Study guide · Law & Business · Business Finances
Business Finances: Where the Money Actually Goes
About 66 minutes · 7 sections
What this guide covers
Most contractors who fail don't fail at the trade — they fail at the money. Jobs that are profitable on paper still sink companies when the cash arrives later than the bills. One of the heavier sections of the exam, this one tests whether you can read your own numbers: what a bid must recover, what the statements tell you, which taxes are yours to handle, and which records the law makes you keep. Payroll-tax mechanics — deposits, withholding rates, the payroll forms — live in the Employment section, where the exam puts payroll.
Key terms
- Overhead
- Costs that don't trace to one job. Home-office overhead runs the company (office rent, office salaries, general insurance); field overhead runs a particular jobsite (the trailer, the superintendent).
- Working capital
- Current assets minus current liabilities — what's available to run jobs after near-term obligations.
The rules the exam tests
9 rules · 4 minCash, credit, and collections
You can show a profit on paper and still run out of cash.
Payroll and supplier bills go out weeks before the owner's payment comes in. You must fund that gap from working capital or a credit line.
On the job
Profit measures earning; cash measures timing. The exam and real life both test whether you know the difference.
Exact wording
A company can be profitable on paper and still run out of cash: when payroll and supplier bills go out weeks before the owner's payment comes in, the gap must be funded from working capital or a credit line.
Standard trade practice
Depreciation never takes cash out of the bank. Keep it out of your cash projection.
A cash projection counts only money that actually moves. Start with the beginning balance, add expected receipts, subtract expected payments. Depreciation moves no cash, so never subtract it as an outflow in a direct cash projection.
On the job
Profit and cash are different questions, and this is the one that decides whether payroll clears. A profitable job with slow receivables can still run the account dry, so the projection counts movement rather than earnings.
Exact wording
A cash projection counts only money actually moving — beginning balance plus expected receipts minus expected payments. Depreciation is not a cash payment, so it is not subtracted as a cash outflow in a direct cash projection.
Standard trade practice
Use a bank line of credit to bridge short-term timing gaps.
A revolving line lets you borrow, repay and re-borrow up to a set limit, so draw only what is needed when bills come due before receivables arrive, and repay when collections land. That matches short-term needs to short-term sources.
On the job
A line of credit is priced for bridging, not for financing. Drawing only what is needed and repaying as receivables land keeps the interest small; carrying a permanent balance on it turns a timing tool into expensive long-term debt.
Exact wording
A revolving bank line of credit is commonly used to bridge short-term timing gaps: draw only what is needed when bills come due before receivables arrive, and repay the draw when collections land — matching short-term needs to short-term sources.
Standard trade practice
Under 2/10 net 30 terms you take 2 percent off by paying within 10 days.
The 10-day discount clock runs from the invoice date. Terms of 2/10, net 30 are a cash discount for prompt payment: deduct the 2 percent by day 10, or pay the full amount by day 30.
On the job
Look at what the discount is worth annualized before deciding it is small. Paying twenty days early to save 2 percent is a very high effective return, which is why the terms exist and why passing them up is a real cost rather than a neutral choice.
Exact wording
Terms of 2/10, net 30 offer a cash discount for prompt payment: deduct 2 percent when paying within 10 days of the invoice date; otherwise the full amount is due by day 30.
Standard trade practice
An accounts receivable aging report sorts each customer's unpaid invoices by age.
An aging report's columns are current, 30, 60, and 90-plus days, set by how long each invoice has been outstanding. Grouping the invoices this way makes slow accounts surface before they become losses.
On the job
An aging report turns one number into a picture of risk. A large receivable balance can be healthy or nearly dead depending on how it distributes across the columns, and the total alone cannot tell you which.
Exact wording
An accounts receivable aging report lists each customer's unpaid invoices grouped by how long they have been outstanding — current, 30, 60, 90-plus days — so slow accounts surface before they become losses.
Standard trade practice
In a bank reconciliation, you subtract outstanding checks from the bank statement balance.
