Managing a Construction Business
Knowing how to manage a construction business is the key to being a successful contractor. There are many ways to enter the construction field with extensive opportunities for a rewarding career in the industry.
The US Bureau of Statistics provides an Occupational Outlook Handbook where you can find entrance requirements, salary, job descriptions, job outlook, and more for the construction industry.
A construction company can be just an owner, an owner using subcontractors, or an owner with employees, with more variations depending on the number of people involved.
There’s more information about running your own construction company in the article called The Lifecycle of a Construction Business.
Carpenters can enter the construction business with a desire to learn and the agility to perform physical work. Hands-on learning in the industry is the best way to prepare for owning and managing a construction business. Score, community colleges, and libraries are good places to learn more about managing a construction business.
Preparing to Own a Construction Business
Learning construction may take 2 to 5 years or longer to have enough knowledge to manage a construction business. Plus, a business or construction certificate or degree will improve your success.
Electricians, plumbers, HVAC, and specialty contractors have additional education and licensing requirements.
Contractor Licensing requirements vary from state to state. Levelset, a cloud-based platform that offers payment facilitation for construction companies, has compiled a Guide for Licensing in each state.
Skills Needed to Manage a Construction Business
As an owner, a large part of the day is talking on the phone and coordinating projects. Sales, customer service, and planning get juggled throughout the day. The day’s filled with interruptions, so the ability to move from one task to another under pressure is essential.
- Being organized
- Construction know-how
- Understanding finances
- Problem-solving ability
- Good time-management
- Great communication skills
Putting time into learning and understanding how to manage a construction business is a great start. Establishing a construction business also takes a financial investment.
The basic setup for a startup construction business:
- Office space
Managing a Construction Business Office
The office is where the behind-the-scenes work happens and where the project begins. It’s where the paperwork for the construction business gets handled.
Basic office setup:
- Cell phone
- Filing boxes/cabinet
- Office supplies
- Accounting software
All the activities of the office are called administrative functions. In a construction business, administrative activities facilitate work on the projects, help the company comply with laws, and support the company’s growth.
- Handling correspondence
- Drafting contract paperwork
- Ordering office supplies, materials
- Product research
- Maintaining technology
- Filing paperwork
Sales functions keep the company operating. Selling for a construction business involves:
- Relationship building
- Understanding the requirements of the project
- Being able to present and finalize contracts
- Meeting with potential customers
- Calculating and writing up an estimate
- Presenting the estimate
- Closing the deal and entering into a contract
Learn more about Establishing Hourly Rates and The Terms Estimate, Quote, Bid, Proposal, Explained.
In a construction business, accounting tracks the company’s finances and the profitability of each project.
- Paying bills
- Paying taxes
- Paying employees
- Preparing financial statements
Human Resource Functions
The laws around employees are extensive, and the paperwork is immense for a construction business. Look to Score and your state Department of Labor and Industry, state Department of Economic Security, and IRS for guidance.
Human Resource Tasks:
- Payroll & Benefits
Here’s some helpful information on Hiring Employees for your Construction Business.
Managing a Construction Business In the Field
The contract outlines the work to be performed. The goal is to complete the project on time and within the budget defined by the agreement.
There are job site interactions with clients, material suppliers, subcontractors, and inspectors. Communication between all people involved is a regular part of keeping the project moving forward to completion.
Scheduling is an integral part of managing a construction business. A forecasted schedule is prepared and coordinated with the homeowners and everyone involved with the project. The anticipated schedule can and often does change; however, the contract can involve penalties for not meeting completion dates.
There is scheduling for:
- Appointments with potential clients
- Meetings with homeowners, designers, architects
- Walk-throughs with subcontractors
- Inspections with city Inspectors
- Labor work schedules
- Material deliveries
Project management is the oversite of all the project’s details; it’s the budget and the labor and materials from beginning to completion.
The budget for the project was determined during the estimating process with a contract agreeing to provide the labor and materials for a specified cost. Project management keeps the project in line with the project’s budget.
Managing a construction business means managing people, budgets, and unplanned obstacles. Many factors play into whether the labor hours will stay within the budget; weather, equipment failures, site conditions, code issues, and a host of other situations.
