Grant Thornton's Construction group says the flurry of recent tax legislation and lingering effects of the economic downturn make this tax planning environment one of the most challenging in recent memory.

Contractors need to improve cash flow by effectively managing their tax burdens and leveraging any new incentives, according to the tax advisory firm. Tax planning over the next two years will require thoughtful and nimble analysis, it says, and contractors should consider the following tips:

Lawmakers have extended and doubled bonus depreciation, allowing full expensing for many assets placed into service through 2011. Property qualifying for bonus depreciation that is placed in service after Sept. 8, 2010, and through the end of 2011 will be eligible for 100 percent expensing.

2. Review deferred compensation plans
Most contractors are struggling to remain profitable in this difficult environment. If your company cannot afford large bonuses to retain key employees, now is the time to revisit alternative compensation arrangements.

3. Some S corporations should consider taking gains.
If you converted to S corporation status in 2004 or 2005, consider sales of “gain” property in 2011. Special provisions enacted over the last two years provide a reduced seven-year period for sales that take place in 2009 or 2010 and a five-year period for sales of property during 2011.

4. Take advantage of capital asset expensing deductions.
Rules originally intended for small businesses were significantly expanded to allow contractors to expense up to $500,000 of 2010 fixed asset costs, provided less than $2 million of assets were placed in service throughout the year. Unlike bonus depreciation, this applies to new or used assets.

5. See if you can lower property taxes.
A property tax review can ensure that real and intangible property is excluded from the personal property tax base. In addition, there may be opportunities to lower the property tax valuations on real property. The review would not only generate savings in the first year, but also in future years.

6. Examine capital asset depreciation methods and lives.
Depreciating fixed assets is one of the most complex aspects of tax law. Understanding and properly applying these rules can accelerate income tax deductions, and these deductions often add significantly to the current tax flow. For contractors who have under-reported prior depreciation, recent IRS guidance allows “catch-up” deductions with an automatic change in accounting method.

7. Consider a separate entity to own and lease fixed assets.
Often referred to as leasing or procurement companies, these entities help manage assets and may significantly reduce sales and use tax, which is collected and remitted regardless of whether a company is profitable.

8. Maximize Section 199 deductions.
The Section 199 domestic production activities deduction is a unique tax incentive available to most contractors. This incentive allows taxpayers to deduct 9 percent of qualifying production activities, which includes the construction or substantial renovation of domestic real property.