Balancing Tax Planning and Bonding
For many contractors, the end of the year triggers a singular focus on minimizing tax obligations. While this is an understandable objective, it represents only half of a complete year-end financial strategy. An equally, if not more, important goal is the strengthening of the company’s balance sheet to ensure bonding capacity is sufficient for the coming year. These two goals, tax mitigation and balance sheet enhancement, sometimes conflict. Decisions that lower taxable income, such as accelerating expenses or making large capital purchases, may deplete the very assets that surety underwriters value most: cash and working capital.
A successful year-end strategy requires a delicate balance, navigating the needs to minimize the money sent to Uncle Sam without compromising the confidence of the surety.
Key Metrics Your Surety Underwriter is Watching
To strike this balance, contractors must understand the key financial metrics that form the basis of a surety’s credit analysis. While a full financial review is complex, two metrics stand above all others in importance.
First is Working Capital
- Calculated as Current Assets minus Current Liabilities, working capital is the clearest indicator of a company's short-term financial health and liquidity. It represents the resources readily available to fund daily operations, cover unexpected costs, and manage the ebb and flow of project cash flow. A strong and growing working capital position signals to an underwriter that a contractor can weather project delays or payment issues without becoming financially distressed. Since cash is the most significant component of current assets, any strategy that aggressively reduces cash will have a direct, negative impact on working capital.
Second is Equity, also known as Net Worth
- Calculated as Total Assets minus Total Liabilities, equity represents the owners' stake in the company. A key component of equity is retained earnings, which are the cumulative profits that have been reinvested back into the business over time. A healthy equity position, particularly one built on consistent retained earnings, demonstrates a history of profitability and prudent financial management. It shows the underwriter that the business is not just surviving, but thriving and building long-term value.
Common Year-End Traps and How to Avoid Them
With these key metrics in mind, several common year-end tax strategies should be viewed with caution. Understanding these traps is the first step to avoiding them.
Trap 1: The 'Buy a Truck' Strategy
The most common tax-motivated mistake is making a large, cash-funded capital expenditure right before year-end. While depreciation rules can make this attractive from a tax perspective, it immediately depletes cash and reduces working capital dollar-for-dollar. The alternative is to consider financing options, because while a well-structured loan might add a long-term liability, it won’t significantly impact the working capital calculation, preserving liquidity while still achieving the business goal of acquiring the new asset.
Trap 2: Excessive Owner Distributions
Taking large bonuses or distributions at year-end to lower the corporation’s taxable income directly reduces the company’s cash and retained earnings. This weakens both working capital and equity. A more bond-friendly approach involves planning for reasonable, consistent distributions throughout the year and retaining a healthy portion of the profits within the business to fund future growth.
Strategies that Help with Taxes and Bonding
Cash Basis
Paying Bills Early. Contractors can choose to pay taxes on a cash basis, even while maintaining accrual basis financial statements for other reporting purposes. By paying project-related bills before the work is invoiced or payment is received, contractors can recognize those expenses sooner, reducing taxable income under the cash method. This strategy allows contractors to leverage the benefits of cash-based tax reporting—namely, deferring income recognition while accelerating expense recognition.
To maintain accurate financial statements for bonding purposes, a construction-focused CPA can make the necessary adjustments. Typically, this involves using the percentage-of-completion method for financial reporting, ensuring that costs incurred—but not yet billed—are properly included as current assets (under costs in excess of billings). This method of reporting allows working capital to be maintained for bonding while still reducing cash for tax purposes.
Write Off Disputed Accounts Receivable or Change Orders
Surety underwriters typically exclude accounts receivable over 90 days old from working capital calculations. They may also reduce or eliminate late-stage underbillings tied to disputed or unapproved change orders. Therefore, these amounts do not contribute to the contractor’s bonding capacity. As a result, if a contractor has any disputed receivables or unresolved change orders, it's worth evaluating whether to write them off. Doing so can create a tax benefit without negatively impacting the contractor’s bond program.
A Year-End Discussion Checklist for Your Team
The key to avoiding these traps is proactive communication. A contractor should schedule a dedicated year-end strategy meeting with their surety agent and their construction-focused CPA. The agenda should include the following questions:
- What are our projected revenue and bonding needs for the first and second quarters of next year?
- Based on our current financial position, what is our estimated bonding capacity?
- What is our target for year-end working capital and equity to support our growth goals?
- If we are considering a specific equipment purchase or capital investment, what is the pro-forma impact on our working capital?
- What are the most bond-friendly strategies available to manage our tax liability without harming our balance sheet?
By addressing these questions collaboratively, the contractor and their advisory team can develop a holistic plan that achieves both tax efficiency and a stronger foundation for growth, and effectively avoids costly surprises in their bond program.
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