- Showing up on-time
- Setting up tools and workspace
- Performing work according to the contract
- Cleaning up and packing up
Following safety guidelines is priority one on the job site. For guidance, read Job Safety and OSHA.
- Purchasing materials
- Picking up or receiving delivery
- Making returns
Tools and Equipment
Learn about Cargo Trailer Theft and how you can protect your assets.
Following through is vital to the success of the construction business. Before collecting the final payment, there are a few things to wrap up.
- Final inspections
- Closing-out permits
- Paying subcontractors
- Completing lien waivers
- Thank everyone!
- Ask for referrals
Because history is fun, enjoy these articles, History of Systems for Measuring Length and
History of Systems for Measuring Length
From the beginning of history, humans improvised using what was available to establish measurement systems. The earliest system for measuring length was the human body. Greeks adopted the human body for their measurement units, and the Romans based their method of measure on the Greek system.
While the human body system was convenient and practical for building rough structures, it created confusion for commerce. Because units came from body measurements, the unit sizes varied from region to region and even within a locality. Through much refinement, we now have uniform standards for universally consistent measures.
Today Americans will recognize these units; however, now they have been standardized. While the rest of the world uses the metric system for all purposes, the United States uses two systems; the Metric System and the United States Customary System.
Historical Units of Length
|Unit of Length
|Width of a thumb at the base of the nail
|1/36th of a yard
|5 digits across or 5 inches
|Length of the average foot or 11 1/42 inches
|Man’s forearm from the elbow to middle fingertip
|Distance of the human step
|Length of man’s girdle or belt
Different unit sizes between locations caused trade disputes and made commerce between regions difficult. As trade grew between countries, establishing a uniform system for measuring length became more important.
To become standardized, everyone has to agree to use the same standard. A standard represents a unit established by an authority. Many years ago, the thumb, hand, and foot were standard measurements for lengths determined by a person of power, such as a king. Objects with etchings made from ivory, wood, or metal bars let everyone know the standards. Authorities placed standards in areas where the public could find them.
Leaders of countries understood that everyone should use the same standard for measuring. Scientists had to find an accurate system to determine the standards. The scientists also needed to find a material and design for the bar that would not shrink, expand, or change shape.
As technology changes, the standard is revised to be more precise. Today, the proton standard bar is a visual representation; however, the standard for length is not a tangible object. Instead, the standard for the length measurement has a description explained as the speed of light.
British Imperial Units of Measure
The British Imperial System derives from the Roman, Saxon, and Norman period’s systems for measuring length.
In 1495, the King of England, King Henry VII, instituted a set of standards known as the Winchester measure. Winchester was the capital city where the standard was. Next, Queen Elizabeth ordered the creation of the Exchequer Standards in 1588. England used the Exchequer Standards until 1824 when the Weights and Measures Act passed.
Beginning in 1824, the British Imperial System was the official system in Great Britain. The British Imperial System, also known as the Imperial Units System, replaced the Winchester and Exchequer Standards. In 1965 the metric system replaced the British Imperial System.
Early Fathers of Metric
In 1668, John Wilkins (1614-1672), the bishop of Chester located in Cheshire, England, proposed a universal measurement system based on the timing of the swing of a pendulum. He multiplied and divided the standard units by tens, hundreds, and thousands creating the first decimal system.
Two years later, in 1670, Gabriel Mouton (1618-1694), a French priest, proposed the now-called nautical mile based on one minute of the earth’s arc. He proposed a decimal subdivision system for shorter units. Most consider Gabriel Mouton to be the founding father of the metric system.
Metric Units of Measure
In 1790, the National Assembly of France assigned the French Academy of Sciences to create a consistent standard for all measures. In 1795, France adopted the metric decimal system based on units of 10.
The new standard chosen equaled one ten-millionth of the distance between the north pole and the equator. The name given to the new standard of length was mètre (meter), taken from the Greek word metron, meaning a measure.
After the Academy selected the most accurate standard, it was presented to the Council of the Assembly by a delegation of scientists on June 22, 1799. The mètre represented the distance between the polished ends of the bar at a specific temperature. The platinum bar representing the standard is called the “Mètre des Archives.” The Council deposited the mètre (meter) in France’s National Archives.