Outstanding checks are checks you have written that the bank has not paid yet. Your check register already recorded them as spent, so only the bank statement balance is overstated — subtracting them from your book balance too double-counts them.
On the job
Outstanding checks come off the BANK side because the register already recorded them when they were written. Subtracting them again on the book side double-counts, which is the most common way a reconciliation fails to balance.
Exact wording
In a bank reconciliation, outstanding checks are subtracted from the BANK STATEMENT balance: the check register already shows that money as spent, and the bank does not yet.
Standard trade practice
is money you already earned but cannot spend until it comes due.
In a cash plan, retention is a receivable the customer holds, not available cash — so record retained amounts as arriving on the date retention is released.
On the job
Bidding a job as if retention were spendable on billing day is a common way to run short mid-project.
Exact wording
Retention is money already earned that the customer holds back until it comes due. In a cash plan it is a receivable, not available cash — treat retained amounts as arriving when retention is released.
Standard trade practice
An accounts payable aging report groups what you owe suppliers and subcontractors by invoice age.
Each unpaid supplier or subcontractor invoice falls into one bucket — current, 30, 60, or 90-plus days — so current payables stand apart from those aging into overdue and you can set payment priorities. The due date and any cash-discount deadline come from each invoice's payment terms, which the buckets do not show. The payables aging report mirrors the accounts receivable aging report.
On the job
Age and due date are different things: a 40-day-old invoice on net-60 terms is due later than a 10-day-old one on net-15, so the aging ranks by age and the terms decide the deadline.
Exact wording
An accounts payable aging report lists what the company owes its suppliers and subcontractors, grouped by how long each invoice has been outstanding — current, 30, 60, 90-plus days. It shows which payables are current and which are aging into overdue and helps set payment priorities; the actual due date and any cash-discount deadline depend on each invoice's payment terms, which the buckets do not show. It is the mirror of the accounts receivable aging report.
Standard trade practice
You spend real cash on loan principal but never book it as an expense.
Each principal payment reduces a liability on the balance sheet, so your cash plan must include it. Only the interest portion is an expense and reaches the income statement; principal never appears there.
On the job
A cash plan built from the income statement misses every principal payment, which is one of the ways a profitable company runs out of cash.
Exact wording
Paying down loan principal reduces a liability on the balance sheet: it takes real cash out of the bank, so a cash plan must include it, but it is not an expense and never appears on the income statement — only the interest portion of a loan payment is an expense.
Standard trade practice
Take away
9 rules · 4 minCosts, overhead, and pricing
A direct cost is charged to one job and no other.
Indirect costs — overhead — support the whole company or, in some accounting systems, a particular jobsite. A job's own materials, labor, subcontractors, and permits are direct costs. Where a cost genuinely could sit on either side, and jobsite indirect costs are the usual example, what matters is treating it the same way on every job and making sure your bids actually recover it. Consistency settles the judgment calls; it does not make a misclassification correct.
On the job
This split is what makes a bid honest. A cost charged to one job is direct; a cost that keeps the company running is overhead and has to be recovered across all jobs. Mixing them either loads one job with the company's costs or leaves overhead unrecovered.
Exact wording
Direct costs are charged specifically to one job — its materials, its labor, its subcontractors, its permits. Indirect costs (overhead) may support the whole company or, in some accounting systems, a particular jobsite. Where a cost genuinely could sit on either side — some jobsite indirect costs are the usual example — what matters is treating it the same way on every job, and making sure your bids actually recover it. Consistency settles the judgment calls; it does not make a misclassification correct.
Standard trade practice
Your bid must recover direct job costs, a fair share of overhead, and planned profit.
You can recover overhead and profit through one markup on direct costs, but only if you set that markup high enough for both. A markup sized for profit alone leaves overhead to be paid out of that profit.
On the job
Three components, and the third is the one that disappears first under bidding pressure. A markup that covers direct costs and overhead but not profit produces work that is busy and unprofitable.
