Construction Seminar Tax and Audit Tips

Welcome toSurviving & Thriving in our Current Economy

Bank Perspectives on Construction Lending in a Tough Credit Environment

Moderator - Robert W. McLeodUniversity of Alabama, Professor of Finance and the John Bickley Faculty Fellow in Finance and Insurance at the University of Alabama. Chairman of Financial Economics Consulting Group, Inc.

Panelists• Bank of Tuscaloosa, VP Walker Evans• Bryant Bank, SVP Kevin McMahon• First National Bank of Central Alabama, EVP Jim Clayton• Regions Bank, SVP Charlie Dunn• Renasant Bank, City President Kyle Faught

Punch List for a Healthy Financial Statement

Bryan R. ChandlerManaging Shareholder

Three C’s of Contract Surety Underwriting

1. Character

a) Management team

b) Integrity

c) Reputation

d) Honesty

e) Trust

2. Capitala) Profitability

b) Working Capital

c) Net Worth

d) Line of Credit

e) “Off balance sheet” value

Three C’s of Contract Surety Underwriting (Continued)

3. Capacitya) Ability to do the work

b) Contract terms

c) Operations

d) Experience

e) Type of work

Three C’s of Contract Surety Underwriting (Continued)

Causes of Contractor Failures• Substantial and sudden increase in job size• Expansion into new geographic areas, new types of

construction and business• Changes in key personnel• Lack of managerial skills• Under capitalized• Inadequate working capital and credit lines

Causes of Contractor Failures(Continued)• Accounting systems not equipped to track construction costs on a job-by-job basis• Failure to properly estimate job profitability and cost to complete• Poor billing and collection procedures• Co-mingling of personal and business• Contractual obligations misunderstood• Inability to produce accurate internal financial statements

Punch Items for a Healthy Financial Statement

• Don’t focus solely on the income statement.• Bankers and sureties use the entire financial statement, including footnotes and supplemental disclosures and schedules.• The balance sheet is a “point in time” financial snapshot of the assets, liabilities and net worth of the company.• The other elements of the financial statements also paint a “picture” of your company’s operations.• It is important to run your company so you make a good “picture”.

A picture makes an impression of how you operate.

Do your best to always make a good picture.

Be careful of trying to paint a picture that is not “real”. It may be easy to spot.

Key Elements in the Contractor’s Financial Statement• Contract schedules• Retainage• Over/under billings• Unapproved change orders/claims• Fade analysis• Backlog – revenue and profit• S Corporation income tax disclosures• Material changes in estimates• Joint ventures

Contractor KPIs(Key Performance Indicators)

• Liquidity

• Net worth

• Profitability

• Debt covenants

Contractor Warning SignsEquity Ratios• Debt to equity > 3 to 1• Working capital to equity < 1.3 to 1• Interest bearing debt to equity > 80%• Overhead to equity > 1 to 1

Billings Ratios• Underbillings to equity > 20%• Cash to overbillings < 1 to 1

“Underbillings are unusual and overbillings should be in the bank.”

Contractor Warning Signs (Continued)Liquidity/Working Capital Ratios• Average age of receivables > 60 days• Average age of payables > 45 days• Revenue to working capital > 20 to 1 • Revenue increasing > 50% in one year

Operating Ratios• Job profit fade > 10%• Overhead increasing > 50% in one year

Other Red Flags• Related party receivables• Shareholder loans

• Development activities

• Investment in non construction activities

• Increasing or constant bank borrowing

• Purchase of substantial amount of fixed assets in one year

• Operating losses for two consecutive years

• Substantial decrease in backlog

• Non-existent or incomplete contract disclosure in financial statements

Contractor Warning Signs (Continued)

Questions?


Tax Tips for Your Tool Box

Kim SmithKaty Beth Jackson

Tax Tips

• Construction industry methods of accounting• Maximizing depreciation deductions• Domestic production activities deduction• Maximizing tax deductions for entertainment facilities and per diem

Tax Traps

• Pitfalls of construction industry methods of accounting• Limits on accelerated depreciation• Limits on the domestic production activities deduction• Pitfalls of entertainment facilities and per diem

Tax Tips: Construction industry methods of accounting• Methods of accounting for construction contractors

- Cash- Accrual- Accrual excluding retentions

• Tax definition of a long-term contract- Completed contract method- Percentage of completion method• De minimis exception for percentage of completion method

Tax Tips: Construction industry methods of accounting• What is the tax definition of a long-term

contract?• Examples of long-term contracts• This tax definition may differ from the one used

in your financial statement reporting

Tax Tips: Construction industry methods of accounting• Completed contract method of accounting for long-term contracts

• May be used by any contractor whose 3-year average annual gross receipts are $10 million or less on jobs expected to be completed within two years

• Timing of recognition of contract income and contract expenses on your tax return

• Remember to allocate some of your indirect general & administrative expenses to job costs