Copies of the standard were distributed to delegates. The mètre bar for the United States, National Prototype #27, is in the collection at the NIST museum in Gaithersburg, Maryland.
It took another 170 years until Great Britain and Canada adopted the metric system.
Thomas Jefferson (1743-1826) recognized the need for a universal measuring system and supported a decimal measurement system. On July 4, 1790, Thomas Jefferson, serving as Secretary of State to President George Washington, presented a report to establish a uniform currency.
In 1792, two years after the National Assembly gathered in France, the United States Congress passed the Mint Act. The decimal currency system established the value of a dollar at 100 cents and had already been established in 13 states when the Mint Act passed.
United States Customary System
The U.S. Customary System derives from the British Imperial System. Three countries: the United States, Liberia, and Myanmar use the Imperial System.
In 1832, the United States adopted the yard as the standard unit of length. The standard for the yard is 3 feet or 36 inches.
Customary length units: inch, foot, yard, and mile.
Treaty of the Mètre
In 1866, an Act passed by Congress legalized the use of the metric system for contracts, dealings, and court proceedings; however, the Act did not mandate its use.
In 1875, the United States was among 16 other countries to sign the Treaty of the Mètre at the Convention of the Mètre held in France. The Treaty of the Mètre (Meter) established the International Bureau of Weights to be directed by the General Conference and situated near Paris.
Bureau of Weights
The Bureau of Weights and Measures is an intergovernmental organization comprised of member governments and associates of the Conférence Générale des Poids et Mesures, CGPM.
The General Conference on Weights and Measures is the International Bureau of Weights and Measures’ supreme authority. In 1960, the General Conference revised the metric system, giving the newer system the name International System of Units (S.I.), abbreviated S.I.
|Ratification of the Articles of Confederation
|The U.S. Constitution is signed, giving Congress the power to fix the standard for measures
|Ratification of the Constitution
|France adopts the Metric System
|The mètre bar is selected and deposited in the National Archives in France
|Secretary of the Treasury declares the meter as the official U.S. length measure
|An Act of Congress legalizes the metric system
|Convention du Métre (Convention of the Meter) established the Treaty of the Métre (Meter)
|Mendenhall Order is published
|The National Bureau of Standards (NBS) established
|The U.S. Army and Marine Corps adopt the metric system
|S.I., the International System of Units, is established
|Great Britain adopts the metric system
|Canada adopts the metric system
|The Metric Conversion Act is signed
|The United States Metric Board abolished
|NIST redefines the meter in terms of the speed of light
|The Omnibus Trade and Competitiveness Act passes
|Executive Order 12770 – Metric Usage in Federal Governmental Programs Issued
|60 nations voted unanimously to revise the SI
|S.I. is revised
April 5, 1893, the Superintendent of Weights and Measures, T.C. Mendenhall, published the “Mendenhall Order,” defining the standard for length as the international meter for both metric and customary measures.
National Institute of Standards (NIST)
Congress established the National Bureau of Standards (NBS) in 1901 and, in 1903, renamed it the Bureau of Standards. Thirty years later, in 1934, the name reverted to the National Bureau of Standards (NBS) again. In 1988 the name changed to the National Institute of Standards and Technology (NIST).
U.S. metric study interim report – A History of the Metric System Controversy in the United States issued in August 1971 was the Tenth in a series of reports prepared by the National Bureau of Standards.
UNT Digital Library offers a free pdf version of A Brief History of Measurement with a Chart of Modernized Metric System. The U.S. National Bureau of Standards published the pamphlet in 1976.
United States. National Bureau of Standards. Brief History of Measurement Systems: with a Chart of the Modernized Metric System, pamphlet, August 1976; Washington D.C.. (https://digital.library.unt.edu/ark:/67531/metadc123542/: accessed August 11, 2022), University of North Texas Libraries, UNT Digital Library, https://digital.library.unt.edu; crediting UNT Libraries Government Documents Department.
In 1986, the National Bureau of Standards updated Weights and Measures Standards of the United States: a brief history by Lewis V. Judson, first published in 1963. The publication details the history of standards of weights and measures sold at $1. Today, NIST provides the publication as a pdf for free.
