No one wants to be audited by the IRS. The time and expense can affect your business’ bottom line, not to mention the trauma of having IRS agents rummaging through your books with a crowbar.
Knowing ahead of time which issues can trigger an audit and what IRS tax examiners look for can protect your company and help you audit-proof your tax returns.
When performing an audit, IRS examiners come well armed. Over the past decade, the IRS has developed a library of “Audit Techniques Guides” to bring examiners up to speed on specific issues in various industries, including construction. These guides are used to train IRS agents how to focus their attention. So, if your construction company is hit with an audit, you can expect that the IRS will be well informed and on the lookout for aggressive position stances common in the industry.
Here are four of the top target areas described in the IRS Construction Industry guide that you should be aware of.
1. Cash versus accrual accounting has been a hot button for the IRS in recent years. Uncle Sam doesn't like cash-basis accounting both because it delays tax payments and because the timing of income and expenses can be manipulated. Many companies, on the other hand, like cash-basis accounting because income isn’t taxed until it’s received. With the more complex accrual method, a company accounts for transactions when they occur, which is not necessarily when the cash is received.
Construction firms are often frustrated by the IRS’s stand on these two accounting methods, particularly if the companies incur costs to buy materials but don’t technically hold inventory. There have been cases when companies have ordered materials and had them delivered to jobsites, and the IRS forced them to change to accrual accounting because the materials were deemed to be “inventory.” Auditors are likely to conclude that materials are income-producing inventory when the cost totals 15% of gross receipts or more.
Good news: In a major policy shift, the IRS announced a while back that it would allow many service businesses that maintain inventory and have annual average gross receipts of $10 million or less to use cash-method accounting.