Exact wording
A bid must recover three things: direct job costs, a fair share of overhead, and the planned profit. A markup on direct costs can cover overhead and profit — if it is set high enough to include both. A markup that covers profit only lets overhead eat that profit.
Standard trade practice
Divide the cost by one minus the margin to set the price.
Gross profit is a share of the contract price, not of cost, so the profit dollars sit inside the price. Do not add the percent to cost: cost of $80,000 at a 20 percent margin prices at $100,000, not $96,000.
On the job
Markup and margin are not the same arithmetic, and the difference grows as the percentage does. Adding 20 percent to cost does not yield a 20 percent margin on price — dividing by one minus the margin is what does.
Exact wording
To hit a gross profit equal to a given percent of the contract PRICE, divide cost by one minus the margin — do not just add that percent to cost. Cost of $80,000 at a 20 percent margin prices at $100,000, not $96,000.
Standard trade practice
Divide fixed overhead by your gross-margin rate to find break-even revenue.
Break-even revenue is the sales volume where gross-margin dollars exactly cover fixed overhead — the overhead that does not change with job volume. Gross-margin rate is the share of each revenue dollar left after direct job costs.
On the job
Break-even tells you how much revenue simply keeps the doors open. Fixed overhead divided by the gross-margin rate is the volume at which margin dollars exactly cover overhead, and everything below it is a loss no matter how well each job priced.
Exact wording
Break-even revenue is fixed overhead divided by the gross-margin rate: at break-even, gross-margin dollars exactly cover overhead.
Standard trade practice
Update the cost to complete as soon as job costs run ahead of progress.
The cost to complete estimates what the remaining work will cost. Spending ahead of progress puts that estimate in doubt, so your first step is to find the cause and update it now, not when the phase finishes.
On the job
Spending ahead of progress is a signal, not a verdict. The reforecast is what turns it into information: find the cause, update the estimate to complete, and see whether the job still finishes where the bid said it would.
Exact wording
When job-cost reports show spending running ahead of progress, the first step is to find the cause and update the estimated cost to complete — not to wait for the phase to finish.
Standard trade practice
Set the overhead rate in your bids as expected annual overhead divided by expected annual base.
Underestimate the year's overhead, or overestimate the year's volume, and every bid under-recovers.
On the job
The overhead rate is a budget output, not a rule of thumb. Expected annual overhead over expected annual direct cost gives the rate; using a number carried over from a different year of volume under-recovers or over-prices.
Exact wording
The overhead rate a contractor builds into bids comes from a budget: expected annual overhead divided by the expected annual base it is recovered over. Underestimating the year's overhead, or overestimating the year's volume, makes every bid under-recover.
Standard trade practice
You spread the fixed costs of a machine you own over the hours you work it.
Ownership's fixed costs — depreciation, financing, insurance, storage — run whether the machine works or sits. So owning tends to win at high utilization, renting at low utilization. Compare cost per working hour at your utilization, not purchase price against rental rate.
On the job
Ownership costs run whether the machine works or sits. That makes utilization the deciding variable: enough hours and ownership spreads its fixed costs thin, too few and renting is cheaper even at a higher hourly rate.
Exact wording
Owning equipment spreads its fixed costs — depreciation, financing, insurance, storage — over the hours it actually works, so owning tends to win at high utilization and renting tends to win at low utilization. Compare cost per working hour at YOUR utilization, not purchase price against rental rate.
Standard trade practice
Contingency money in your estimate covers the risks you carry under the contract.
The risks you carry are hidden conditions you priced or retained, quantity surprises, and price movement you bear. Contingency in the estimate or cost budget absorbs them, so your planned profit survives. Work or costs the contract pays extra for go through its adjustment or change process, not contingency.
On the job
The boundary is who carries the risk under the contract, not whether a cost is 'inside the scope' — a hidden condition may be compensable under a differing-site-conditions clause, and then it is a change, not a draw on contingency.
