CFMA Building Profits article by Gretchen Kelly - Leaving your home state: Communication is Key
Posted 3-7-2011 | By Gretchen Kelly | Download Article
As published in the January/February 2011 Issue of CFMA Building Profits Magazine
In recent months, more and more contractors have won jobs or are considering bidding on work in locations they’ve never worked before. While we’re glad they’ve won the work, we’re also glad they’ve called their accountant.
Opportunities to bid on jobs outside their home state are appealing to contractors looking to generate backlog, revenue, and profits. But, entering a new location also comes with increased compliance requirements, hidden costs, and additional risks.
Performing work in a new location is similar to starting a new business. It’s critical for contractors to understand the costs of doing business, applicable laws, and regulations. As with any business plan, strategy, or set of actions, the key to success and compliance when entering a new market is communication.
Create an effective internal communication system among your company’s estimating, accounting, project management, and legal departments. This way, everyone understands the different costs and compliance requirements associated with a new location, which in turn helps improve profits and reduce risk.
PREBID COMMUNICATION
To reduce the risk of unnecessary mistakes in the job estimate, there are a few key steps you should follow in the prebid process – regardless of the new potential location. Often, there is very little time between when an opportunity arises and bid submission. It’s like a NASCAR race – everyone in the pit must be ready at the right time.
Every contractor has a set of processes and procedures for bidding projects. Depending on the size of the company and project, the estimator (or group of estimators) is responsible for the bid.
When entering a new jurisdiction, an estimator will evaluate whether certain direct and indirect costs will vary significantly from the contractor’s home state so profits aren’t left “on the table.” Then, the estimator presents this information to the accounting department to evaluate these costs.
Project Summary & Information Request Forms
Project summary and information request forms are great ways to foster communication between accounting and the estimator. A prebid meeting to review these forms allows accounting to ask the estimator relevant questions and express any concerns before responding to information requests. A communication misstep in the beginning may cause delays and errors later in the project.
Start with a project summary form or checklist prepared by the estimator. This form should be used by the accounting, estimating, and project management departments throughout the project to communicate key information. It may contain different information from contractor to contractor, but should include:
- Project owner
- Timing
- Project location
- Labor requirements
- Project type
- Material requirements
- Opportunity leader
- Equipment requirements
- Project value
- Copy of the RFP or bid package
The estimator then provides accounting with a copy of the project summary and an information request form. The goal: Gather key cost data that might differ significantly from the contractor’s home state. Depending on the contract and the contractor, labor burden and sales and use tax are likely the most significant costs that can be affected by a new location.
The information request should include very specific information about labor requirements in order for accounting to provide an accurate labor burden rate. The project summary will likely cover most of what is needed to evaluate sales and use tax.
Research Labor Burden
For a subcontractor or self-performing GC, labor burden is a significant cost and varies from state to state. The information request form should provide labor requirements, base rates, and start and end dates.
This provides accounting ample information to research related tax rates for the area and revise labor burden rates for sales and estimating during the prebid process. When conducting initial payroll research, some of the issues to consider include:
- State unemployment wage base and new employer “high experience” tax rates. With recent increased claims, many states have raised their unemployment wage base and tax rates. A higher wage base or tax rate costs contractors significantly more on labor-intensive projects. Conversely, contractors with exceptionally high experience rates due to layoffs during the past few years may find a lower “new employer” rate in a different location. Most accounting firms and payroll service providers have state and local tax guides readily available and can assist in obtaining the amounts and rates for a specific location.
- Per diem rates for lodging, meals, and incidentals. When sending employees to a new location, contractors may need to reimburse them for lodging, meals, and incidentals to entice them to travel for extended periods of time. Per diems are not taxable to the employee and are deductible by the contractor; however, they are an added cost to consider. Domestic per diem rates for 2011 can be found at www.gsa.gov/perdiem.
- Travel expenses. Contractors should consider the added expense of travel for field personnel and supervisors throughout the project.
- Union benefits. Nonunion contractors may perform work on a job or in a location that requires them to use union workers. If this is the case, then these direct costs will differ from historical costs and should be analyzed.
Research Sales & Use Tax Systems
All contractors must be aware of sales and use tax laws and regulations because they vary widely among states and localities. Over the past few years, we have seen a significant increase in contractor sales and use tax audits, as well as an increase in the amount of settlements.
It can be very costly if contractors get this one wrong, so a little research goes a long way. Be sure to ask the following questions when materials and services are incorporated into the project:
- What materials, services, and rental activities are taxable?
- Is the contract with or for a nonprofit, and is the exempt status passed onto the contractor?
- Does the contract include the sale of tangible personal property?
- Will subcontractors be used?