NIST maintains U.S. standards, which is now part of the U.S. Department of Commerce and is a nonregulatory agency. NIST provides calibrations and standards to the states, and they also enforce the standards. The International Bureau of Weights and Measures, located in France, maintains worldwide uniformity of standards.
Credit N. Hanacek/NIST
U.S. Metric Board
The Metric Conversion Act sanctioned the metric system as the preferred system of weights and measures for trade and commerce and called for voluntary conversion to the metric system. The Metric Conversion Act of 1975, passed by Congress, established the United States Metric Board (USMB). The board’s function was to provide planning, coordination, and public education in implementing the Metric System.
The U.S. Metric Board dissolved in 1983. The responsibility for voluntary metric conversion moved to the Department of Commerce.
National Institute of Standards and Technology Redefines the Meter
SI, the International System of Units, is the international standard for measurement.
In 1983, the S.I. replaced the meter bar with a new definition. The new description for length is the path traveled by light in a vacuum in 1/299,792,458 of a second. Click here to learn how NIST refined the meter through technology.
Omnibus Trade and Competitiveness Act
In 1988, The Omnibus Trade and Competitiveness Act amended the Metric Conversion act of 1975. The Omnibus Trade and Competitiveness Act’s passing required all Federal agencies to use the metric system.
In response to the slow conversion to metrification, President George Bush issued Executive Order 12770 – Metric Usage in Federal Governmental Programs on July 25, 1991. The order designated the Secretary of Commerce to direct and coordinate metric usage by Federal Departments and agencies. The Secretary of Commerce was authorized to charter an Interagency Council on Metric Policy (ICMP).
The National Institute of Standards and Technology (NIST) chairs The Interagency Council on Metric Policy (ICMP)
A unanimous vote passed on Nov. 16, 2018, at the 26th General Conference of Weights and Measures scientific meeting in Versailles, France. Scientists from 60 countries voted to revise the SI and adopt a system based on the speed of light and constants found in physical science instead of physical objects.
History of the Tape Measure
July 14 became National Tape Measure Day after Alvin Fellows filed a patent in 1868. In celebration, here is a short history about the people that played a role in developing that nifty little measuring tool found in every carpenter’s toolbox.
Evolution of the Tape Measure
James Chesterman, an English flat wire maker, was granted the first patent for a steel tape measure in 1821. Flat wire formed the hoop part of crinoline skirts in the 1800s. The stiff crinoline fabric made from horsehair and cotton formed the bell shape and supported an underskirt known as a petticoat.
Attempts to use stiffened cord, whalebone, and brass for skirts had all failed to hold up. The fashion industry found steel to be the solution. The steel flat wire was lightweight, strong, and flexible.
The process to form the hoops used soft coiled steel rods. Steel rods were heated to soften and then scoured with acid to remove the oxide, followed by a coating of rye flour. After drying, the steel was shaped into diameters up to 6 feet around. James Chesterman made the wire stronger by using a heat-treated process, allowing the steel to form at longer lengths.
In 1842, when hoop skirts fell out of fad, James Chesterman produced the first long steel tape from the surplus wire. James adapted his plant to produce measuring tapes with etched graduated markings on the steel wire and marketed the new product with a case as a Steel Band Measuring Chain.
William H. Bangs, Jr.
In 1864, William H. Bangs, Jr. from Connecticut became the first to file a patent for a spring-loaded tape measure with a click secured.
The design, patterned from one piece of metal, eliminated the need to use separate pieces of metal and allowed the click, spring, and pivot action without escaping the spring’s pressure. The mechanism held the tape where it was stopped and returned to its case by sliding a button.
William H. Bangs, Jr. assigned his patent to Nathanial L. Bradley and Walter Hubbard, both from Connecticut.
Four years later, Alvin Fellows, also from Connecticut, improved upon William H Bang, Jr.’s measuring tape by adding a locking mechanism and enclosing the tape in a metal case.
Alvin Fellows received a patent on July 14, 1868, for a spring click tape measure. Because of that, once a year we now celebrate National Tape Measure Day. Alvin Fellow combined the internal parts, redesigned the case, and added components: lever, knob, cover plate, and spring lock. The tape could be locked to hold in place and released with a button. The spring action allowed the tape to retract. This new feature helped the tape measure find its place in construction.
