Modern Home Builder - Winter 2016 - Volume 2 - 8
Bradford L. Hall
While much of the national economy has improved since
the depths of the Great Recession of 2007, many sectors across
the U.S. have not been that fortunate - especially the construction industry, where new housing starts have been inconsistent from market to market. With these challenging business
conditions coupled with rising tax rates and limited deduction
options, builders need to do what they can to improve cash
flow by effectively managing their tax burdens and leveraging
any available tax incentives.
Here are some tips to help construction managers navigate
the choppy waters of the industry.
CHOOSE THE RIGHT CORPORATE STRUCTURE
When positioning your construction business to take advantage of federal tax laws and limit the risk of an audit, the first
thing you need to do is chose the most appropriate corporate
structure. The most common options are S corporations and C
corporations. Both are popular choices for construction companies, but they each have different rules set by the Internal
Revenue Service (IRS).
Often an S corporation is preferred because it allows additional tax breaks and lowers the risk of an IRS audit. Ask any
construction business owner who has been audited and they will
tell you that it isn't a walk in the park. The S corporation designation shelters your company from this risk by placing a larger
liability on the shareholders and means that business losses don't
fall exclusively on the business owner's shoulders.
C corporations, on the other hand, are riskier. While an S
corporation has 0.5 percent chance of being audited, C corporations are audited approximately 5 percent of the time.
UNDERSTAND THE DIFFERENT
The next important step is determining the correct accounting method for your business. Construction business owners
report their income and expenses based on one of two ac-
counting methods - the cash method or the accrual method.
Both methods can be used on the same annual tax return,
but they must be used consistently to reflect the treatment
of income and expenses. It is critical to use the most advantageous method to increase cash flow and defer taxes. Otherwise, you may wind up paying taxes on money that hasn't
been collected yet.
Here is a breakdown of the different accounting methods:
) Accrual Accounting: This method requires reporting
income and expenses in the same year that they were
earned and incurred. The "completed contract method"
and the "percentage of completion method" are the two
most popular accrual methods in the construction industry. If construction owners use the completed contract
method, they can report all income and expenses from a
contract in the year the project is completed and accepted by the customer. Under the percentage of completion
method, the reporting is spread throughout the lifetime
of the project and income is reported in proportion to the
percentage of costs incurred to date.
) Cash Accounting: This method is used mostly by business
owners. It requires cash receipts to be reported as they
are received even if it is just a deposit for the job. It also
requires expenses to be reported as they are paid.
There are various exceptions within the construction field
regulating who can use either form of accounting, and it is
best to consult with a trusted tax advisor who specializes in
construction before determining which method is right for