Exact wording
A contractor contingency is money carried in the estimate or cost budget for uncertain costs and risks the contract leaves with the contractor — hidden conditions it has priced or retained, quantity surprises, price movement it bears — so the planned profit survives when those risks occur; work or costs for which the contract gives the contractor additional compensation are handled through the contract's adjustment or change process, not out of contingency.
Standard trade practice
A worker's hourly cost is the base wage plus labor burden.
Labor burden is payroll taxes, workers' compensation, and other insurance and benefits, each a percent of the wage. A comp rate quoted per $100 of payroll is that same percent. Add the percents, apply them to the base wage, and bid that cost.
On the job
A wage is not an hour's cost: the taxes and the compensation premium ride on every hour, and a bid built on the bare wage loses the burden on each one.
Exact wording
The burdened hourly cost of a worker is the base wage plus the labor burden — payroll taxes, workers' compensation, and other insurance and benefits — each figured as a percent of the wage; a workers' compensation rate quoted per $100 of payroll is the same percent, and the percents are added together and applied to the base wage to get the hourly cost carried in a bid.
Standard trade practice
Take away
14 rules · 6 minFinancial statements and ratios
A balance sheet reports assets, liabilities, and equity as of one date.
Assets are what the company owns, liabilities what it owes, and equity what is left for the owners. The balance sheet shows all three as of a single date — a snapshot, not a period.
On the job
A balance sheet is a snapshot at one instant, not a record of a period. That is what makes it the statement a surety reads first: it shows what stands behind the company on the day it is asked.
Exact wording
A balance sheet reports what the company owns (assets), what it owes (liabilities), and what is left for the owners (equity) AS OF a single date — a snapshot, not a period.
Standard trade practice
An income statement reports revenue and expenses over a period of time.
The last line of an income statement is the net profit or loss for that same period: revenue minus expenses. The same report is also called the profit and loss statement.
On the job
An income statement covers a span of time, which is exactly what the balance sheet does not. Reading one for the other is the common error — a strong year on the income statement says nothing about whether the company can pay next week.
Exact wording
An income statement — the profit and loss statement — reports revenue and expenses OVER a period and ends with net profit or loss for that period.
Standard trade practice
A loan spent on equipment appears twice on the statement of cash flows.
The statement of cash flows sorts cash into operating, investing, and financing activities. Borrowed cash is a financing inflow; spending it on equipment is an investing outflow. Equipment financed directly, with no cash moving, is a noncash transaction disclosed separately.
On the job
The three buckets stop a loan from looking like earnings. Cash borrowed and cash repaid are financing, not operating, so a company can show healthy cash while its operations produce none.
Exact wording
The statement of cash flows sorts cash into operating, investing, and financing activities. Loan cash received and then spent on equipment is a financing inflow plus an investing outflow; equipment financed directly with no cash moving is a noncash transaction disclosed separately.
Standard trade practice
Working capital is current assets minus current liabilities.
Current means assets that turn to cash within a year and debts due within that year. A building is a fixed asset, a long-term note is a long-term liability, and neither belongs in working capital.
On the job
Working capital is the cushion between what is owed soon and what is available soon. Only CURRENT items count: a building and a long-term note are real but cannot pay this month's bills.
Exact wording
Working capital is current assets minus current liabilities. Fixed assets and long-term liabilities are not part of it.
Standard trade practice
The current ratio is current assets divided by current liabilities.
Lenders and sureties read the current ratio as short-term ability to pay: whether short-term obligations can be met from short-term assets. It is a ratio rather than a dollar figure, so companies of different sizes compare on the same scale.
On the job
The current ratio is the first number a lender or surety looks at, and it answers one narrow question — can short-term obligations be met from short-term assets. It is a ratio rather than a dollar figure so that companies of different sizes can be compared.
Exact wording
The current ratio is current assets divided by current liabilities — lenders and sureties read it as short-term ability to pay.
Standard trade practice
The quick ratio leaves inventory out. Inventory has to sell before it pays a bill.
The quick ratio is current assets minus inventory, divided by current liabilities. It asks whether your near-cash assets alone cover your current obligations.
