The past couple of years have been challenging to say the least. Companies across all spectrums were hit hard by the pandemic. The one sector that seemed to have weathered 2020 better than others was construction. That said, 2021 has been more of a struggle for contractors as they face a shrinking backlog, price escalation on materials, and even weather. One way construction companies seeing a reduction in revenue in 2021 can get help is by taking advantage of the Employee Retention Credit (ERC). The ERC was initially introduced by the Coronavirus Aid, Relief, and Economic Security Act in March 2020 and extended several times via various other legislation. Most everyone has heard of the ERC, but they don’t realize how beneficial it can be.
At a high level, the ERC allows companies to take a fully refundable credit against FICA tax as reported on a quarterly Form 941. Under the 2021 Consolidated Appropriations Act, the ERC for the first and second quarters of 2021 expanded the benefits originally provided for with the 2020 version of the credit. The 2021 ERC is computed as 70 percent of an employee’s wages up to $10,000 for the quarter, or up to a $7,000 credit per employee, per quarter. For example, a company with 100 employees could receive up to $700,000 that is fully refundable to the company in the form of a refund check (or direct reduction to payroll tax liability), not a credit that will be used over time. To qualify for the credit in 2021, a company will need to show a drop in revenue of 20 percent in a quarter of 2021 compared with the same quarter of 2019. When performing an analysis to determine the extent of a revenue reduction, it is important to note that revenue is determined on the same basis as it is determined for income tax purposes. The American Rescue Plan Act of 2021 expanded the ERC to the third and fourth quarters of 2021; however, initial legislation working its way through Congress may potentially eliminate the ERC for the fourth quarter of 2021, except for recovery startup businesses.
In addition, there are some tax proposals on the table that could make construction contractors and other taxpayers change the way they look at the end of the 2021 calendar year. Some of the most recent changes being proposed would increase tax on operating income. Proposals include:
- Increase the top ordinary rates from 37 percent to 39.6 percent for individuals who earn more than $400,000 as single or $450,000 as married filing jointly
- The qualified business income deduction (QBI) would be phased out for taxpayers with taxable income exceeding $400,000 for single or $500,000 for married filing jointly
- Creation of a new 3 percent surtax on taxpayers with modified adjusted gross income (before itemized deductions) in excess of $5 million
With this in mind, taxpayers may want to take steps to accelerate income into 2021 to take advantage of the lower rates. This could be done through delaying equipment purchases or more aggressive billing. Also, since the majority of construction contractors recognize revenue on a percentage completion basis, revenue is earned as costs are incurred. Thus, it may be beneficial to incur more costs prior to year-end to increase revenues and recognize profits in 2021 while rates are lower.
One additional provision being discussed would see an increase in the top capital gains rate to 25 percent. If that happens, businesses in the process of being sold may want to consider making some changes to how the deal is structured by accelerating the sale into 2021 as much as possible. For example, for sales that are set up on an installment basis, it may be more beneficial to elect out of installment treatment and pay all the tax on the front end if possible. However, Congress is currently considering making the increased capital gains rate retroactive to September 13, 2021, which may limit the planning opportunities for transactions completed after that date. Sales that don’t get completed until 2022 could see an increase in the benefit of using qualified opportunity zone funds to defer the capital gains tax due to the higher proposed rates.
None of the proposed tax legislation mentioned above is finalized yet, but it’s good to be aware of the possibilities when approaching year-end.
If you have any questions about how to calculate the ERC or updates to tax policy and their effects, reach out to your BKD Trusted Advisor™ or submit the Contact Us form below.