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IRS Issues Fact Sheet for Construction Firms

As part of its attempt to improve taxpayer compliance, the IRS has issued a number of “fact sheets” directed at specific industries. The latest example provides information on income and expense reporting for construction firms. Here are the highlights of the new IRS directive.

Income items: Contractors, subcontractors and workers are required to pay tax on income received for all kinds of work, including side jobs and work paid for in cash. This includes jobs performed in exchange for credit on a bill or goods or services in a barter exchange. You must report the income even if you are not issued a Form 1099 or W-2.

Accounting: Generally, construction firms will use the cash or accrual methods of accounting. With either method, the treatment of income and expenses must be handled on a consistent basis.

Cash method: Cash is reported as income when received and expenses when paid. If you use the cash method for reporting expenses, you must use the cash method for reporting your income. In general, income is “constructively” received if you have unfettered access to it.

Note that certain construction firms are not permitted to use the cash method. These include a corporation and/or a partnership with a C corporation as a partner with average annual gross receipts exceeding $5 million and a business with substantial purchases of materials (generally, 10–15% of its gross income).

Accrual method: The accrual method requires income to be reported in the year it is earned. Expenses are reported in the year they are incurred. The purpose of an accrual method of accounting is to match income and expenses in the correct year.If you use an accrual method for reporting expenses, you must also use an accrual method for income.

Most construction businesses use two different tax accounting methods, one for long-term contracts and one overall method for everything else, which is often the accrual method.

Expense items: Ordinary and necessary business expenses are deductible. An “ordinary” expense is defined as one that is common and accepted in the construction business. A “necessary” expense is one that is helpful and appropriate for the construction business. Several frequently deducted business expenses are:

*utilities;

*car and truck expenses;

*advertising;

*employee salaries;

*trade association dues;

*rent expense;

*supplies;

*continuing education;

*small tools expected to last one year or less;

*steel toe work boots; and

*business licenses.

Expenses for business assets that are expected to last more than a year must be capitalized. Then they are depreciated over their useful lives. Personal expenses—including clothing that can be worn off the job site, fines and penalties and the non-business use of vehicles or computers—cannot be deducted.

Caution: This is just a general overview of items that may closely be examined by the IRS. You can rely on your professional advisers for more guidance.

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