Contractors Center Point

When to Sever and Aggregate Contracts, Know the Tax Consequences.

Recently, we were asked by a client about the tax rules for the severing and aggregating of jobs for tax purposes.  (Severance is where one contract is treated as two or more contracts for tax purposes.  Conversely, aggregation is where two or more contracts are treated as one for tax purposes.)  Since this is a subject that could impact all contractors, we thought we would share a brief summary of those rules.

The factors to consider when deciding whether or not to aggregate/sever contracts are as follows:

n    Is there independent pricing? (for severance)

n    Does the contract provide for separate delivery/acceptance?  (for severance)

n    Would a reasonable business person have entered into the separate contracts at the beginning of the process? (for severance)

n    Is there interdependent pricing? (for aggregation)

n    Would a reasonable business person have not entered into one contract (on the terms provided) without having also entered into the other contract? (for aggregation)

As should be expected with anything related to the Internal Revenue Code, there are exceptions.  The first is that a contract being accounted for under the percentage-of-completion (POC) method (either required or elected) can’t be severed without prior written consent unless it’s determined that the sole purpose for not applying severance is to take undue advantage of the 10% deferral election under the POC method.  (Note: aggregation of jobs (or not severing jobs) may dilute the actual percentage complete, which in turn would reduce the amount of gross profit recognized in a given year - or, as in the case of the 10% election, might cause a complete deferral of gross profit recognition until following years.)  However, aggregation can still be applied if the contracts are on the POC method and the circumstances meet the factors listed above.

The second exception is really more of a "requirement".   A contract must be severed if the number of units to be produced is increased through a change order or the exercise of an option, and the contract provides for separate delivery/acceptance of these additional items.

Should aggregation or severance be employed, it should be noted that there is a disclosure requirement to be attached to the return that includes the contractor's name and tax identification number.

For more information, please contact Lisa White, Tax Manager, at lwhite@macpas.com.

Construction Backlog Rose in September, Still Weak Overall

Construction backlog rose 3.2 percent in September compared to August, but is still down compared to November 2008, according to American Builders and Contractors Nov. 16 Construction Backlog Indicator (CBI).  Backlog reached 5.9 months in September from 5.68 months in August.  

Although the backlog indicator rose for September, a large portion of this was driven by the infrastructure category. Overall backlog remains weak.    

On a monthly basis, the average backlog for all regions except the South saw an increase. Middle States was the only region to post a higher backlog compared to November 2008, when ABC first started collecting data, but it still has the lowest overall backlog out of the four regions.  Specific highlights by region are as follows:

 

• The average backlog for September rose in all regions with the exception of the South, where CBI fell slightly by 0.05 months from August to 5.76 months, or roughly 0.9 percent.
• The West had the largest monthly backlog increase from August to September, up 0.5 months to 6.3 months, or a healthy 8.1 percent.
• The backlog for the Northeast region rose 6.2 months in September, up 7.3 percent from August.
• The Middle States registered a modest increase in September of 0.2 months in backlog, or 3.5 percent.

The heavy industrial category has the shortest backlog out of the three industry segments ABC monitors at 4.5 months.  This weak backlog continues to be driven by a lack of privately financed construction in the commercial, institutional and heavy industrial categories. Infrastructure is the only industry segment with a higher backlog compared to November 2008, but it has declined for the past two months.  Specific highlights by industry are:

 

• The heavy industrial category is now associated with the shortest backlog. In September, heavy industrial backlog was down to just 4.5 months. This compares to 6.5 months registered in November 2008.
• Although the infrastructure category continues to enjoy the lengthiest backlog at 9 months, backlog has now declined for two consecutive months.
• Commercial and institutional sectors saw a modest increase as backlog went from 5.35 months in August to 5.58 months in September.

Companies with less than $30 million in revenue saw their respective backlogs increase 1.8 percent from August to September, while companies with annual revenues of $30 million to $50 million rose 13.2 percent on a monthly basis.  Companies with annual revenues exceeding $100 million continue to see a decline, falling 8.2 percent in September.  Companies in all revenue categories are down compared to November 2008 except those with annual revenues between $50 million and $75 million.   

 

For more information on the ABC Construction Backlog Indicator please contact David B. Blain at dblain@macpas.com.

 

How to Be Prepared for Stimulus Work

Recently we provided a blog post on how to identify stimulus project opportunities with the federal and state governments. In that post we discussed different websites to access to find projects as well as requirements as a contractor to qualify for certain projects.

Now that you have identified opportunities that fit your organization, are you ready to succeed with these projects. Success goes far beyond the actual earth moving or construction of the project. Success for stimulus projects ultimately lies with your ability to properly plan, preparation and recordkeeping for the project.

When preparing for government and stimulus related work, consideration of these three steps could be the difference between a profitable, efficient project and one that is layered with delays that ultimately impacts cash flow and possible termination of the contract.

1. Learn the Rules and Reporting Requirements

Contractors must have a clear understanding of the law to be competitive and profitable. Stimulus-funded projects require contractors to follow the same laws, policies and procedures as any other public works project. Understanding the Davis-Bacon act and the local prevailing wage policies for your area will ensure that wages and fringe benefits are paid and reported according to the law. 

With the passage of the stimulus plan comes additional reporting requirements. These additional regulations were established to encourage competition, transparency and accountability:

• Quarterly online reports that show project status, number of jobs created, etc.
• "Buy American" requirements for materials used in construction and manufacturing
• Whistleblower protections for those who alert the federal government to contractors questionable use of stimulus funds; and
• Greater authority for the Government Accountability Office to audit any records of the contractor and subcontractor.