Alvin Fellows also assigned his patents to Nathanial L Bradley and Walter Hubbard.
Bradley and Hubbard Manufacturing Company
Nathaniel L. Bradley started his career successfully in Meriden, Connecticut selling clocks in 1850 at age 21. Two years later, Nathaniel was elected director of the clock company that he formed with his brother William, Walter Hubbard, Orson Hatch, and Chitten Hatch, which they named Bradley, Hatch & Company. When Orsen and Chitten Hatch left the company in 1854, Nathaniel reorganized the business with his brother William L. Bradley and brother-in-law Walter Hubbard and called the new company Bradley and Hubbard.
In 1875, the company became Bradley and Hubbard Manufacturing Company. Bradley and Hubbard Manufacturing Company expanded into producing kerosene burning lamps and household goods. Over time Bradley and Hubbard Manufacturing secured 238 design and utility patents.
After 88 years, Bradley and Hubbard Manufacturing was sold to the Charles Parker Company in 1940. The following year the United States entered World War II. Bradley and Hubbard’s metal production went toward the war effort. Ten years later, the metal division of Bradley and Hubbard was shut down. Any records that existed for the company perished in a fire in 1976.
Justus Roe and Sons
Justus Roe, a surveyor, established his business in Patchogue, New York with his son Howard in 1876 and began selling tapes made in Brooklyn and New York. When his sons Austin and Henry joined the company, the company became Justus Roe and Sons.
In 1888, Justus patented a tape measure reel design that allowed fingers to be inserted into slots to keep the tape from springing back when wound; however, the tape measure reel was never marketed and sold. Two years later, in 1890, Justus took out a patent for a 14” protractor that folded into a 7-inch rule. Protractors are small tools, usually a half circle or full circle with a scale, that are used to determine the degree of an angle.
Justus Roe and Sons patented the Roe Electric Reel on May 24, 1892, which didn’t have electricity. The measurements were marked with holes and rivets instead of etched markings. Justus Roe’s patented design solved the problem of the rivets getting pushed against the frame and was sold more inexpensively compared to the competitors.
A few years later, Justus’s youngest son Nathanial joined the business. Nathanial designed a printing press that etched measurements onto the steel tape and began selling them in 1895 throughout the country on consignment.
Click here to learn more about Justus Roe & Sons…by Author Louise Muse.
Growth and Change
In 1960, the company expanded into a new location and updated the printing press. Justus Roe and Sons began producing tape for other companies, including Stanley.
In 1976, Justus Roe and Sons became Roe International. In 1981, Roe International was purchased by Irwin and renamed Irwin Measuring Tool Company. Then in 1990, Carol Basset, the company’s president, bought it and renamed it U.S. Tape. U.S. Tape was sold to RAF Industries in 1998 and has kept the name U.S. Tape.
Farrand Rapid Rule
Hiram Farrand received a patent in 1922 for the Farrand Rapid Rule, also called a push-pull tape. The new tape had a concave-convex shape and could manually coil into a small open can. Hiram Farrand opened a factory in 1927. In 1928, Commander Admiral Byrd requisitioned the Farrand Rapid Rule to explore the South Pole. Hiram Farrand made more than a million dollars selling the Farrand Rapid Rule, then in 1931, he sold the company for fifty thousand dollars to Stanly Works and went to work for Stanley.
Stanley Black and Decker
Frederick Stanley started manufacturing bolts, hinges, and hardware in 1843. In 1852, his company became Stanley Works. Today Stanley Black+Decker is the world’s largest tool company and now includes well-known tool brands Irwin, Bostitch, DeWalt, and Porter-Cable.
