Construction Industry Alert: Preparing for the New Medicare Surtax: 3 Areas to Consider

Thanks in part to the new Medicare surtax that takes effect this year, many construction company owners will see a surprising increase in their income tax bill when they file their taxes for 2013. The new Medicare tax will likely have a higher impact on shareholders of privately-held construction companies that operate as pass-through entities such as S-corporations and partnerships. These individuals with investment and W-2 income over a certain level of their adjusted gross income may see their tax bill rise by as much as 5 percent.

Combined with the new increase in tax rates for individuals earning over $450,000, these individuals could see up to a 10 percent increase in their tax bill. This is not welcome news to construction companies, as more money will go toward paying these additional taxes, thus putting a strain on working capital and growth.

With 2013 already halfway behind us, it is imperative that owners of construction companies begin planning now to help minimizing these tax increases. Many techniques will require companies to transact or account for certain items differently than they have in the past. There are a few changes that come to mind that should be evaluated immediately.

1. Owners should evaluate the level of salary vs. cash distributions they receive from their company.

The goal is to redirect more money toward distributions and less toward W-2 wage income to help minimize payroll taxes and the new Medicare surtax. The challenge is to redirect as much money as possible while not raising reasonable compensation issues on the part of the Internal Revenue Service, with the government now being the party claiming that an owner is undercompensated.

2. Owners should determine whether they meet the active business standards defined under the Internal Revenue Code.

If they do not meet these standards, the income reported to them on their K-1 from the business could be subject to these new taxes discussed above. This is especially troublesome for shareholders who are family members (e.g. children) and who may not be considered active in the business. Steps may be possible to increase their level of activity, with the goal of getting them to satisfy the active business standards and, thereby, avoid these new taxes.

3. Contractors who have the commercial property of the business in a separate legal entity and self-charge rent to the operating entity may also be in for a major surprise relating to a tax rate increase on this rental income.

If you find yourself in this situation, you may wish to evaluate the terms of the lease agreement to determine if any additional expenses can be allocated to the rental income, or if the lease terms can be modified to reduce the rental income, thereby minimizing the taxes and relining the lost income stream with other economic consideration.

With the introduction of the new Medicare surtaxes and the increase in the individual tax rates, many companies will be facing higher tax bills in the future. The techniques discussed above are just a few examples of items that should be explored to help minimize these taxes. That is why tax planning in 2013 will play such a vital role for any construction company looking to preserve their working capital for continued growth in the marketplace.

We will be happy to provide further information relating to this subject.  For more information, contact Carlo R. Ferri, Director, Tax Strategies and member of Kreischer Miller’s Construction industry group at Email or 215.441.4600.

 

Information contained in this alert should not be construed as the rendering of specific accounting, tax, or other advice. Material may become outdated and anyone using this should research and update to ensure accuracy. In no event will the publisher be liable for any damages, direct, indirect or consequential, claimed to result from use of the material contained in this alert. Readers are encouraged to consult with their advisors before making any decisions.