If you are in the construction business and have less than $10 million in average gross receipts ($5 million for C corporations), you are likely entitled to use the cash basis method of accounting for income tax purposes. For new, growing businesses, this is especially relevant and useful for pushing your tax liability into next year. You control your taxable income by controlling your cash transactions.
Alternative minimum tax
There is one catch that many taxpayers (and tax preparers for that matter) are not aware of. The difference between income determined under the percentage of completion method (PCM) of accounting for long-term contracts (LTC), as prescribed by Internal Revenue Code Section 460, and income determined using any other method, is a tax preference item for Alternative Minimum Tax purposes. Any significant tax deferral gained by reporting taxable income on the cash basis will likely be eliminated by the AMT.
Item of note – C corporations defined as “small” are not subject to AMT. The small business test = less than $5 million in average gross receipts in the first year test, less than $7.5 million thereafter. However, there is no minimum threshold income level for pass-through entities.
Use Form 6251 (Form 4626 for C corporations) to determine if AMT applies. Show an adjustment for the difference between income arrived at under the PCM and any other method of accounting for LTC. Finally, hope the IRS doesn’t come calling if your preparer misses this.
If you have any questions about how the AMT affects your construction business, I’d be happy to take your call. My phone number is 336-382-2841.
One of the most valuable considerations in offering construction services is to establish and maintain good surety credit. It is critical that you are able to secure bonding when requested/required by a customer. The following is a discussion of ideas that I learned over twenty years as CFO for a highly successful General Contractor. I hope this will help you establish and maintain a solid surety relationship.
Don’t wait until you need a bond to know where you can get one
It’s important to establish a surety relationship before you need a bond. Find the right agent. They should have a reputation for being trustworthy and for keeping business information confidential. Ensure the agent has access to several underwriters. Make sure both your agent and underwriter(s) know the industry and your market well. The rating of the underwriter will be important to your customers. Furthermore, the agent’s knowledge can be a valuable resource in reviewing contracts and qualifying subs.
Maximize the amount of credit by knowing the underwriting criteria the underwriter will use
The surety will base their credit decisions primarily on a ratio of work program (the amount of uncompleted work under contract) to capital. The denominator in the ratio will generally be the lesser of your net worth or your working capital. You can command the best bond program/rate by maintaining a ratio of 20:1 or less.
The surety will make adjustments to your financial statement numbers in calculating your capital balance. For example, they will exclude older receivable balances even if management can establish they are collectible. Also, in measuring working capital, they will exclude prepaid expense balances but will include cash surrender value (CSV) of life insurance policies.
Here are a couple of tips: 1) If the renewal of your insurance policies coincides with the beginning of your fiscal year, don’t pay or record a payable for the renewal deposit or first installment until after the first of the New Year. Your working capital won’t be adjusted by the amount you “prepay”. 2) If working capital contains perpetual, liquid cash reserves of any significance, consider buying key man life insurance via whole life policies. Use the low-yield cash reserves to fund the CSV. The CSV will carry a much higher yield and ultimately fund the death benefit. Plus, the CSV is just a liquid as long as there are borrowing provisions in the policies. Hence, you improve your investment yield and augment your surety credit.
Having an open line of credit agreement with a credible lender will greatly enhance your ability to obtain surety credit.
Keep your surety at the ready by having command of your numbers
Once the relationship is established, the surety will want numbers reported at least quarterly. You need to strive to report to them within 45 days after the end of the quarter. Reporting consistently and timely will instill confidence and trust into the relationship. You will need to submit a balance sheet and an income statement with revenues and work-in-process (WIP) balances calculated using the percentage of completion method. They will want to see an aged accounts receivable detail. They will also require a detail of the WIP.
Tips for reporting WIP: For significant jobs-in-process, the surety will monitor estimated profit against actual results. You need to keep close watch on your estimated costs to complete. Demonstrating a sound ability to estimate is as important as a strong balance sheet. Err on the conservative side. Write-ups are viewed much more favorably than profit fade.
Stay on top of your collections. Cash management and project management should be integrated. Your collection efforts will be much more effective if you put primary collection responsibility in the hands of the project manager.
The surety will need to monitor projected backlog and sales prospects. It will pay dividends if you can develop a mechanism to project sales and profit and report those to the surety on a regular basis.
* * * * * * *
These are some of the more important things I learned over twenty years that help me and my employer maintain a strong surety relationship. We were able to earn the trust of both the agent and the underwriter. The Company was never denied a bond request during my tenure and we were eventually able to eliminate some of the collateral normally required. Sound management and financial practices over time will put you in a position to make commitments to your customers that they can have faith in.
If you think that I can help you in this kind of endeavor, don’t hesitate to contact me. Call 336-382-2841. Or you can use the contact form from my website found here: https://www.bartonltiffanycpa.com/contact/