• Benefits of using this method• Generally, results in maximum deferral of taxable

income• Simpler

Tax Traps: Pitfalls of construction industry methods of accounting

• Completed Contract- Losses on underperforming jobs aren't recognizable until the contract is complete- Bunching of income may occur if several contracts become complete in the same year- AMT adjustment for Long Term Contracts

• Percentage of Completion- Potential loss of deferral

Tax Tips: Maximizing depreciation deductions

• Section 179 Expense (chart on next slide)- Applies to new or used property- 2011 allowable expense $500,000

• Bonus Depreciation- Only applies to NEW property- No limit on bonus - 100% for purchases in 2011

Tax Tips: Maximizing depreciation deductions

Section 179 limits

*The dollar-for-dollar phase out begins at this level

Maximum Sec. 179 Expense Allowed

Maximum Investment in Sec. 179 Property *

2011 $500,000 $2,000,000

2012 125,000 500,000

2013 and thereafter 25,000 200,000

Tax Traps: Limits on accelerated depreciation

• Section 179- Taxable income limitation

• Bonus depreciation- No used property- No real property other than qualified leasehold improvements

• Basis issues for pass-through entities• Financing purchase of assets vs. accelerated depreciation


• Basis issues for pass-through entities:- Applies to pass-through entities (S corporation, partnership/LLC)- Basis can be complicated and can be affected by many different things- The basics:• Income and money contributed to the business by

an owner increase basis• Expenses and money taken out of the business by an

owner decrease basis


• Basis issues for pass-through entities- An owner generally must have positive basis to get the full benefit of most tax deductions

• Disallowed losses or deductions carry over indefinitely• In an S corporation, Sec. 179 can be especially tricky

- It is a deduction which is commonly hung up in basis limitations because owners may only deduct it on their personal return if they have positive basis after considering income earned and distributions taken out of the business


• Financing new assets – should I use accelerated depreciation?

- If you choose to finance the purchase of a major asset, weigh the options:• Downside of depreciating the entire cost of the asset in year purchased• Consider how long you plan to own the asset • Watch out for recapture if you sell• Remember to check taxable income and consider it when deciding

Tax Tips: Domestic production activities deduction• Deduction equal to 9% of qualified domestic production activities income for 2011• Paper deduction that requires no cash outlay• For pass-through entities, the deduction does not reduce an owner’s basis in any way, so it does not cause limitations on the use of other tax benefits• General contractors and subcontractors may qualify

Tax Tips: Domestic production activities deduction

• Qualified domestic production activities income- Net income from manufacturing and production activities conducted in the U.S., including real property construction activities and from engineering and architectural services performed in connection with such construction- The project must involve the initial construction or substantial renovation of real property, including, but not limited to:

• Buildings and their structural components, permanent land improvements, oil and gas wells, and infrastructure

Tax Traps: Limits on domestic production activities deduction

• IRS has moved DPAD to its Tier I list.• February 24, 2011 Tax Case “Gibson” - repair vs. substantial renovation• Two limitations - W-2 Wages and Income Limitation

Tax Tips: Maximizing tax deductions for entertainment facilities and per diem• Good recordkeeping is a must for tax savings in these areas:

- Entertainment- Shareholder personal use of auto- Per diem

• What should the records show?- How much was paid and when/where was it paid- Business purpose- Business relationship among people involved

• Potentially large tax savings are available if you handle the recordkeeping correctly

• Entertainment Facilities and Personal Use of Auto

– Entertainment Facilities• Includes hunting camps, boats, condominiums

– No deduction allowed– Includes Depreciation and operating costs, maintenance

costs, and losses on disposition.

• Club Dues– Nondeductible if for business, pleasure, recreation or other

social purpose– Deductible if for professional organization, civic or public

service organizations as long as primary purpose is not entertainment.

• May include club dues as taxable wages subject to employment taxes to receive deduction.

Tax Traps: Pitfalls of entertainment facilities and per diem

Tax Traps: Pitfalls of entertainment facilities and per diem

• Entertainment Facilities and Personal Use of Auto– Personal Use of Auto

• Limitation on depreciation unless employee pays for personal use or the company reports the personal use on the employee's W-2

• May use Annual Lease Value Table to compute personal use

• Per Diem– Paid by contractor for lodging, meals and incidental

expenses– To be fully deductible, must be paid at or below the

federal per diem rate for the location– May not pay per diems in excess of allowable federal

rate without including in the employee's W-2

Questions?


Blueprintsfor Success

Kim SmithTax Manager

Construction Practice Group

Shareholders

Bryan ChandlerCPA, CFP, PFS

ManagingShareholder

ScottGoldsmithCPA

LeighanneFaughtCPA

TracieManderson CPA Manager

Katy BethJacksonCPASenior

KarenTenbargeCPA Supervisor

KrisWaltersSenior

KimSmithCPA Manager

JessicaMorrisCPASenior

Support: Bobby Bragg, CPA | Practice Growth, Amy Echols| Marketing Director & Kelly Jones, CPA | Firm Administrator

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