December 8, 2023

How Your Contracts are Key to Selecting Accounting Methods That Save Tax Dollars

By Marty McCarthy, Partner, Mid Atlantic Construction Leader

How Your Contracts are Key to Selecting Accounting Methods That Save Tax Dollars Construction

The most successful contractors take a great deal of pride in their attention to detail. That’s how they develop long lasting client relationships and become leaders in their trade. But these same contractors often fall short of their own high standards when it comes to the taxation of contractors. The good news for them is that most contractors can improve their financial circumstances without expensive or disruptive changes to their core operations.

So, how can contractors get better equipped to realize the full-value of accounting tax services and – more importantly – what’s at stake?

Recognizing the Tax Impact of Accounting Methods

For contractors, there are many ways to operate and report taxes under the IRS code. To choose the most tax-effective method, it’s necessary to understand how each may be used. Financial statements are reported under Generally Accepted Accounting Standards while tax reporting is more open-ended. Choosing the “right” method for tax reporting requires an understanding of terms like cost plus, GMP, maintenance contracts, retainage, pay if paid, and cash basis (among many others), as well as their tax ramifications of these.

While the specific terms above may or may not appear to apply to your contracts, it is the nature of those contracts — and the application of the terms in them — that are central to determining the method of tax reporting that will best serve your business. Because no two contracts are the same, each contract must be reviewed alongside tax professionals with specialized industry knowledge to effectively maximize tax reporting practices.

How Contracts Impact Taxes: One Use Case

As we said earlier, contractors that use the percent complete basis method for financial statements reporting purposes and employ the same method for tax purposes are missing opportunities. If that contractor’s construction contract includes “if paid” language for subcontractors, it would be eligible (in most states) to exclude certain costs, thus reducing income when reporting taxes. If they have construction contracts that are maintenance contracts, they can report on a different method. IRS defined residential contracts have yet other reporting methods. These are just a few examples of contracts that can be reported under a different method for tax purposes.

Most contractors are not aware of the many tax opportunities within their existing contracts, particularly if that contract includes terms they haven’t seen before, or their tax advisors do not specialize in the construction industry. With so many moving parts affecting the taxation of construction firms, it’s extremely unlikely that a contractor will recognize the most tax efficient reporting method without expert guidance. Notably, once a method is selected and in place, it’s unlikely to change over that project’s lifetime.

Simple Process, Big Impact

Once you’ve chosen a tax and accounting partner with specialized experience in construction, you’ll need prior tax returns, financial statements, and enough time to talk through your current contracts. With the reporting options available established, the next step is to talk about broader business goals. That will help determine which of the various reporting methods represents the greatest value to the company. For example, a company with contracts enabling tax deferral or retained capital would speak with their advisor and use the method most advantageous in light of their circumstances and goals.

Ask Marcum

If you have any questions about your contracts, accounting methodologies, or tax efficiency in general, contact a Marcum advisor today.

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