David McKelvey is a certified public accountant who provides tax advice to construction firms and is a principal at Friedman LLP of New York. His e-mail address is dmckelvey@friedmanllp.com.

Tax Planning for 2007 Should Start Now

Construction industry firms, especially contractors, can make critical tax planning decisions now that will benefit them next year.

by David McKelvey

The New Year has started, the holidays are behind us and now everyone is back to business: running jobs, bidding on new work, looking for real estate deals. Believe it or not, this is also the time of year when you should start your planning for the 2007 taxes you will file in 2008.

Contractors are special taxpayers, with issues and needs that are unique to the construction industry. What may be good for one company may not work for another. And what worked in prior years may be irrelevant now.

These wide disparities should discourage you from managing tax planning on the fly or by rote. As a rule of thumb, the more you focus on current and future tax concerns and avoid relying on the past to guide you, the better and more successful you and your company will become. And remember, income taxes can reduce your profits by 40 to 50 percent.

Maintaining this focus on proper planning has one basic requirement: starting early. Beginning your year-end planning in November or December is not a wise move if you would like to take advantage of all the savings opportunities available to you. Many companies end up simply getting a tax projection and are told when to pay. While that professional advice is of some help, it really isn’t tax planning. 

True tax planning involves scheduling meetings, reviewing documents, formulating recommendations, making decisions, and implementing changes, all in an effort to utilize the tax laws so that you are paying the least amount of taxes possible.  Waiting until the last minute means you may miss or minimize the benefits of any helpful changes in the tax laws or other time-sensitive recommendations that arise from the planning process, because a large portion of the tax year will already have passed.

Take as an example a recent review of tax accounting methods, job cost methodology, elections, and succession plans undertaken on behalf of a New York-area contractor. The company anticipated and shared information about certain upcoming events with us, giving it the opportunity to execute a change in its accounting method well in advance of the Internal Revenue Service’s year-end deadline.

In addition, the company was able to implement changes to its job-costing methodology and organizational structure, while also maximizing the benefit of a recently enacted federal manufacturing deduction. Overall, the contractor received enhanced tax benefits that were applied consistently and early. Starting in February, with more than enough time to discuss and implement planning options without haste, the company was able to reduce its taxable income by approximately $1,500,000.  At the 45 percent tax rate, that translated into an increase in cash flow of $675,000. 

In another example, a construction company based outside of New York City had a number of projects in the five boroughs. The company began planning in March and, acting on our recommendations, made a change to its organizational structure in May, allowing it to reduce its New York City corporation taxes significantly in its filing the following year. Had the firm waited until December to make the change, it would have lost the tax benefit.

These important conversations with your tax advisor should begin with the following general areas of planning. This is only a partial list, but it will get you started:

• Tax Strategies – Accounting methods, tax basis job costing, and retainage payable all offer ways to reduce tax liabilities with the proper use and planning. A big misconception is that your tax return needs to agree with your financial statements. It doesn’t.

• Organizational Structure – Most contractors have several entities that comprise the organizational structure. More often than not, these structures are formed over time and are maintained without regard to tax efficiency. Firms can achieve permanent tax savings by reviewing this area and making needed changes, without disrupting operations.

• Look-Back Planning – Generating tax deferrals is a great tool, but if not used properly, you may just end up paying interest to the IRS.  Therefore, reducing your look-back interest – which contractors using the “percentage of completion” tax method must calculate at year’s end by reconciling estimated cost versus actual cost – is an essential part of any tax planning process.