The health of the construction industry often echoes the health of the larger economy, be it in a region like Orange County and new housing tracts, or at the national level with things like grand transportation projects linking regions.
The industry contains numerous regional small to midsized firms competing with larger national corporations for private and government construction contracts of varying values.
Construction businesses hold much potential for profitability, but the industry goes through severe boom and bust cycles. There also are some complicated rules which the IRS touches upon in Publication 3780, a tax guide geared towards small construction businesses.
Accounting Methods
Accounting methods are the rules determined in reporting income and expenses. The two most common ones to businesses are the cash and accrual methods. As the name implies, the cash method reports income and expenses as the cash is received. Put simply, the accrual method reports income and expenses as they are earned and not when the cash for it is paid. Generally, construction businesses use the accrual method due to the complexity of contracts and IRS rules requiring C-corporations and certain firms like mining firms to only use the accrual method. Of course, there are some exceptions such as small construction firms taking in an average gross revenue of $10M in a year able to use the cash method if they so choose.
Indirect Costs for Long Term Contracts and Accounting Methods
Indirect job costs such as repairs and depreciation on construction equipment are required to be allocated to long term (1 year or more) contracts. Indirect job cost allocation depends on the type of cost and the type of method used to account for long term contracts. Certain costs are not allowable to be allocated as indirect job costs to long term contracts, such as advertising expenses and expenses related to unsuccessful bids.
GAAP allows for two kinds of long term contract accounting methods, percentage-of-completion method and completed-contract method. As the name implies, percentage-of-completion reports expenses and revenues according to the percentage of a completion of a project. Completed contract method reports expenses and revenues only when the contract is fulfilled. Generally, construction companies use the percentage-of-completion method and allocate indirect costs to their long term contracts as needed.
Independent Contractor or Employee?
Another common issue that arises for small construction firms is the proper classifications of independent contractors and employees. Three factors are considered when determining whether they are an employee or an independent contractor:
- Control over the work done – If you can only control the outcome of the work to be done and not how the work is to be carried out, then that worker is likely an independent contractor and not an employee.
- Financial control – Is the worker paid with a possibility of profit or loss to the worker for a job to be done? Are their expenses not reimbursed by the firm? Then they may most likely be an independent contractor.
- Relationship of parties – Does the worker receive some kind of employer benefit? Or are they only paid on a specific job based on an agreement for work to be done? Workers who are compensated only for a specific job and receive no other benefits such as health insurance are independent contractors.
This is just a general overview of common tax issues small construction businesses may face. Each case will be different and specific concerns will emerge. For those concerns, we are more than capable to assist in those needs. MiklosCPA is a Los Angeles-area accounting firm with a focus on businesses and their tax and accounting functions. We provide a service that uses current cloud-based technologies and personalized communications to help your firm manage the accounting so that you can charge ahead on growing the business. If you are interested in learning more about our services, please contact us!