If, like many contractors, you're looking to maximize your cash flow, you can't afford to leave any stone unturned. One way to keep more dollars in your pocket is to keep your tax bill as low as possible. To this end, there are a number of tax breaks you might want to consider.
One that may have slipped under your radar is the Section 199 deduction. This break has a couple of aliases: the qualified domestic production activities deduction and the manufacturers' deduction. Although those names may throw you off, the manufacturers' deduction may apply to many construction companies and, better yet, the maximum deductible amount has risen to new heights.
Getting the gist
The manufacturers' deduction was introduced in 2004 via the American Jobs Creation Act. As its name indicates, the law's target audience at the time was manufacturing companies. But other industries were invited into the fold as well — including architecture, film production, software, engineering and, most important for our purposes, construction.
To get the most from the deduction, you'll need to identify "qualified production activities" that your business performs regularly. In the building realm, these generally involve construction or major renovation of real property such as residential and commercial buildings. Tasks related to infrastructure projects such as road, power line, water system and communications facility jobs also may qualify.
Once you've identified the qualified production activities, you'll need to determine the taxable income derived from those tasks. This comes from the gross receipts arising from the lease, rental, exchange or other transfer of qualifying production property minus out-of-pocket expenses, such as materials costs.
Calculating the percentage
In this very simplified explanation, to arrive at your deduction, you must choose from the lesser of either your taxable income derived from your qualified production activities or your entire taxable income for the year.
Now, finally, the good news: After beginning at a mere 5% in the introductory 2005 tax year, and going up to 6% for the 2009 tax year, the deduction has risen to 9% for the 2010 tax year. The catch, however, is that the deduction can't exceed 50% of the W-2 wages paid to employees during the calendar year.
Let's look at an example of how the manufacturers' deduction works: Getting out our crystal ball, we see that Contractor X will earn $550,000 in taxable income on $3.5 million in gross receipts in 2010, entirely from qualified production activities. Assuming Contractor X's W-2 wages are adequately substantial, its deduction at the new 9% rate will be $49,500, for a $17,325 tax savings.
Bear in mind that, to obtain savings of this nature, you'll likely have to do some extra administrative work tracking your qualifying construction activities and the related costs (labor, materials expenses and so forth). Because determining the deduction amount is complex, be sure to work with your CPA.
Cutting your losses
As you can see, your construction company's taxable income — both related and unrelated to qualifying activities — plays a huge role in gaining access to this tax break. Of course, that means that, if you have no taxable income for the year, you can't benefit from the deduction. So if you've had a particularly rough year, you may need to look at other tax strategies.
One to consider is the net operating loss (NOL) deduction. Although you generally can't use the manufacturers' deduction to create or increase an NOL, you may be able to accelerate some income into the current year to take advantage of the NOL deduction. To learn more, see the sidebar "NOL extension could still be an option."
Making it a good year
Last year brought great challenges to many construction companies. To help make 2010 at least a little better, make sure you use every weapon in your arsenal. Ask your tax advisor whether the manufacturers' deduction is something you can take into battle come tax time and, if so, how you can get the most from it.
NOL extension could still be an option
If your construction company suffered a net operating loss (NOL) in 2008 or 2009, here's some good news: Recently renewed NOL rules now permit most businesses to carry back their NOLs for up to five years, instead of the previous two.
You must elect to make a carryback by the deadline for filing a return (including extensions) for your last taxable year beginning in 2009. Furthermore, you may claim NOLs that occurred in tax years ending after Dec. 31, 2007, and beginning before Jan. 1, 2010. For the fifth year, your carrybacks are limited to 50% of that year's taxable income.
Small businesses with gross receipts not exceeding $15 million may apply the five-year carryback to both the 2008 and 2009 tax years. If you don't qualify under this criterion, you'll have to choose between either 2008 or 2009 — you can't claim both.
Another positive change brought about by the NOL extension involves the alternative minimum tax (AMT). Before the extension, losses claimed for AMT purposes were limited to 90% of the AMT NOL. Now you're allowed to carry back 100% of your AMT NOL. Doing so could bring some additional savings to a company that typically ends up paying some AMT tax.
Like the manufacturers' deduction, the NOL rules are fairly complex. But they can provide a substantial benefit if followed properly.