On the job
Stripping inventory out is the point. Inventory has to be sold before it becomes cash, so the quick ratio asks the harder question: what if nothing sells between now and when the bills fall due.
Exact wording
The quick ratio strips inventory out: (current assets minus inventory) divided by current liabilities. It asks whether near-cash assets alone cover current obligations.
Standard trade practice
Under , you record revenue when you earn it, not when you bill or collect.
Revenue is earned as you perform the work, so work you have not invoiced yet still belongs to the period you did it. Record it then: not when the invoice goes out, and not when the cash arrives.
On the job
Accrual timing follows the WORK, not the paperwork and not the money. Revenue earned but unbilled still belongs in the period it was earned, which is why an accrual-basis contractor's revenue and its deposits rarely match.
Exact wording
Under the accrual method, revenue is recorded when it is EARNED — not when the customer is billed, and not when the cash arrives.
Standard trade practice
Percent complete is costs to date divided by your total estimated cost.
Cost-to-cost is a percentage-of-completion method for a simple fixed-price contract. Percent complete times the contract price is your earned revenue. Earned revenue minus costs to date is your gross profit to date.
On the job
Cost-to-cost measures progress by money spent against money expected, which is a proxy rather than a measurement of the work. It is the standard method because costs are recorded anyway — but a job with cost overruns looks further along than it is.
Exact wording
For a simple fixed-price contract under the cost-to-cost percentage-of-completion method: percent complete equals costs to date divided by total estimated cost; earned revenue equals percent complete times contract price; gross profit to date equals earned revenue minus costs to date.
Standard trade practice
is a liability called billings in excess of costs and estimated earnings.
Billings in excess of costs and estimated earnings holds the amount billed above the revenue earned to date, so it is an obligation to perform, not profit. The mirror account, costs and estimated earnings in excess of billings, is the underbilling asset.
On the job
Overbilling is a LIABILITY, and the name is the reason it confuses people. Billing ahead of the work produces cash you have not earned yet, so it sits as an obligation to perform rather than as profit.
Exact wording
Billings in excess of costs and estimated earnings is the OVERBILLING account — a liability for amounts billed above the revenue earned to date. The mirror account, costs and estimated earnings in excess of billings, is the underbilling asset.
Standard trade practice
Subtract only job costs from revenue to reach gross profit.
Job costs trace to one job — labor, materials, subcontractors. Overhead does not. Gross profit margin is gross profit divided by revenue. General and administrative expenses come out after gross profit, so they reduce net profit, not gross margin.
On the job
Gross margin measures the jobs; net profit measures the company. Keeping general and administrative costs out of the gross figure is what lets a contractor see whether the work itself is priced right, separately from whether the overhead is affordable.
Exact wording
Gross profit is revenue minus job costs; gross profit margin is gross profit divided by revenue. General and administrative expenses come out AFTER gross profit — they reduce net profit, not gross margin.
Standard trade practice
Straight-line depreciation spreads cost minus salvage value evenly across an asset's useful life.
Salvage value is what an asset is worth at the end of its useful life, the years it stays productive. Subtract salvage from cost, divide by those years, and record that as the annual depreciation expense.
On the job
Straight line is the simplest method and the one worth knowing cold: cost minus salvage, divided by useful life. Salvage is the part most often dropped, and dropping it overstates depreciation every year of the asset's life.
Exact wording
Straight-line depreciation spreads an asset's cost minus its salvage value evenly across its useful life: cost minus salvage, divided by years, equals the annual depreciation expense.
Standard trade practice
The chart of accounts lists every account the bookkeeping system uses. It holds no dollar amounts.
The chart of accounts classifies each transaction as an asset, liability, equity, income, or expense, so the chart is the index that tells the bookkeeper where each entry belongs. Accounts, or account codes, are commonly numbered, but the numbering is only a convenience.
On the job
The chart holds the categories and the ledger holds the amounts; the exam asks which is which.
