QCould you shed some light on how a company can determine whether to classify a person as an
employee or a subcontractor?
The difference between the two is sometimes difficult to determine. The Person is typically properly classified as an Employee if the responses to the questions below are Yes: (1) Do you direct that Person’s activities when they come to work?; (2) Do you provide tools for the Person to use to do the job?; (3) Do you tell them when to come to work and when to leave?; (4) Does the Person work for only your Company?; (5) Do you provide benefits to the Person?, (6) Does the Person do tasks that other Employees are handling?; (7) Has the Company paid the Person as an Employee in the past?, etc. If the answer is no to any of the above questions you may have a Subcontractor relationship.
The Person is classified as a Subcontractor if the responses to the questions below are Yes: (1) Does the Person work for several different Companies that are non-related?; (2) Does the Person provide their own tools?; (3) Does the Person set their own schedule and arrive at work and leave work at their discretion?; (4) Do they have their own Company with their own Identification Number?; (5) Does the Person employ others?, etc. If the answer is no to any of the above questions you may have an Employee relationship.
Unfortunately, there are no absolute rules defining an Employee versus a Subcontractor relationship but we typically let our Contractors know that if it looks like a Duck and walks like a Duck it is probably a Duck; same goes with Employee versus Subcontractor.
When in doubt whether a Person is a Subcontractor or an Employee please seek advice from your CPA. The IRS is focusing on the misclassification of Employees versus Subcontractors and the penalties are severe if a misclassification is made.
QWhat are some year-end considerations for builders and contractors?
For a Contractor/Builder, there are two main areas where we focus our efforts as we get close to the end of their year –Minimizing Income Taxes and Maximizing Bonding Capacity.
In Construction as well as many other Industries, “Cash is King”; therefore, an important part of prior to year-end planning is to minimize the cash outflow for income taxes. The less cash paid for income taxes the more cash left to build the business.
The IRS Tax Code has special rules for contractors with less than $10 Million in annual revenues which allow smaller Contractors to defer income taxes into the future and serves as an interest-free loan. Two methods allowed are: (1) Cash Basis Accounting which allows Contractors to report their taxable income and pay their income taxes based on the actual cash flow; this allows the Company to pay tax as it receives its income and not pay tax on receivables and retention; (2) Completed Contract Accounting which allows the Company to pay tax on the income when the job is completed. Since retention is often held back from the Contractor until the Job is virtually complete, this gives the Company time to complete the job and normally receive the retention before the Income Tax is due.
There are many subtleties with regards to each of these methods, so proper planning and discussion with your CPA is advised. Using these deferral methods allows your Company to take advantage of the rules Congress and the IRS have put in place to help small growing Contractors.
For larger Contractors and Builders, there are other ways to make sure that you and your Company are not paying more than necessary in taxes. Since large Contractors (those averaging more than $10 Million in revenues per year over a three year period) are required to use Percentage of Completion Accounting, the Tax Planning tools for deferral are more limited so the Contractor should strive to be conservative and not overly optimistic on the final estimated gross profits on jobs in progress at year-end. Overstating profits will cause the Company to overpay taxes and pay taxes on profits they might not earn.
Some tax planning tools are similar for both Small and Large Contractors including timing of purchases of major pieces of equipment, using Qualified Retirement Plans to reduce taxable income, etc.
The other focus at year-end is Bonding Capacity. Bonding capacity is based on many factors including a Contractor’s reputation and management skills and style (Character), performance history with regards to skills, experience, knowledge of types of work, equipment, and safety record (Capacity), and financial resources (Capital). The first two items, Character & Capacity, cannot generally be fixed or made to look better at year-end but are a result of the reputation of the Contractor. The final item, Capital, is based on the financial picture at year-end (Balance Sheet) and the financial results for the year (Income Statement). There are decisions made prior to year-end that can impact the result reflected in the financial statements, either positively or negatively impact the presentation and the way a third party assesses the Company. As mentioned above, “Cash is King”, so the Contractor will need to make certain that the Balance Sheet reflects the amount of Cash that is needed to run the Company. A company using the Cash Basis for Income Tax Purposes may be inclined to cut checks prior to year-end to get the tax deduction without realizing they are hurting the presentation for their financial statements which in turn, negatively impacts their Bonding Capacity.
Planning requires taking the time to get together with your CPA before the end of your year to get the best advice and recommendations which will lead to less income tax and higher