For the last few years, companies have benefited from a dynamic tax and regulatory environment characterized by lower taxes and fewer banking regulations.
These conditions allowed strategic contractors to focus on corporate expansion, attract a more qualified and better compensated workforce and increase their investment in the sector. As the country continues to pull itself out of the pandemic and reopen, contractors are hearing more about higher taxes and increased banking regulations.
While the headlines focus on how corporate tax hikes will affect the largest companies, it is generally smaller entities that are most affected by these changes. Similarly, new banking regulations may limit financial flexibility and liquidity for small and medium-sized businesses. If the pandemic proved anything, it is that change comes quickly, so being prepared and flexible is of paramount importance. Even with potential tax and regulatory changes looming, you can manage and alleviate some potential stressors by getting ahead of the issue. We recommend the following three areas of focus, which will help you best utilize the current tax code regulations and get a better understanding of your existing borrowing arrangements. That way, the next time change comes, you’ll be prepared.
While we anticipate the following areas will be key for all contractors seeking success in the years to come, the attention of a qualified financial professional will always be essential in maximizing your benefits – if you have any questions about the Section 179 deduction, bonus depreciation or your bank agreements, contact a Friedman professional today.
Section 179 Deduction
Over the years you’ve probably used this part of the tax code, which — if applied consistently year over year — can provide significant tax savings.
Section 179 allows companies to write off the full purchase price of qualifying new or used equipment. Section 179 is particularly notable for contractors like you, because almost all of your equipment is eligible, including heavy machinery, vehicles, tools, computers, software, office equipment, furniture and more. With Section 179, contractors can review annual budgets, allocating a certain amount towards upgrades and improvements that can help the company grow, tackle larger and more complex jobs requiring upfront capital investment, and modernize their business.
For 2021, the deduction is limited to $1,050,000 and cannot exceed the annual business income. It is reduced on a dollar-for-dollar basis for costs in excess of $2,620,000. Furthermore, state limitations may apply as well. Needless to say, the Section 179 deduction is a very valuable tool in your current (or future) high tax environment.
The Tax Cuts and Jobs Act doubled the amount of bonus depreciation allowed for qualified property from 50 to 100 percent for property placed in service through January 1, 2023.
Beginning in 2023, the percentage will decrease by 20 percentage points each year until the bonus allowance reaches zero in 2027. Either new or used equipment purchases qualify for bonus depreciation.
Similar to Section 179, bonus depreciation can be effective in planning your growth while reducing tax liability. Given the phase-out over the next five years, contractors will need to act quickly to take full advantage of the opportunity.
Under most bank agreements, certain restrictions limit a contractor’s financial and operational flexibility. These may include blanket liens, minimum balances and annual requalification.
Banks will almost always put a lien on all company assets and that can limit the business’ ability to sell assets and grow operationally without bank approval. In addition, certain lenders require minimum balances held in escrow. In the current operating environment, that may mean missing out on access to liquidity and impeding flexibility. Lastly, annual requalification gives the lender the right to call loans early if certain requirements are not met and could jeopardize a company in a one-off down year.
Contractors must know if they are subject to these restrictions. That way, they may be able to negotiate their agreement to limit their impact or find a lender able to accommodate less restrictive lending.