1843 – Frederick Stanley builds a factory to make wrought iron bolts and handles
1852 – Frederick Stanley’s business, Stanley Works, is incorporated
1854 – Stanley Works begins to manufacture boxwood rules
1857 – Frederick’s cousin Henry founds Stanley Rule and Level Company
1910 – S. Duncan Black & Alonzo G. Decker founded Black & Decker
1920 – Stanley Works purchases Stanley Rule and Level
1931 – Stanley introduces the first steel tape rule
1963 – Stanley introduces the PowerLock Tape Measure
1999 – Stanley introduces the FATMAX Tape Measure
2010 – Black and Decker merged with Stanley Works to become Stanley Black and Decker
2014 – Black and Decker rebrands to Black+Decker
2017 – Stanley Black + Decker purchases Craftsman from Sears
Tape Measure Markings
- Most extended lines at 1 inch
- 1/2” is halfway between the inch
- 1/4” smaller line between the 1/2”
- 1/8” smaller line between the 1/4”
- 1/16” is the shortest line
- Red numbers indicate 16-inch-on-center spacing
- Red marks every other foot for 24-inch-on-center spacing
- Black diamond
- 16-inch-on-center spacing = six framing members per 8 feet
- 24-inch-on-center spacing = four framing members per 8 feet
Why does the end of the tape wiggle? The 1/8” thick end is a feature called “true zero.” The feature produces accurate measurements, whether taken from outside or inside the object.
- Nail Grab – small slot on the hook to grab nails or screws
- Scribing Tool – the serrated edge of the hook for scratching a mark
- Adjustable End – 1/16” inch metal plate moves to allow for accurate inside and outside measurements
- Housing Size – listed on the case for inside measurements
- Concave shape – keeps the tape from collapsing
Pro-tip: To use as a compass to form an arc or a circle, hammer in a nail or insert a screw at the point to measure from, then rotate tape from the appropriate distance.
For accuracy, always use the same measuring device for all measurements on a project. If using multiple tape measures, calibrate the tape measures. The calibration process involves comparing the tape measure with another accurate measurement tool, such as a metal ruler. Different tape measures can have varying degrees of accuracy. Class 1 tapes have the highest degree of accuracy. Most commercial tape measures, such as Stanley, Milwaukee, and Irwin are Class 2.
If the lines of the tape measure line up with the other measuring tool, the next step is to check the condition of the end hook to see if it is bent and has debris attached. Remove foreign debris from the blade and hook. If the hook end is bent, minor adjustments can be made by using two pliers by holding one stationary and using the other plier to adjust. If the rivets are loose, tightening may be possible by using a drift punch and hammer to adjust.
- Keep the tape clean
- Keep it dry
- Retract the tape slowly
- If the hook end gets bent, replace the tape measure
Pro-tip: Keep the hook-end in good shape. A bent hook-end will produce inaccurate cuts.
Audit-Proof Your Business
Audit-proofing your business requires dedication to the financial paperwork. To have the best outcome for an audit requires a commitment to regularly staying caught up and understanding your tax obligations.
Lagging on the paperwork and disorganization gets business owners in trouble. When business owners take shortcuts or avoid doing paperwork, the mistakes can become a big burden later on.
The best practice to audit-proof your business starts with a knowledgeable accountant and a CPA. Accountants take care of the day-to-day accounting. The CPA is a business partner that will assist your company in staying compliant with tax laws and guide your business planning and growth. Both an accountant and a CPA are very important for audit-proofing your business.
Types of Audits
Internal audits are performed within the company and may be referred to as a self-audit. A self-audit can be performed at any time during the year. The end of the year is particularly important to discover transactions that may be coded incorrectly or were mistakenly entered into the wrong account. An internal audit assures every account is reconciled before preparing the tax return. It also helps to assure that all documentation is collected to complete the tax return.
External Audits assure owners that internal processes are following Generally Accepted Accounting Procedures (GAAP) and industry standards. GAAP principles apply consistent standards to procedures to comply with established rules and regulations.
An external audit helps to identify areas to improve internal controls and regulatory compliance. External audits lend impartial credibility to the accuracy of financial records.
Normal preparation of financial statements by a CPA will not include assurance. The financial statements will not include a formal report to verify the accuracy or completeness of the statements. Financial reports without assurance are intended for the companies internal use.
