|
With the passage of the American Jobs Creation Act of 2004 (AJCA), U.S. contractors who provide architectural, engineering or actual construction services for projects within the United States have received a potentially significant tax benefit.
The act includes the new production activities deduction, which is sometimes called "the manufacturer's deduction" because Congress initially intended it for U.S. manufacturers. But in its final version the tax break could apply to construction companies.
Calculating the deduction. Essentially, the deduction allows you to deduct 3 percent of qualified production activities income (QPAI) in 2005 and 2006. This amount rises to 6 percent for 2007 through 2009 and tops out at 9 percent in 2010.
To calculate QPAI, you need to first determine your construction company's domestic production gross receipts (DPGR), which include income from construction, engineering or architectural services performed in the United States. You must then reduce this amount by the sum of the following:
- Cost of goods sold that are allocable to these receipts
- Other deductions, expenses or losses directly related to these receipts
- A portion of other deductions, expenses and losses not directly allocable to these receipts.
There are, however, two important limitations. First, the deduction cannot reduce your taxable income below zero. Second, it's limited to 50 percent of the W-2 wages you pay during the tax year.
Determining qualified activities. As of this writing, the most recent IRS guidance regarding the production activities deduction limits qualifying activities for contractors to the construction of real property, permanent structures, permanent land improvements and substantial renovations.
You cannot include personal property sold in connection with construction, engineering and architectural services in your DPGR calculation. You may, however, add in engineering and architectural services even if you don't undertake the corresponding project.
Re-evaluating your operations. One way the deduction may affect your operations is to inspire a reassessment of your use of independent contractors. Naturally, engaging these workers will lower the amount of W-2 wages you pay and, consequently, your deduction may be limited. Thus, by hiring new employees instead, you can increase your allowable deduction.
Another item worth considering is how your company compensates partners (if it's a partnership) or you (if it's a sole proprietorship). Any income distributed to owners in these types of entities, be it through guaranteed payments or earnings allocations, isn't includable in your W-2 wage base.
Therefore, operating as a partnership could severely limit your eligibility for the production activities deduction, depending on the number of partners in your organization and how much compensation they receive. Alternatively, if you incorporated your business, you could compensate those same individuals via W-2 wages and make better use of the deduction.
These benefits notwithstanding, approach an entity change cautiously. There are many other factors - financial, legal and operational - to consider before making this decision.
Addressing accounting woes. The production activities deduction may also bring on some accounting woes - particularly if your construction business has both qualifying and nonqualifying gross income. To track eligible and ineligible projects, and their associated direct and indirect costs, you'll need to ultimately extract this information from your accounting system.
Depending on the sophistication of that system, doing so could prove difficult and expensive. In addition to determining the cost of goods sold and direct costs, you must establish a method of allocating indirect costs to qualifying and nonqualifying projects. IRS guidance provides some options for properly allocating these costs, but getting the job done may call for an upgrade to your accounting system, a revision of your accounting methods - or both.
|
print this page
e-mail this page
