Although some may argue that paying more tax than required might be considered patriotic, it’s important to recognize that strategically minimizing tax liability (within the legal framework, of course), is a common and prudent practice in the United States. The U.S. Tax Code, also known as the Internal Revenue Code (IRC), contains several provisions which can help contractors reduce their tax burden.
Reducing Overall Tax Liability
At this time every year we encounter contractors who are upset about their tax liability. They complain because after years of struggling financially, they experience a profitable year, just to be told to hand over a substantial amount of their profits to the government taxing agencies. What some owners don’t know, and often find out after the fact, is that with some strategic tax planning they can reduce their overall tax liability. Tax planning should be part of a contractor’s financial plan. Identifying ways to reduce tax liability and use those savings in a way that benefits the contractor should be sought.
It’s helpful to consult with your CPA, or other professional tax preparer, to customize the various strategies for your specific situation. With so many tax issues that can affect your business, it’s essential to ensure that every potential deduction is considered, even if you need to delve further into the details with your tax professional before making a decision. When implementing a long-term tax plan, it is crucial to keep up with the evolving tax laws, which may necessitate a course correction to your existing strategy.
There are no cookie-cutter solutions, as each business faces unique challenges, but here are five popular tax planning strategies that we have found particularly beneficial to contractors.
1. Education Expenses (Yes, They’re Deductible!)
Generally, education expenses are considered valid when they include classes to improve specific skill sets required for a particular position, or to learn about updated methods or processes, especially if needed for compliance. Additional deductions may be available for the type of training that is required to obtain licenses which are applicable to your industry.
One example is the LEED certification, which gives contractors and their teams a competitive edge when bidding on contracts in an environment with increased awareness and implementation of green building standards. This is a double win for contractors.
2. An Appreciation for Depreciation
Depreciation, while not a cash item, is one of the best ways to obtain a deduction. Whether it is buildings, equipment, machinery or vehicles, these are just a few of the items contractors can depreciate. Each item has a useful lifespan through which it can be depreciated over time.
In addition, there are different types of depreciation methods which can be applied to each item: Straight-Line, Double-Declining Balance, Units of Production and Modified Acceleration Cost Recovery System (MACRS), to name just a few. To find out which method is best for your business, it’s wise to consult with your tax professional based on the type of item and the time frame allocated for its depreciation.
3. Section 179
The use of Section 179 is another strategy. Section 179 is a section of the U.S. Internal Revenue Service code that allows businesses to deduct the cost of certain depreciable assets in the same year they were purchased; which means that instead of depreciating the cost of the item over a number of years, the cost will be deductible; it accelerates the depreciation amount to one year, increasing expenses while decreasing net income, thus reducing tax liability. Contractors are advised to compare the benefits of depreciating versus the use of Section 179 to the assets which allow a choice between these options.
4. Always Do Your Research
Research and Development is often an area overlooked by contractors. Costs incurred for developing, designing, and testing innovative ideas can qualify as deductible expenses. Development of eco-friendly techniques to improve efficiency and durability in buildings, innovative design, and testing of new equipment and machinery to enhance performance and safety, or conducting research to improve safety standards and promote ergonomic designs in the workplace that can help reduce accidents and injuries, are a few of the costs that qualify.
5. Benefit Your Employees
Implementing Employee Benefit Programs can be part of a contractor’s tax planning strategy. These programs include health insurance plans, retirement plans, disability and life insurance, personal time off, and employee assistance programs. In addition to the tax benefit, these programs help improve employee morale.
We’ve outlined only a few of the common strategies used by many contractors to reduce their tax liability. To implement these tax planning strategies, as well as others that may be available to your business, contact a tax professional who can provide more specific guidance. To effectively implement new tax strategies, it’s important to ensure they meet your standards for risk tolerance and the precise needs of your business.
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Johnathon Roberie