Tax Planning in a Year of Uncertainty
Published November 12, 2020
If there has been one certainty in recent years, it has been an active environment in the tax and financial planning arena. From major tax reform approved in December 2017, to an annual process of last-minute tax extender bills, and now an election year in 2020 to continue the run. Through the noise, one constant for the contractor has been the importance of proactive planning to help maximize company cash flow. With a host of tax and financial planning items to consider, below are four unique 2020 issues that will directly impact year-end planning.
Paycheck Protection Program (PPP)
The construction industry was the leading recipient of U.S. Small Business Administration (SBA) Paycheck Protection Program (PPP) funding when implemented this past spring at the onset of the coronavirus pandemic. While the program’s ever-changing requirements have caused most CFO’s and business owners to question their sanity, the focus has switched to the loan forgiveness process during the last few months. With 2020 winding down, there is an expectation that in many cases formal SBA forgiveness will not happen until 2021.
For Federal purposes under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, PPP loan forgiveness was originally noted as excluded from gross income. However, the IRS issued Notice 2020-32 in April 2020, indicating that expenses associated with tax-free income are nondeductible. This is consistent with prior IRS positions and results in the net effect of reversing any tax-free benefit of the exclusion of loan forgiveness under the PPP. While members of Congress have stated disagreement with this position, no fixes have been formally implemented.
The CPA profession is currently anticipating IRS guidance in the coming months where the IRS takes the position where a taxpayer has ‘reasonable expectations’ of forgiveness, then qualified expenses paid in 2020 should not be deducted on 2020 returns. This would result in the increase of taxable income in 2020, versus the ability to defer to 2021 when formal forgiveness may be granted. This anticipated position from the IRS is based on historical court cases and rulings that establish that a debt can be deemed to be discharged before a debt is legally cancelled, when the facts and circumstances make it clear the debt will never have to be repaid.
However, this still raises questions regarding the definition of ‘reasonable expectations’, for example a taxpayer having a strong year in 2020 year to date, could the SBA challenge the economic need, specifically for those recipients of funds in excess of the $2M audit threshold? Pending guidance, does this then create a reasonable position to allow qualifying expenses to be deducted in 2020, and added-back to taxable income in a future year? Subject to future IRS guidance and legislation, the conservative answer is to consider qualifying expenses as not deductible when performing 2020 planning, but a taxpayer with reasonable uncertainty of forgiveness needs to analyze the impact and risk profile in a position of pushing to 2021.
A final consideration in this process, is the financial accounting conformity requirement under IRC Section 451(b)(1)(C) added by tax reform in 2018. This requires a taxpayer with an audited financial statement, revenue cannot be deferred to a period later than when revenue is recognized for financial statement purposes. Therefore, it is important to coordinate both the tax and financial statement process to align with this requirement.
The PPP program creates a range of impact in various financial and tax areas to consider, such as state taxability, financial reporting, bonding/surety communication, and the application and allocation of nondeductible expenses that may impact certain tax credits. These limitations and work-in-process calculations can be unique to those in the construction industry.
The CARES Act, passed March 27, 2020, provided a wide range of relief to business and individuals adversely affected by the coronavirus pandemic. Specifically, it temporarily changes rules permitting a net operating loss (NOL) incurred in 2018, 2019 or 2020 to be carried back five years. This may help a construction company in two main instances; the first providing some cash flow reprieve if one of these years has been in a loss position, allowing the recovery of prior taxes paid; or the second strategically taking advantage of any accelerating deductions to create taxable losses to carryback to a year in a higher tax rate environment before 2018 tax reform.
Tax Credits & Deductions
Various Federal tax credits and deductions have reduced tax liability, increased cash flow, and improved competitiveness for construction contractors. Most recently, the Energy-Efficient Commercial Buildings Deduction (179D), which expired at the end of 2017, was retroactively extended late in December 2019 to cover tax years 2018 – 2020. This deduction allows qualifying contractors doing work in the public sector to receive up to $1.80 per square foot tax deduction for energy-efficient buildings placed into service, providing significant tax savings for those contractors that qualify.
An election year brings another element of uncertainty with the annual questions of timing business revenue and expenses around year-end. While the process continues to the January 5th Georgia Senate runoff, it is important to remember the 2021 base tax environment is currently scheduled to be consistent with 2020. The most important position to take is to stay flexible, be aware of various tax policy, and consider the long-term view with tax and financial planning and potential impact on your specific company operations and personal planning goals.
For more information about how these changes may affect you and your construction business, please reach out to your MCM tax professional or contact Partner Matt Neely, CPA, via email at firstname.lastname@example.org or by phone at 812.670.3434.