- Who collects and remits the tax?
- What is the tax rate(s) for the locality?
This type of information can generally be found online; however, familiarity with the contract and expertise in multistate sales and use tax is required.
All companies want to be profitable, and documenting and communicating the right information for a new job location in the prebid process will reduce your company’s risk of missing hidden costs. If your company is awarded the job, then your team should be armed with as much information as it needs to go forward profitably.
PREMOBILIZATION EFFORTS
Once awarded a project, a contractor should conduct an informational meeting with all employees involved in the project. The final terms of the contract and the scope of the project may have changed, and this meeting will highlight material changes that need to be communicated before moving forward on project setup.
During the premobilization meeting, a setup checklist should be created for the accounting and legal departments to prepare for compliance issues and better communicate information requirements and processes to project management, as well as field and accounting personnel. Here are some of the key issues that should be addressed in the setup checklist.
Registration
As discussed earlier, operating in a new jurisdiction is like starting a new business, and will likely require a contractor to register to do business in the new state. Doing so will create other compliance requirements, but will protect your company in the event of claims or collection issues.
Before registering in a new state, be sure to consult with your company’s attorney to fully understand the related issues. (For more on how to select the right attorney for your company, see “What to Look for in a Construction Lawyer” by Susan L. McGreevy beginning on page 28). There are also agencies that can act as your company’s registered agent for a reasonable fee.
Payroll Tax
The internal accounting team must be ready to manage payroll tax as soon as employees begin work in a new state. Registration for withholding and unemployment is done on a state-by-state basis, and the rules for filing and withholding differ greatly. Poorly managed payroll can be very expensive and can take a major portion out of a contractor’s gross margin.
Common errors include withholding and remitting taxes from employee wages to the wrong state and reporting and filing unemployment in the wrong state. Not always, but generally taxes are withheld from and unemployment is paid to the “worked in” state.
If it’s discovered that your company withheld taxes and filed withholding returns in the wrong state, then it may be able to amend its returns and receive a refund of incorrectly reported taxes, but this is very complex and takes a great deal of effort. Original returns should be filed in the correct state along with remittance of the withholding taxes.
Penalties and interest will be assessed for late payment and filing. A contractor will be required to prepare and file Form W-2c: Corrected Wage and Tax Statements, and employees who have already filed their individual income tax returns will be required to file amended state income tax returns.
If wages for unemployment are incorrectly reported and remitted, these returns will require amendments, as well as amending Form 940: Employer’s Annual Federal Unemployment (FUTA) Tax Return. Again, penalties and interest will be assessed for late payment and late filing when state unemployment is filed in the correct state.
Keep in mind that no deduction is allowed for FUTA when state unemployment is paid late, and additional and unnecessary federal unemployment tax may be due.
Sales & Use Tax Review
As previously mentioned, much of the information required for sales and use tax should be gathered in the prebid process; however, a review of the laws and regulations should be performed before work begins. Sales and use tax compliance will be based on the facts and circumstances of the contract, and the laws and regulations of the state.
Failure to collect, remit, and report sales and use tax to the correct jurisdiction is also very costly. If a return is required but not filed, then the state statute will leave the contractor subject to audit indefinitely (in most cases).
Moreover, if it’s discovered that a contractor filed in the wrong state, then it might be too late to obtain refunds of incorrectly paid or remitted sales and use tax. Again, significant penalties and interest will likely be owed for late payment and filing.
Another common error is paying tax incorrectly on taxable materials and services. Most state budgets are “in the red” and sales and use tax audits can provide a significant revenue source. Understanding the laws and regulations will minimize time spent responding to auditors, as well as the cost of additional tax, penalties, and interest.
Business Income Tax
Another tax compliance issue to consider is state income tax at the entity and shareholder/partner levels. Contractors must evaluate filing requirements, applicable taxes, and the added cost of compliance. These are real costs that will cut into job profitability.
As with payroll and sales tax, failure to file in the right state can leave contractors subject to additional tax, penalties, and interest, as well as add to professional fees paid for correcting the situation. Spend time with your tax advisors up front to avoid embarrassing and costly tax problems at the shareholder/partner or company level.
POSTCOMPLETION ANALYSIS
As with any project, a postmortem should be performed to evaluate job profitability compared to budget and should be shared with the team. Issues specific to the new location should be highlighted and can be used to update internal forms and checklists before considering other new locations.
CONCLUSION
It’s very difficult to over communicate. If a contractor’s internal departments communicate effectively and efficiently throughout all phases of a project, then it will most likely be more profitable.
Reduce your company’s risk of costly mistakes by creating an internal communication system to help all stakeholders work together more efficiently, effectively, and profitably.