Recent news and events... - Barton L. Tiffany, CPA PC

Corporate Transparency Act

The Corporate Transparency Act is set for enforcement beginning January 1, 2024!

The probability that you will have reporting obligations under this law, beginning in the new year, is high. The governing agency is the Financial Crimes Enforcement Network (FinCEN). All reporting entities formed before December 31, 2023, will have until January 1, 2025 to report. All entities formed in 2024 will have 30 calendar days after formation to comply.

Proceed with care and caution

The FAQ link (here) to the Financial Criminal Enforcement Network website is quite detailed. It will give you a better idea as to what your reporting obligations will be.

The American Institute of Certified Public Accountants is recommending to its members and their clients to proceed with caution. The penalties for non-compliance look to be quite severe.

Filing your tax returns for 2023 will not encompass this reporting obligation. It will be a separate reporting function. It will involve gathering and reporting data completely separate and distinct from what we will report to the IRS. Different information… different federal agencies.

To date, it is uncertain as to what extent I, as a CPA, can help you with this process. The North Carolina Bar Association has not yet determined whether a CPA assisting in this process would constitute unauthorized practice of law. Hopefully that issue will be clarified before we roll into the new year, at which time the reporting mechanisms will be deployed and you can start the reporting process.

I can discuss the new law with you from a business perspective. However, until doing so is deemed to be practicing law or not, I cannot assume any liability for advising or assisting you with respect to your reporting obligations. Hopefully before it comes time that you need help to gather and report the data, we will have better guidance from both federal and state authorities as to the extent to which I can advise and assist you.

If you haven’t already done so, please familiarize yourself with this new law and keep this reporting obligation on your radar screen.

Long-term contracts and AMT

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.

Year end tips to enhance your financial statements…

Contractor Tips — Year end financial statement tips for Contractors

As the end of the calendar year approaches, here are some tips for those in the construction business to enhance your year-end financial statements for surety credit purposes.

November billings

First, be as aggressive as possible in billing work put in place before the end of November. It may skew your Billing in Excess of Costs and Earnings balance. Don’t worry about it. Collections in December for November’s work will put extra cash on the year-end balance sheet. Cash is King!

Transaction timing

Second, the surety will make adjustments to your financial statement numbers in calculating your working capital and owner’s equity balances. 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.

Increase your efforts to collect old receivables. If surety credit is critical, consider offering discount terms to resolve problem accounts. Don’t be shy in asserting lien rights in order to push the collection.

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. This keeps the cash on your balance sheet or the liability for a “prepaid” asset off the books.

Revenue calculation

Finally, recognize all of the allowable profit on work-in-progress under the percentage of completion (POC) method. Usually the POC calculation is on a cost-to-cost basis, hence the more cost you recognize, the more profit you’ll book. Make sure that your subcontract labor and material suppliers invoice you on a timely basis at year-end. Make sure that you record the obligations for current year work in your job costs for the year. Don’t hold disputed invoices out of your year-end accruals. Post your best estimate of what you believe the disputed invoice to be. Hold payment until the dispute is resolved but get the cost in the books so that you can recognize the related profit. Also, if you don’t receive timely invoices for significant pieces of work you know have been put in place, make your best estimate of those obligations and accrue the costs.

Caution: Whenever you estimate an accrual, you’ll need to be able to back it up with documentation if auditors ever come calling.

These are simple and legitimate steps that you can take to paint your financial statements in a proper and positive light. With work programs on the rise, surety credit will be tougher to underwrite. Maybe these suggestions will help you in that effort.

If there is anything I can do to help you or your business, I hope you’ll contact me.

Maximizing surety credit

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/

Builders Risk Insurance for Construction Projects

If you are a business owner with a need to build a new facility or undertake a major renovation/retrofitting project, don’t overlook the cost and issues related to insuring the project. Insuring the cost of a construction project often isn’t as easy as you might expect.

Most property policies exclude the cost of major construction, necessitating that a new, separate policy be obtained. If you have to pull a permit to do the project, it's probably not covered by your existing policy. In underwriting such coverage, carriers must consider a wide range of risks in the determination of the premium rates, deductibles, limits and exclusions they are willing to offer. Underwriting criteria include:

Materials used in construction
Site location
Time of year construction is in progress

The foremost consideration for the underwriter will be the construction materials used. If flammable materials (wood) will be used at floor level or in the frame, the premium rate could be double, even triple what they would charge for non-combustible materials. Furthermore, policy limits for wood frame construction are usually a fraction of the coverage available for non-combustible materials.

Stick built roof trusses over non-combustible framing/walls (joisted masonry) usually carry a lower rate than wood framing but there are usually lower coverage limits to joisted masonry than construction using non-combustible materials.