2. Streamline Accounting and Reporting Processes

The largest barrier standing between a contractor and government work is often the company's accounting system. Having a robust construction specific accounting system with good reporting features can help to resolve this possible barrier. Some accounting system necessities are:

Construction Economist Reports Mixed Picture for 2010 Construction Market

In its 2010 Construction Outlook report, released at the Outlook 2010 Executive Conference in Washington, D.C., on October 16, McGraw-Hill Construction (MHC)estimates that new construction starts will show a decline of 25 percent in 2009, followed by an increase of 11 percent in 2010. The 2009 decline would follow declines of 7 percent in 2007 and 13 percent in 2008. Unlike previous years in which weak residential markets powered the declines, the primary cause of this year's sharp decline is commercial construction - dropping by 43 percent. According to the report, "the diminished activity is taking place … amidst the longest and steepest recession since the Great Depression." MHC predicts that high commercial vacancy rates and a large volume of commercial loans coming due could be the greatest threat to a robust recovery in the commercial construction sector. Looking to 2010, the report predicts the following:

• Single family housing for 2010 will advance 32% in dollars, corresponding to a 30% increase in the number of units to 560,000 (McGraw-Hill Construction basis). 
• Multifamily housing will improve 16% in dollars and 14% in units, after steep reductions in 2008 and 2009. 
• Commercial buildings will drop 4% in dollars, following a steep 43% drop in 2009. The weak employment picture will further depress occupancies, making it even more difficult to justify new construction. 
• Institutional buildings will begin to stabilize after losing momentum in 2009. Square footage will retreat another 2% after sliding 23% this year. The dollar amount of construction for this sector will edge up 1%, helped by a growing amount of energy-efficiency upgrades to federal buildings and continued strength for military buildings. 
• Manufacturing buildings will drop 14% in dollars and 3% in square feet, hampered by the substantial amount of slack manufacturing capacity. 
• Public works construction is expected to rise 14%, given more wide-ranging strength across all project types. 
• Electric utility construction will slip 3%, continuing to settle back after a record high in 2008.

Overall, growth areas will include the construction and retrofitting of federal buildings, and the construction of highways, bridges, sewer and water projects. MHC economists say this sets the stage for a "more sustained expansion in 2011." To learn more please contact David B. Blain at dblain@macpas.com.

Accessing Federal Stimulus Projects – Where to go and what to do

Stimulus funding for infrastructure projects is available but the big question is how to find it. This article will help contractors with two key questions regarding stimulus projects:

• Where can I find stimulus projects?
• What is required of me, the contractor, to apply for stimulus work?

Where can I find stimulus projects?

The best source for identifying stimulus projects is at two main locations:

• www.fedbizopps.gov
• www.eva.state.pa.us

The first site is a federal website. The second website is a link to federal stimulus projects within the Commonwealth of Pennsylvania. This same website can be used for other states as well. Just change the state designation from PA to the abbreviation for the state you are looking at for stimulus projects.

Other options for locating stimulus projects would be through federal agencies that manage their own projects through the federal stimulus program. Those agencies would be:

• Department of Defense 
• Department of the Army 
• Engineers 

This information can be obtained through agency supplements from the federal stimulus bill located at www.fedaccess.com/agency-supplements.htm. Once you access this supplement information look for:

 

• DFARS – Department of Defense
• AFARS – Department of the Army
• EFARS – Engineers

Other areas to turn to would be through the Small Business Administration (SBA) (www.sba.gov). The stimulus bill was developed to provide opportunities to small contractors to complete maintenance and infrastructure work throughout the United States. The stimulus bill has a number of small business “set asides” to allow for smaller contractors to bid on stimulus projects. The small business “set aside” requirements are based upon the following as established in 13 CFR Section 121:

 

• Size – Based upon gross revenues. Important for qualification as a small business.
• Number of Employees
• NAICS code

Other “set aside” options found in 13 CFR Sections 121 through 127 are

 

• 8(a) set aside programs
• Mentor or protégé programs
• Service Disabled Veteran Owned businesses
• HUB Zone 
• Woman Owned businesses 

What is required of me, the contractor, to apply for stimulus work?

All interested contractors who want to bid on federal stimulus projects must complete the following in the order as outlined:

Step 1 - Register as a contractor and qualifying business through the Business Partners Network at www.bpn.com

Step 2 - Register as a contractor and qualifying business at www.federalreporting.gov.

When registering with the Business Partners Network be sure to have available your Employer Identification Number (EIN) and information on Electronic Funds Transfers (EFT) as all stimulus projects are paid to the contractor through EFT. The Business Partners Network will also require registration with Central Contractors Regulations (CCR) and Online Reporting and Certification Applications.

If you are filing under the SBA for one of the many “set aside” opportunities you will need to complete these additional steps:

1. Determine your company size and NAICS code
2. Determine eligibility for disadvantaged business status
3. Certify where required
a. www.sba.gov
b. www.dbs.gov
4. Register with CCR

In total, there is much more to the process or qualifying for federal stimulus projects then the bidding process. Knowing the requirements of the federal and participating state governments will allow for contractors to gain an advantage in regards to obtaining stimulus projects. If you would like more information on this please feel free to contact David Blain at dblain@macpas.com.