Under a New Administration, Understanding Your Tax Options is More Important than Ever
By Paul Gevertzman and Joseph Molloy, CPAs and partners at Anchin
As a general rule, uncertainty makes for a difficult environment, and this is especially true for the architecture, engineering and construction (AEC) industries, where business pipelines are defined by long-term commitments and relationships.
We’ve seen a range of clients struggling at times throughout the pandemic. With many projects delayed and others cancelled, it has been an uneasy time. On the other hand, AEC companies involved with life sciences and healthcare projects, among other commercial real estate niches, are doing well.
The takeaway is that many AEC firms are pivoting and adapting to meet rapidly shifting market needs. They are growing their capabilities in new and emerging niches outside of the traditional commercial and residential ground-up construction that has dominated the industries for years.
Company realignment affects balance sheets, which means optimizing a tax strategy is critical to improving liquidity and preserving capital. There’s also the added wrinkle of government aid in the form of Personal Paycheck Protection (PPP) loans and Employee Retention Credits (ERC) — combined with a change of administration — which will hopefully bring much-needed financial assistance.
As AEC firms saw halts on construction projects and pipelines delayed, PPP loans provided many companies with a bridge to return to customary business volumes. There was a high degree of uncertainty about whether or not the expenses to which PPP loans were used for would be deductible. The IRS subsequently declared that these costs would not be deductible.
Congress specifically overrode the IRS position that expenses attributable to the forgiveness were not deductible, hence making them deductible. The Consolidated Appropriations Act of 2021 also authorizes additional permissible non-payroll costs to qualify for loan forgiveness, including costs related to personal protective equipment (PPE).
The act, signed in late December, also authorized a second round of PPP loans in 2021 for borrowers who took and fully utilized a First Draw PPP loan in 2020. But to qualify for PPP2 loans, the maximum number of employees a company can have at the time of application is 300, compared with 500 under the original program. There is also a gross receipts reduction test to demonstrate a reduction in revenue and the maximum loan is the lesser of 2.5 times the monthly payroll costs or $2 million versus $10 million on the original loan.
Workforce retention is another major issue for AEC firms, particularly as they look to deliver on new and emerging market demands during the pandemic. The ability to keep employee head counts up is crucial to staying active and agile enough to seize new opportunities, as well as to take advantage of the available government programs. Workforce retention is also a major emphasis for PPP as the amount of the loan and the criteria for forgiveness are based on the company’s payroll, number of employees and number of employees retained. These requirements incentivize companies to retain their workforces.
Previously, if a business took out a PPP loan, it was not allowed to claim the ERC as well. The new law retroactively changes that to allow the ERC if the business also has a PPP loan. However, a firm cannot utilize the same wages utilized for forgiveness, or other payroll credits, for the ERC. This change is retroactive to the date of the enactment of the CARES Act.
Additionally, eligibility for the ERC has been extended through the end of 2021. The percentage of qualified wages eligible for the credit increases to 70 percent, up from 50 percent under the original program, of qualified wages up to $10,000. Also, the $10,000 wage limit per employee is now available on a quarterly basis, allowing $7,000 per quarter as opposed to $5,000 for all of 2020, a significant increase.
In 2020, if a business had fewer than 100 employees (based on average monthly full-time employees during 2019), all wages up to $10,000 per employee would qualify, whether or not the employees were providing services. In 2021, that threshold is now 500 employees, based on average monthly criteria. Please note that the headcount is based on the average of full-time employees for 2019. To be a qualified employer, a business must either have been fully or partially suspended due to a shutdown order or have had a gross receipts decline for the quarter.
For 2020, that decline in gross receipts needed to exceed 50 percent relative to the same quarter in 2019. For 2021, that decline only needs to exceed 20 percent relative to the same quarter in 2019. Shutdowns affected many AEC firms, so this is likely to apply even if the gross receipts eligibility test was not met for that quarter.
And finally, if an employer received the ERC, they would be required to reduce their tax-deductible wage expenses by the amount of the credit received.
To Defer or Not to Defer
AEC firms are re-examining their options for reducing tax burdens that may change under the Biden administration. The Tax Cuts & Jobs Act of 2017 reduced rates from 39.6 percent to 37 percent and, on top of a 20 percent reduction for pass-through businesses, produced an effective tax rate just under 30 percent on pass-through income for the owners. This was a significant tax effect for these firms and their owners.
President Biden has signaled an intention to undo a number of laws passed by the Trump administration, including increasing personal tax rates and removing the 20 percent deduction for those owners of pass-through businesses earning more than $400,000 per year. Removing that 20 percent deduction and raising corporate tax rates, as is widely expected to occur, may result in some firms and their owners facing a significantly higher tax liability.
Overall, it’s crucial to monitor fiscal conditions within the country, especially with the national debt set to stretch further as much-needed assistance is deployed to Americans. Historically, during times of high government debt, a rise in taxes has followed suit.
The tax laws for AEC firms offer options based on the facts and circumstances — to defer income for tax purposes. Every AEC firm should take advantage of these provisions in order to retain money within the company instead of paying it out currently for taxes. This results in improving the company’s cash flow and balance sheet.
However, many companies are debating whether to defer or pay taxes now so they can lock in Trump-era rates and avoid future tax liabilities in a year when income tax rates could rise. Even post year-end, there are still decisions based on a company’s individual circumstances that can alter the timing of revenue and expense recognition.
In any event, these tax strategies are extremely important to help AEC firms navigate their issues during these uncertain times.
— Anchin is a New York City-based accounting firm serving clients across a variety of industries, including real estate, private equity, construction and architecture/engineering.