It’s a familiar scenario. On a day-to-day basis, executives 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 Whether it’s purchasing a new piece of equipment to replace an outdated one, or hiring extra help to handle a brand new project, they tend to focus on “taking care of business” now and put off thinking about the tax consequences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, especially in light of recent tax reform measures. Here are four tax mistakes that could leave serious money on the table – or worse, land you in trouble with the tax authorities. Here are four tax mistakes to avoid:
1. Failing to depreciate new equipment correctly
This could be a two-part opportunity to decrease taxable income by a significant amount. One tax provision – Section 179 – is currently in force permanently; the other – Section 168k – expires in 2022.
Section 179 allows for an immediate tax depreciation deduction of the entire cost of qualified property in the year it is placed into service. Although not all purchases are included, all construction equipment and machinery purchases are allowed. Under the 2018 tax act, the definition of the qualified property has been expanded to include qualified leasehold improvement property. Total purchases must be less than $2.5 million to receive the full benefit of $1,000,000. Anything over $2.5 million in purchases is a dollar-for-dollar decrease in section 179 tax depreciation expense. Both of these amounts are indexed for inflation starting in 2019.
The Section 168k or “bonus depreciation” provision allows for an immediate 100% tax depreciation expense for qualified assets bought and placed in service between September 28, 2017, and December 31, 2022.
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 new IRC 199(A) deduction
Beginning in 2018 under the new tax act, companies should be aware of the new IRC 199(A) deduction. This deduction – in effect through 12/31/2025 – allows an individual taxpayer to deduct up to 20% of qualified business income from a partnership, S corporation, sole proprietorship and trusts. The qualified business income is determined for each qualified trade or business of the taxpayer and 199(A) has various phase-out and phase-in elements in the respective calculation. Not understanding the calculation or which activities qualify for the deduction of taxable income could cost a taxpayer a significant amount of tax savings.
4. Misclassifying employees as independent contractors
This issue isn’t technically about tax savings, but rather about tax penalty avoidance. The question: should the people work on your jobs be issued a w-2 or a 1099? It’s one that 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 performs 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 misclassification 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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