Exact wording
The chart of accounts is the organized listing of the accounts, or account codes, the bookkeeping system uses to classify transactions — assets, liabilities, equity, income, and expenses; it is the index that tells the bookkeeper where each entry belongs and holds no dollar amounts itself. Accounts are commonly numbered, but the numbering is a convenience.
Standard trade practice
The journals post their entries to the general ledger.
The general ledger is the main book of accounts: each account in it carries its own debits, credits, and a running balance — the cumulative net of those postings. The financial statements are built from those posted balances.
On the job
Everything on the balance sheet and income statement traces back to a ledger account balance.
Exact wording
The general ledger is the main book of accounts: entries are posted to it from the journals, each account in the ledger carries its own debits, credits, and running balance, and the financial statements are built from those posted balances.
Standard trade practice
Split each financed truck payment into interest and principal. Only the interest is an expense.
On the books, the interest part of each payment on a financed business asset is an expense of the period, while the principal part only reduces the loan balance. The asset is capitalized and depreciated over its accounting life. On the tax return, principal is never deductible; business-use interest may be deductible, subject to tax limitations and capitalization rules. The asset's cost is recovered through whichever cost-recovery rule applies — regular depreciation, 179 expensing, bonus depreciation, or another — not through the loan payments.
On the job
Three things happen when a financed truck payment goes out — interest, principal, and the asset's own cost recovery — and the tax side adds conditions the bookkeeping side does not, which is why 'the interest is deductible' is a book rule stated too flatly for a return.
Exact wording
For a business asset bought with a loan, the books and the tax return are kept apart. On the books, each payment's interest portion is an expense of the period, the principal portion reduces the loan balance and is not an expense, and the asset is capitalized and depreciated over its accounting life. For income tax, principal is never deductible; business-use interest may be deductible subject to tax limitations and capitalization rules; and the asset's cost is recovered through whichever cost-recovery rule applies — regular depreciation, Section 179 expensing, bonus depreciation, or another — not through the loan payments.
Standard trade practice
Take away
2 rules · 1 minRecords for the Registrar
Keep your contracting records for at least five years after the project is completed.
Records means every contract, document, receipt, and disbursement from your contracting work. You must make them and keep them available for the Registrar to inspect for at least five years after completion. Failing to keep them, or refusing a written request to produce them, is cause for discipline.
On the job
The records rule is a license rule, not just bookkeeping hygiene: five years after completion, for the Registrar.
Exact wording
A licensee must make and keep records of all contracts, documents, receipts, and disbursements from their contracting work, available for the Registrar's inspection for at least five years after the project is completed. Failing to keep them, or refusing a written request to produce them, is cause for discipline.
You must comply with the Registrar's written request. Delay is treated the same as refusal.
The duty runs to licensees, applicants, and registrants under the Contractors State License Law. The Registrar of Contractors, or a designee, may request any information or records required in discharging any duty of the Registrar. Delaying, obstructing, or refusing without lawful excuse leaves you subject to discipline.
On the job
The exam tests that delay counts as refusal, and that applicants and registrants are covered, not only licensees.
Exact wording
A licensee, applicant, or registrant subject to the Contractors State License Law who without lawful excuse delays, obstructs, or refuses to comply with a written request from the Registrar or a designee for information or records required in discharging any duty of the Registrar is subject to discipline. Stalling a written request is treated the same as refusing it.
Take away
15 rules · 11 minSales and use tax on construction
You are the consumer of the materials you furnish and install.
Consumer means you pay the tax on your materials cost, not on what you bill. On a construction contract, either sales tax applies to the sale of those materials to you, or use tax applies to your use of them.
On the job
On an ordinary construction contract you pay the tax on your materials cost rather than billing your customer tax on them. There are two narrow routes by which a contractor becomes the retailer of materials instead, and both appear under Where people go wrong.
Exact wording
Construction contractors are CONSUMERS of materials they furnish and install in performing a construction contract — either sales tax or use tax applies to the sale of those materials TO the contractor, or their use BY the contractor.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
A contractor is the consumer of the supplies and tools the business uses.