- Assurance is obtained by obtaining evidence
- Highest level of assurance is an audit
- Level of assurance needed for financing depends on loan size, collateral, and overall risk
- Compiled statements are not audited or certified
- The compilation report includes a letter from the CPA to make the CPA’s role more apparent
- If the CPA is not independent, the CPA must disclose the lack of independence
- Assures financial reports have been prepared following the financial reporting framework
- Used by lenders for financing small amounts
- Performed by an independent CPA
- For higher levels of financing
- Provides limited assurance
- Performed by an independent CPA
- CPA performs verification and substantiation procedures
- Highest level of assurance
A tax return may be selected randomly for an audit or an audit may result because of a “red flag.”
Each year a certain number of returns are randomly chosen to be audited; they are selected by “luck of the draw.”
The IRS uses formulas that compare your return against other returns. The formula looks for normal ranges. If a deduction is not within a range for your business industry and size, the return will be flagged for a manual review.
Reasons your return may be flagged:
- Missing or mismatched paperwork
- Calculation and data entry errors
- Rounded numbers
- Low income with high deductions
- Claiming losses several years in a row
Your return may also be selected because of an audit of another taxpayer’s return if there are transactions connected to your tax return.
The IRS looks for inconsistencies by linking payer records with the recipient records through 1099s. To audit-proof your business, always report all income.
Audit by Letter
IRS letters are sent out about 6 months after the tax returns are filed. The IRS mails the audit letter. They never communicate by email or through a phone call. If you question the legitimacy of an IRS letter, contact a tax preparer or a local IRS office to verify that is authentic. The IRS will send a letter that will have a notice number beginning with CP or a letter-number beginning with LTR located on the top or bottom right-hand corner. You can also contact the IRS at 1-800-829-1040.
Types of IRS Audits
The IRS has three general types of audits:
- Adjustment letters that are sent for miscalculations
- Correspondence audit that will request additional documentation
- Examination audit that looks closer at records
A CP2000 notice isn’t an audit; however, the process is the same. A CP2000 notice is used to inquire about underreported income. The IRS has information showing that you haven’t reported all income on your tax return. Often, it’s for a 1099-NEC, if you are self-employed.
Responding to IRS Audit Notices
IRS notices require a quick response. Don’t ignore IRS notices, respond promptly.
If the notice is correct and you agree, then make the payment or payment arrangements quickly to avoid interest and penalties.
If you do not agree , the notice should be discussed with your CPA to determine how to respond or to determine if representation is needed. Documentation or a letter of explanation may clear up the issue if the evidence is provided to support your figures.
Always send the IRS copies, never send original documents.
- Field audits take place at the taxpayer’s home, place of business, or accountant’s office
- In-Office audits take place at an IRS office
Prepare for the audit. Cooperate with the auditor and provide everything the audit correspondence asks for.
Have documents readily accessible. Neatness helps convince auditors that you are attempting to keep organized and accurate records.
Organize records in a logical order. Keep receipts flat and by date. Paper clip small receipts together to keep from losing. Organize checks by check number and invoices by invoice numbers.
Provide additional backup records with logs and calendars. Auditors will disallow deductions if documentation isn’t provided.
Treat the experience as an opportunity to improve your business.
After the Audit
- Keep track of correspondence with tax agencies.
- Send correspondence by certified mail.
- Stay compliant by filing on time.
Burdon of Proof
All expenses must be ordinary and necessary business expenses. More importantly, can you provide a business purpose for the expense? To audit-proof your business, each transaction must have a business reason.
- Ordinary expense – common and accepted for your industry
- Necessary expense – helpful and appropriate
Obtain, maintain, and retain records
- Records are now commonly available through online accounts
- POS terminals make it easy to retrieve lost and missing receipts from the vendor
Match documentation with every transaction on the bank and credit card statements
- An invoice for every income deposit
- A receipt for every expense
- Bank accounts
- Processor accounts
- Savings, brokerage, reserve, trust accounts
- Credit card accounts
- 1099’s with income
- Income records with bank statements
- Sales tax
- Payroll taxes
A few more tips to audit-proof your business:
- Never mix personal and business transactions
- Avoid cash transactions
- Use accounting software
- Use a mileage app
- File all required 1099’s and W-2s
- Know the rules for deductions
- Keep backup records
Audit-proofing your business requires paying attention to the financials and a partnership with an expert account and CPA. Using this approach to your accounting will provide assurance of accuracy.