Richard G. Anderson, CEO of Anderson & Catania Surety Services LLC, discusses the delicate balance between tax obligation and financial retention strategies as it relates to a contractor’s bonding capacity and the role of the surety in finding that balance.
Which year-end tax deferral strategies are commonly used by construction companies?
Year-end tax deferral strategies can vary by the type of contractor. Consider the timing of equipment purchases. Road and equipment-heavy contractors are more sensitive to depreciation factors in a given year than, let’s say, a general contractor. Tax benefits can be substantial.
Let’s look at two scenarios:
Scenario #1 – Timing of construction contracts. A contractor may not want to totally close out a contract within a fiscal period in order to defer profit recognition. This can result in an overbilling on the balance sheet that will soon become recognized profit in the succeeding fiscal period.
Scenario #2 – Timing of revenue. A contractor may pay all their payables and not yet deposit receivable checks until after the fiscal year-end.
How is a deferred tax liability analyzed by the bonding company underwriters?
Most bond companies will try to ask the question of the timing of deferred tax liability in order to give a realistic evaluation of how much may be currently due and how much is really long-term. There are bond companies that take a conservative approach and will tend to treat most of the deferred taxes as a current liability.
How do you work with contractors to help frame how much net profit should be retained in a fiscal year to ensure that a contractor can access the desired level of bonding program capacity?
Make no mistake about it, a bond company will want to see the maximum amount of profit stay in the company and have the tax decisions be along those lines. There is always a decision scale between maximum retention of profit and the extreme of tax planning. The CPA is paid to minimize tax liability however, this cannot be at the extreme to sacrifice financial support for surety bond credit. Every year the contractor must make those decisions to balance both tax burden and financial retention strategies to support their company’s financial goals and growth.
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Every year, a contractor is faced with the decision-making about their taxes. Ironically with the advice of the CPA. The CPA is engaged typically to help with their financial planning, financial structure, formatting. However, very important of course, is their tax planning. Ironically, when the bond company’s involved, the bond company’s interest is usually at the opposite end of the spectrum in that the bond company wants to see the contactor maximize their retained earnings, maximize profit in the corporation.
Every single year, there has to be some balance as to the ultimate decision making by the contractor in that, does the contractor want to support the present bond program, does the contractor want to grow.
Certainly, if that contractor has the desire to grow, the bond company is going to want to see the investment of retained earnings. It’s incredibly important for the contractor to engage their accounting firm to help them with their tax planning at the fiscal year-end. And in the decision-making, it is helpful, from a bond company standpoint, that those decisions will help support the surety bond program that is desired. Again, individually the contractor has to make those decisions and use the information in front of them, from the accountant, in order to make those informed business decisions.