How Contractors Pay Employees Could Be a Problem

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I bought my first real estate investment property over 30 years ago. And since I’m a CPA, you can be sure I found all the real estate tax loopholes I could!

Although I never had a construction firm, I’ve had a lot of construction firms as clients. It’s pretty common practice in the construction business to reimburse employees for the tools they use. Actually, this is a common practice in automobile dealerships, car repair shops, agriculture, aviation, and telecommunication as well as the construction industry.

The idea is that a portion of what you pay to an employee is actually a reimbursement for tools that are used on the job. It doesn’t need to get reported on the Form W-2 and won’t be taxable to the employee (generally it’s offset by the cost of the tools) and the employer doesn’t have to pay payroll taxes.

The IRS isn’t buying it. They are currently targeting construction contractors who use this method of compensation and are recharacterizing the tool rental payments to turn them into payroll. However, if the employees reported the rent (even if offset by expenses), employers can often escape payroll taxes on the tool payments.

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