Consumer means the end user who bears the tax on the purchase. Supplies here include oxygen, acetylene, gasoline, acid, and thread-cutting oil — examples, not the whole list. Tools and parts for tools you use in your business count too.
On the job
The consumer rule reaches the small consumables too, which is where contractors get surprised. Oxygen, acetylene, gasoline, acid, thread-cutting oil, tools and tool parts are all things the contractor consumes rather than sells, so tax attaches to their purchase.
Exact wording
Contractors are the consumers of supplies such as oxygen, acetylene, gasoline, acid, and thread-cutting oil, and of tools and parts for tools, which they use in their business.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
You are the retailer of the fixtures you furnish and install.
That holds on contracts other than with the United States government, so tax applies to your sale of the fixture. Where the contract states the fixture's sale price, tax applies to that price; where the contract states no price, the sale price is deemed your cost price. A contractor who sells fixtures, materials, or machinery and equipment, or other tangible personal property, whether in connection with a construction contract or otherwise, must hold a seller's permit. Only a contractor working solely on construction contracts that do not involve the sale and installation of fixtures, and who is not otherwise in business as a seller or retailer, needs none.
On the job
If your trade installs furnaces, water heaters, or plumbing fixtures, you are selling fixtures — so you will need a seller's permit from the CDTFA on top of your contractor's license. Cabinets cut both ways: a PREFABRICATED cabinet — 90 percent or more of its total direct labor-and-material cost incurred before it is attached — is a fixture, making you its retailer. A cabinet that does not meet that 90-percent test is materials, making you the consumer of the lumber and hardware — and the test turns on WHEN the cost is incurred (before attachment), not where the cabinet is built.
Exact wording
On contracts other than with the United States government, construction contractors are RETAILERS of fixtures they furnish and install — tax applies to their SALE of the fixture, and where the contract states the fixture's sale price, tax applies to that price. A contractor who makes sales of fixtures, materials, or machinery and equipment — or of other tangible personal property, whether in connection with a construction contract or otherwise — is required to hold a SELLER'S PERMIT. Only a contractor engaged solely in construction contracts that do not involve the sale and installation of fixtures, and who does not otherwise engage in business as a seller or retailer, needs none; where the contract does not state the fixture's sale price, the sale price is deemed to be the contractor's cost price of the fixture.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
Your fee stays out of the measure of tax on a cost-plus contract.
The measure of tax is what tax is calculated on. Both a cost plus a fee contract and a time and materials plus a fee contract exclude the fee — whether it is a lump sum or a percentage of costs.
On the job
Cost-plus and time-and-materials are ordinary ways to write a contract, and everything else in this section is about what does get swept into the taxable measure. The fee does not.
Exact wording
Where a contractor enters into a construction contract for cost plus a fee, or for time and materials plus a fee, the FEE itself is not included in the measure of tax — and that holds whether the fee is a lump sum or a percentage of costs.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
Repairing a fixture in place is a construction contract.
In place means the fixture stays attached to the realty. A repair is also a construction contract when the contract requires you to reaffix the fixture to the realty. Construction contract rules then decide the tax, not the rules for a retail sale of parts.
On the job
It matters that a repair in place is still a construction contract rather than an ordinary sale of parts, because the contractor rules decide the tax instead of the ordinary retail rules.
Exact wording
A contract to repair a fixture in place, or a fixture the contractor is required by the contract to reaffix to the realty, is a construction contract.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
You are the retailer of fixture repair parts only when you bill them separately from labor.
A lump sum repair contract prices the fixture parts and the repair labor together, so you are the consumer of those parts, not the retailer. A United States construction contractor is the consumer of the parts in every case.
On the job
How the invoice is written decides who owes the tax and on what amount. A contractor who is the RETAILER owes tax on the gross receipts or sales price of the parts sold. A contractor who is the CONSUMER owes tax on the price of the parts sold to or used by them.
