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Small Contractors Mean Big Bucks To the IRS

Small Contractors Tax Questions

The economy is getting stronger, and construction job growth is on the rise, according to news from the Associated Builders and Contractors (ABC), published on June 2, 2017. Small construction companies are sprouting like new apple trees, and tax agencies just love that kind of low-hanging fruit. Easy pickins mean easy tax revenue.

Don’t let your small—or even your larger—construction company fall to the grim reaper! Avoid common mistakes, take a little extra time and care with your record-keeping, and you’ll harvest profits, while paying only the required taxes, and avoiding IRS and other tax agency audits.

Employment Challenges of Independent Contractors

You need a crew on the house at 123 Any Street. You only need them for a short time, or don’t want to add them to your staff until you’ve tried them out. Are independent contractors the way to go?

An independent contractor is a natural person, business, or corporation that provides goods or services to another entity under terms specified in a contract or within a verbal agreement. You do not generally have to withhold or pay any taxes on payments to independent contractors. Those persons or companies are responsible for reporting any income from your work to tax authorities, and for paying all applicable taxes.

Advantage: Your paperwork and tax burden are minimized. You will have to issue IRS Form 1099 to each one at the end of the tax year, but that is far less work than hiring them as employees entails. You may be required to carry workers’ compensation insurance for independent contractors, though. Go to this site to see what the requirements are in your state: http://www.nfib.com/content/legal-compliance/legal/workers-compensation-laws-state-by-state-comparison-57181/

Recruit People with Permission To Work

U.S. law requires companies to employ only individuals who may legally work in the United States – either U.S. citizens, or foreign citizens who have the necessary authorization. This diverse workforce contributes greatly to the vibrancy and strength of our economy, but that same strength also attracts unauthorized employment.

You can require a Green Card from the prospective employee, but those can be forged all too easily. There are many Internet-based systems that allow businesses to determine the eligibility of their employees to work in the United States. E-Verify, for instance, is fast, free and easy to use – and it’s a good tool for employers to ensure a legal workforce.

Underpayment of Unemployment Taxes

Underpayment of unemployment taxes can leave you with a big bill to pay, should you terminate or lay off an employee, and you haven’t “banked” enough to cover his or her claim.

There is a formula to use to ensure that you don’t underpay your federal unemployment tax act obligation (FUTA). The good news that only the first $7,000 of the employee compensation is taxable and the tax would not exceed 6%. This form will help you with these calculations: https://www.irs.gov/pub/irs-pdf/i940.pdf

Calculate your state unemployment tax act (SUTA) amount according to your state’s rules and regulations. The locales with highest rates are District of Columbia (5.9%), Alaska (6.6%) and New Mexico (6.7%).

Underpayment of Workers’ Compensation Insurance

Research quotes for commercial workers’ compensation policies and choose the one that best meets your needs. To determine the per-employee costs of contributing to these funds, calculate the total amount of the premium, add three percent, then divide the total by the number of employees.

NOTE: Depending on the state, employers with one or more employees may be obligated to carry workers’ compensation insurance coverage. Other workers who may not be covered include farm hands and independent contractors. However, insurance companies may require that independent contractors be covered. In that case, there is not much you could do other than look for a different insurance company.

Failure to meet these challenges correctly can lead to audits by the IRS, your state’s employment commission, and insurance companies. The auditors look for independent contractors to be added as employees when calculated for taxes. So, be careful when hiring them. Many states define independent contractors differently from the IRS. Take Virginia, for example. There, a person or company must be registered with the state as a business and have its own federal employer identification number (EIN), in order to qualify as an independent contractor. Knowing your state’s rules, and complying with them may take a few minutes at the hiring stage, but could save you hours—and dollars—if you find yourself under audit.

Accounting Records

Lack of Readily Available Accounting Information

Don’t be tempted to put off your accounting chores until the end of the year. Receipts get lost; memories fade. Do them at least monthly, though weekly is probably more advisable. Set aside a couple of hours on a day each week when things are typically slow(ish), and get it done.

Miss-classification of Transactions

Money that is apparently misspent or misallocated is a big, bright red flag to auditors! You label something “nails,” but are they the ones your team pounded in at 123 Any Street, or did your wife get a manicure? Yes. They just might ask.

If you haven’t already, set up a chart of accounts. Your accounting software should enable you to do that easily. Also, if you don’t already have one, find a good accountant or CPA. You don’t have to go running to him or her for everyday stuff, but for a reasonable fee, you’ll get correct answers and guidance. He or she is likely to help tailor your chart of accounts to your business and its frequent purchases or payouts.

Lack of Support Documentation

RECEIPTS: KEEP ’EM! If you claim that you spent $1,000.00 on supplies, but have no pile of supplies in your yard or on a job site, and an auditor smells something fishy, you’d better have receipts that total $1,000.00 for supplies! Common sense? Yes. But how many of you have cleaned out your pants pockets and found wadded up receipts that should be in a file at the office? Or how many have gone looking for a receipt that has gone to that Great Receipt Graveyard in the sky?

The IRS is very clear on this point: “Everyone in business must keep records.” It is the business owner’s responsibility to ensure all necessary records are provided on request by any tax agency.

Meeting the Challenges

Assuming you have a budget for accounting (and you should!), there is a way to deal with these challenges. Try setting up accounting software, as we mentioned earlier. One to try might be Xero, at https://www.xero.com/us/why-xero/your-business/construction/.

All contractors—whether in construction or any industry—must fill out a form W-9 before any payments can be issued to them. That protects the company from back-up withholdings, if the taxpayer is a troublemaker and does not file or pay income taxes.

These forms can be found online, or can be obtained from that CPA you should have hired. One such firm—Make My Day CPA (MMDCPA)—has stores where you can use workstations and print out the forms, as well as 1099s, when it is time to file them with the IRS.

Questions You May Have

  • Does a particular contractor need to be qualified as an employee?
  • Is my company considered as “doing business” in another state, when I have a contractor or subcontractor doing work in that state?
  • How do I handle payroll—deductions, federal deposits, etc.?

The answer to all three: Ask an expert. Ask a CPA. It’s money well spent to get the right answer, the first time, and keep your company from being picked off by the IRS and other tax agencies.