One thing is certain regarding the effects of the 2020 pandemic on businesses: it’s created both winners and losers. While many sectors such as restaurants, tourism and hospitality are faltering, sectors like tech, shipping/logistics and some retailers are booming.
If your business experienced a great year despite the pandemic – or even because of it – you may consider changing your accounting methods this year. It could help you defer taxes and hold onto some of your profits for the uncertain times ahead.
Here is a sampling of the most common accounting method changes or elections that may provide tax savings to those in the construction industry:
Reoccurring Items Change
Does your business own any real property? Does it pay insurance premiums? If it does and you keep your books on an accrual basis, you may be able to change your accounting method to deduct certain prepaid portions of these expenses in the current period. The reoccurring items exception is broad in applicability, but many limitations can apply. So, a dissection of your balance sheet is usually required to identify all possible savings or deferrals in this area.
Accounting for Long-Term Contracts Changes
Contractors have a myriad of methods available to account for earnings on contracts that straddle year end. Prior to the Tax Cuts and Job Act (TCJA), any Contractor over $10 million in gross annual receipts was required to report their earnings using the percentage of completion method.
Though this method arguably matches income to the period earned most accurately, it can also accelerate income compared to other allowable methods. Since the TCJA, any contractor now under $25 million in average annual receipts can implement other methods of accounting for their long-term contracts on their tax return. For small contractors, the “completed contract” method or the “accrual less retainage” method may be valid options to defer the income recognition.
Overall Accrual to Cash Method Change
If you are keeping your books on an accrual basis and your revenue limits are below the thresholds mentioned above, now could also be a good time to change your overall method of accounting from accrual to cash. By matching deductions to the period paid and revenues to the period collected, this method often offers more control over the timing of certain deductions. When particular attention is paid to your billing and payables cycles near year end, it can provide serious deferrals from year to year.
One important thing to remember is that most of these changes can be limited to effecting only your reporting for tax purposes. For instance, if you require bonding and your surety demands your financial statements reflect income under the “percentage of completion method,” that does not preclude you from using another method for tax return. Often, with having book and tax methods diverge, you can get the best of both worlds. Look strong for bonding but defer a solid portion of your income tax liability annually.
Too often when I ask why a client or perspective client uses the accounting methods they do, the answer is simply:
- They do things the way it has always been done, or
- That it would be too much work to make a change
Though there is certainly a cost benefit analysis to be performed before making any of the changes noted above, I always encourage businesses to at least perform that analysis. If you have not at least explored the possibilities with a tax professional, how can you really conclude that your current methods are most suitable for your individual business?
Bowers & Company CPAs aims to offer helpful information to our clients and friends. Learn more about how we can help should your construction company need accounting and financial services.
Disclaimer: To ensure compliance with requirements imposed by the Department of Treasury, we inform you any U.S. federal tax advice contained in this document or video is not intended for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.