The Best of Both Worlds – Minimize Tax? Maximize Income?
Many small businesses face a common dilemma regarding financial reporting. They want to minimize tax, which means reporting low income. But they also want to keep their banker happy, which means reporting high income. I often need to counsel clients that they can’t have it both ways. Or can they?
Construction contractors can have it both ways by properly keeping track of their Work-in-Progress (WIP) inventory. WIP is the difference between the work you have done on a project and the amount you have billed the client. If you are involved in a long term project and you haven’t billed the client for all the work you’ve done, it’s likely you have some WIP.
The beauty of WIP is that you can (and should) record it as revenue but don’t need to pay taxes on it. Sort of like a receivable but not quite as you haven’t billed it yet. Because it is recorded as revenue, it increases your net income and keeps your banker or bonding agent happy. But it doesn’t need to be included in your calculation of taxable income until you bill the client. So your taxable income is lower than your accounting income and you pay less tax.
So what do you need to make this happen?
Most importantly, you need a way to measure your WIP. Some of our clients simply make a list of the projects they are working on at the end of the year and estimate the costs they have incurred on those projects in excess of their billings. Other clients maintain detailed project costing systems that give them real time information about their WIP. These systems might be integrated with their general ledger or their estimating software.
Secondly, you need an external accountant who has the ability to help you with the measurement and subsequent reporting of WIP to your bank and the tax department. That’s what we do. Really well.
Your solution depends on the complexity of your business and the perceived benefits compared to the costs of implementation and maintenance of a project costing system.
Talk to us about construction project accounting.
Written by: Doug Johnstone, CA
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