Site location is of prime concern. Availability of and proximity to adequate fire protection is a critical factor. If your project is near a fire house within a municipality/county that provides sound infrastructure and fire fighting capability, you’ll be able to command a lower premium rate and higher per project policy limit. Rural locations will increase, possibly double, the premiums and cut the per-project limits significantly.

Geographic locations, i.e. those in flood zones, subject to extreme weather, or earthquakes, will carry higher rates, higher deductibles, lower limits, and/or exclusion of coverage when covering perils arising from flooding, wind/wind-blown rain, and earthquakes. A project within 50 – 75 miles of the Atlantic or Gulf coasts, in progress between May 1 and November 30 (hurricane season), will carry higher premiums and be subject to either exclusions or higher deductibles for windblown rain. West coast underwriting criteria, with which I am less familiar, will vary based on weather patterns. Earthquake coverage for west coast projects will be of more critical importance and will affect coverage and cost in like manner.

Any policy should contain some measure of coverage for materials in transit or stored offsite as well as a variety of after-disaster costs, i.e. debris removal, pollutant cleanup, record retrieval, expending expenses, to name a few.

Coverage for projects without unique and significant risks can usually be obtained by the contractor, sometimes at discount premiums, via a “reporting form” policy. Assuming the project falls within the underwriting parameters specified in the policy, coverage is provided without carrier approval. As long as the contractor reports the qualifying projects and pays the premium timely. Also, the premiums are due monthly instead of up front so changes to the contract as the work progresses are reported systematically instead of at the end of the project. Administratively, reporting form policies are very simple and easy to both procure and underwrite. However, some lenders will not accept a reporting form, primarily to avoid the possibility that the contractor will fail to report the project and pay the premiums on a timely basis.

The alternative to a reporting form policy is a contract form policy which is project specific and subject to underwriting before the policy is issued. Such policies are available to both owners and contractors, depending on which party is responsible for the coverage. Premiums are due up front and will carry some measure of earned (non-refundable) premium.

If the other party to the construction contract is responsible for carrying the builders risk policy, you will need to ensure that the deductibles, exclusions and sub limits of the policy, coupled with the contact terms, don’t leave you exposed to significant uninsured/underinsured costs. The construction contract should clearly address the coverage required for the project, who is responsible for the procuring the coverage and for paying uninsured costs.

Builders Risk coverage can be an unforeseen impediment to getting a project underway. If you find yourself wrestling with insurance issues that are derailing your contract negotiations and you need objective advice, please don’t hesitate to give me a call. I can help you sort out these kinds of issues.

The ABCs of accounting for costs incurred under long-term contracts

Actually, the title of this post should be the reverse, i.e. the CBAs of accounting for long term contract costs: Capitalize, Budget and Allocate. If you incurred costs under a long-term contract (i.e. a contract not completed during the accounting year in which it commenced) and are required to submit GAAP basis financial statements (i.e. for licensing purposes) or do not qualify for cash basis tax reporting, here are some basic principles that need to be applied in accounting for your costs. For most, this will be stating the obvious. However, over the years, I’ve seen several companies misapply these simple rules.

C – Capitalize direct and indirect contract costs in work in process

For GAAP purposes and for any method of tax reporting other than cash basis reporting, all costs directly and indirectly associated with the completion of the contract, from signing to completion, should be capitalized as job costs and not expensed as general overhead. In fact, certain costs may be incurred, e.g. design costs unique to the project, as part of the sales/procurement process, and must be capitalized in job costs. Architectural and engineering costs incurred in a building design would be properly capitalized in work-in-process and only expensed outside of job costs if the selling effort fails.

B – Budget all your production/construction costs by project

The primary method prescribed by both GAAP and IRC Section 460 for the recognition of revenue under long-term contracts is the Percentage of Completion Method (PCM) on a cost-to-cost basis. Simply put, you recognize revenue for at the end of each accounting period in the same ratio as Actual Costs incurred to Total Estimated Cost. You can’t properly account for your contract revenue unless you have an accurate idea as to what your final contract costs will be.

A – Allocate indirect costs

Many costs will be incurred where it is either impossible or not cost effective to directly charge them to the job. Such costs would range from labor overhead/burden to liability insurance to small equipment usage charges and production facility/shop/yard related overhead. Such costs are most effectively charged to jobs using any number of reasonable allocation methods. The impact of this is most critical if you are a smaller producer/contractor who qualifies for the Completed Contract Method of accounting for tax purposes. And, if you are using the PCM, don’t forget to factor such costs into your Total Estimated Costs as well.

Please forgive me if this is useless, old hat, news. However, if it raises questions about how you are recording costs related to a long-term contract, please feel free to contact me.