation, which permits immediate deduction of a percentage of qualifying asset purchases, is being phased out. In 2024, the deduction will reduce from 80% to 60%, affecting capital investment strategies. The deduction will drop to 40% in 2025 and sunset after 2026. For construction companies, this means higher upfront costs for purchasing new equipment and machinery, potentially impacting project budgets and timelines. Decisions to delay or reconsider purchasing new equipment due to the reduced immediate tax benefits could impact the overall productivity and efficiency of operations, as older equipment may require more maintenance and be less efficient.

Businesses might turn to alternative financing options, such as leasing, to mitigate the impact of reduced bonus depreciation. Leasing can spread the cost of equipment over time, potentially offering more manageable cash flow implications. However, this approach may also come with higher long-term costs compared to outright purchases.

The phase-out could affect the competitive landscape, particularly for smaller construction firms that rely heavily on bonus depreciation to manage their tax liabilities. Larger firms with more robust financial resources may be better positioned to absorb the impact, potentially widening the competitive gap.

Keep in mind that your construction company can potentially combine bonus depreciation with the Section 179 deduction within the same tax year. As bonus depreciation phases out as planned, contractors may still be eligible to claim Section 179 deductions.

4. Employer Credit for Paid Leave

The tax credit for employers providing paid family and medical leave is also set to expire unless extended by Congress. This credit has been a valuable incentive for construction companies to support their employees’ well-being, which is crucial in an industry known for its demanding work conditions.

Strategic Tax Planning

Given these impending changes, it is vital for construction business owners to proactively adjust their tax strategies. Consulting with tax professionals and financial advisors can help navigate these transitions and optimize tax positions.

By staying informed and planning ahead, construction businesses can mitigate the impact of these tax law changes and continue to thrive in a shifting economic landscape.

Kirsten Sokom

Kirsten Sokom

Principal
Audit services for construction, manufacturing, and distribution companies; engagement quality control and best practices.

Nikki Allen

Nikki Allen

Tax Manager
Preparation of individual, small business, partnership, S Corp, and corporate tax returns.

The Importance of Strategic Financial Planning

Construction firms can foster long-term sustainability and gain a competitive edge through strategic financial planning. By gaining an understanding of its current financial position, influence of external factors, and internal capabilities, a company can develop its blueprint for financial growth.

Evaluate Current Financial Position

To derive an effective process towards meeting desired objectives, a company should first assess its current financial position. This process involves analyzing past financial statements to understand revenue trends, expense patterns, and profitability as well as evaluating current assets, liabilities, equity and cash flow to identify strengths and weaknesses. Examining Key Performance Indicators (KPIs) is another effective method of measuring and tracking financial performance. The table below summarizes several relevant KPIs for construction firms and their importance:

KPI
Importance
Gross Profit Margin
Indicates the efficiency of project execution and cost management
Net Profit Margin
Reflects overall profitability and financial health
Cash Flow
Essential for maintaining liquidity and ensuring the ability to meet financial obligations
Change Order Rate
High rates may indicate issues with project scope definition or client communication
Current Ratio
Measures the ability of a company to cover its short-term obligations with its short-terms assets
Job Cost Variance
Helps identify discrepancies and areas for improvement in estimating and budgeting
Backlog
Indicates future revenue and workload, aiding in capacity planning
Equipment Utilization Rate
Indicates efficiency in equipment management and helps minimize costs
Here you will find a summary of some important KPI's that every contractor should monitor, published by RSM

The understanding and ongoing evaluation of relevant financial metrics and current financial position provides valuable insight into a company’s financial trajectory. This knowledge enables owners and management to make informed and timely business decisions while also developing and updating strategies that align with short-term and long-term financial goals.

Management should also perform trend analysis which offers insights into the factors driving financial performance. This comprehensive assessment of a company’s current financial position and underlying drivers establishes a solid foundation for effective financial modeling. A clear grasp of current financial metrics and trends allows for more accurate projections and enhances the reliability of the financial models informing strategic planning and risk management.

Develop Financial Models

A vital component of strategic financial planning is performing scenario analysis. This proactive process allows companies to explore how various changes in assumptions–such as project costs, delays, or economic shifts–could impact financial outcomes. By forecasting best and worst-case scenarios and reviewing the financial models reflective of these potential outcomes, a company can derive effective strategies to navigate potential challenges. It is important to keep in mind industry trends and internal capabilities while developing financial models to ensure realistic expectations of projected outcomes. The valuable insights gained from this analysis empower decision-makers to make informed choices about project selection, investment opportunities, and resource allocation. Regularly updating financial models as new data and market conditions emerge ensures that companies remain agile and ready to seize opportunities for growth.

Strategic financial planning offers several advantages and it is never too late to get started. Involving owners, management, and project managers in these processes assists in developing a collective understanding of financial performance metrics and encourages a collaborative effort in monitoring and achieving financial goals. Crow Shields Bailey provides assistance with strategic financial planning. Please let us know if our team of skilled professionals can be of service.

Savanna Wood

Savanna Wood

Senior Accountant
Audits of construction contractors, manufacturing and distribution companies, and employee benefit plans. Review and compilation services for non-public companies.