Year-End Tax Planning for Contractors
With another tax year on the horizon, now is the ideal time to begin planning for the 2025 tax year. Proactive tax planning allows business owners to reduce, defer or even eliminate potential tax liabilities. Below are key strategies to consider as you prepare for year-end and beyond.
Maximize Retirement Contributions
Maximizing retirement plan contributions can be an effective way to lower your 2025 taxable income. For 2025, employees can defer up to $23,500 into their 401(k) plan. Taxpayers aged 50 and older can contribute an additional $7,500 in catch-up contributions.
New for 2025, individuals aged 60 to 63 qualify to make a higher catch-up contribution of $11,250 instead of $7,500. Keep in mind that income limitations and plan-specific rules may affect eligibility, so it’s important to confirm your limits with your plan administrator or tax advisor.
Make Proper Estimated Tax Payments
For the 2025 tax year, the IRS interest rate remains 7% for individuals. Taxpayers with larger tax liabilities should use year-end planning to estimate their total tax exposure and ensure sufficient estimated payments are made. Proper planning can help avoid costly underpayment penalties and interest and protect cash flow during the year.
Permanent Expensing of Domestic R&D Expenditures
The Tax Cuts and Jobs Act (TCJA) of 2017 significantly altered § 174, requiring domestic research or experimental (R&D) expenditures incurred in taxable years beginning after December 31, 2021, to be capitalized and amortized over a 5-year period. This change placed a burden on many contractors and manufacturers involved in product design, innovation and process development.
With the passing of the One Big Beautiful Bill Act (OBBBA), businesses may once again immediately expense domestic R&D costs beginning in 2025.
Leverage Accelerated Depreciation
The method of expensing assets used for tax purposes differs from that used on the financial statements, which can result in larger tax depreciation deductions earlier in an asset’s life. Two primary strategies can help contractors accelerate deductions and reduce taxable income:
1. One common way to accelerate the depreciation of an asset for tax purposes is by expensing it under the IRC §179. This allows taxpayers to deduct the cost of certain property as an expense when the property is placed in service. Under the OBBBA, the maximum amount of allowable §179 expense is $2,500,000 on qualified property that is placed in service during the 2025 year. However, there is a $4,000,000 phase-out threshold. If a business places qualified property in service during the year exceeding the $4,000,000 threshold, the amount of allowable §179 expense is phased out $1 for $1.
2. Like the §179 expense, businesses can also elect to take bonus depreciation on qualified assets placed in service during the year. For fixed assets placed in service after January 19, 2025, 100% of the qualified asset’s basis is allowed to be deducted as bonus depreciation on the tax return, no matter if the asset is new or used. Unlike the §179 deduction, there are no phase-out thresholds for the bonus depreciation deduction, which can make it even more appealing in some cases.
The use of accelerated depreciation methods, such as §179 and bonus depreciation, allows businesses to increase their depreciation deductions. That, in turn, reduces taxable income, making depreciation an incredibly important part of tax planning for businesses.
Qualified Business Income Deduction
The OBBBA made permanent one of the most valuable benefits for contractors structured as pass-through entities or sole proprietors — the §199A qualified business income deduction (QBID). Under the TCJA, the §199A deduction was originally set to expire on December 31, 2025. Qualified business income (QBI) is generally the amount of taxable profits after wages and guaranteed payments, and many taxpayers are able to receive a deduction equal to 20% of this amount. Though the QBID is a great tax planning opportunity, it can become very complicated and comes with phase-out thresholds. Rules change once taxable income exceeds certain thresholds, and limitations then apply.
New York State Pass-Through Entity Tax
It is important to note that the OBBBA did not affect New York State’s pass-through entity tax (PTET) program. This program allows an S corporation or partnership to pay the state-level tax associated with that entity’s New York State taxable income, shifting the tax liability from its individual owners to the business itself.
The amount of PTET paid becomes a federal deduction for the business and a state-level tax credit that is passed through to the individual owners. For New York State, an annual election into the PTET program must be made by March 15th of the respective tax year (i.e., March 15, 2025, for the 2025 tax year).
Conclusion
Effective tax planning requires a big-picture approach, strategically timing income, deductions and investments to minimize overall tax liability across multiple years. You may find it more beneficial to use certain methods and deductions in different years to end up in the most favorable tax position each year.
As always, it’s essential to consult with your tax advisor or contact our team to determine the best tax-planning strategies that can position your contracting business for maximum tax efficiency in 2025 and beyond.
Contributing Author: Luke Bennett, CPA, is a tax senior accountant with extensive experience in personal and corporate income tax preparation, tax planning and tax closings. He has a strong background serving clients in the construction and manufacturing industries. For more information on this topic, you may contact Luke at lbennett@dmcpas.com or (315) 472-9127.