Exact wording
On a construction contract to repair a fixture, a construction contractor other than a United States construction contractor is the RETAILER of the parts when the sale price of the parts is billed separately from the repair labor, and is the CONSUMER of the parts furnished under a lump sum repair contract. A United States construction contractor is the consumer of the parts furnished in every case.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
You owe sales tax when you sell off surplus parts or used equipment.
In addition to sales of fixtures and of machinery and equipment, tax applies to all retail sales by contractors of tangible personal property, including parts, supplies, tools, construction equipment, buildings you sever or will sever, and furniture — even furniture sold with a building that is sold in place.
On the job
Selling off surplus material or used equipment is a retail sale like any other, and making such sales is one of the things that turns a contractor into a retailer who has to hold a seller’s permit.
Exact wording
In addition to sales of fixtures and of machinery and equipment, tax applies to all retail sales by contractors of tangible personal property, including parts, supplies, tools, construction equipment, buildings severed or to be severed by the contractor, and furniture, including furniture sold with a building even though the building is sold in place.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
You cannot avoid sales or use tax with the prime contractor's resale certificate.
With a valid seller's permit you may issue your own resale certificate to the supplier and buy fixtures and machinery and equipment for resale, but materials only if you are also in the business of selling materials. A certificate taken from the prime contractor, interior decorators, designers, department stores, or others never cancels your sales or use tax on materials or fixtures you furnish and install. One exception: you may take a resale certificate on a fixture furnished and installed for a person who is not the owner of the realty and who will lease it in place as tangible personal property. On a United States construction contract, a sale of machinery and equipment to a United States contractor or subcontractor is a sale for resale, so a resale certificate may be issued, only where title passes to the United States before the contractor makes any use of the property. Use that machinery or equipment before title passes and you are its consumer, so you owe sales or use tax on it, resale certificate or not.
On the job
A resale certificate handed down by the party above you does not move the tax off your own furnish-and-install work.
Exact wording
A contractor holding a valid seller’s permit may buy fixtures and machinery and equipment for resale by issuing a resale certificate to the supplier, but may not buy materials for resale unless the contractor is also in the business of selling materials. A contractor cannot avoid liability for sales or use tax on materials or fixtures they furnish and install by taking a resale certificate from the prime contractor, interior decorators, designers, department stores, or others. One exception is a fixture furnished and installed for a person who is not the owner of the realty and who will lease it in place as tangible personal property, where a resale certificate may be taken. On a United States construction contract the resale treatment is narrower still and carries a condition: a sale of machinery and equipment to a United States contractor or subcontractor is a sale for resale, so a resale certificate may be issued, only where title passes to the United States before the contractor makes any use of the property. A contractor who uses that machinery or equipment before title passes is its consumer and owes sales or use tax on it, resale certificate notwithstanding.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
You buy tax-free for an out-of-state job only if you certify in writing at purchase.
This out-of-state-use exemption covers tangible personal property and applies only if you hold a valid California seller's permit. Your written certificate goes to the seller and must give that permit number, identify the property, and state that you will use it outside California to perform a contract improving real property, so the property becomes part of real property located outside the state. Certify at the time of purchase, because a certificate given after the purchase is not recognized. The exemption follows the certified use: if you use the property in any other manner or for any other purpose than the certificate states, you owe sales tax as though you made a retail sale of it at the time of that use, measured by what you paid for it.
On the job
A contractor working across a state line would otherwise pay California tax on materials that never improve California real property. The certificate has to travel with the purchase, not follow it.
Exact wording
A construction contractor holding a valid California seller’s permit may buy tangible personal property without California sales tax where the contractor uses it outside California to perform a contract improving real property, so that the property becomes part of real property located outside the state. The exemption is available only if, at the time of purchase, the contractor certifies in writing to the seller — giving the seller’s permit number and identifying the property and that use — because a certificate given after the purchase will not be recognized. And the exemption follows the certified use: if the property is used in any other manner or for any other purpose than the certificate states, the contractor is liable for sales tax as though making a retail sale of it at the time of that use, measured by what the contractor paid for it.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
Selling machinery and equipment is not a construction contract. Installing it too changes nothing.
Property furnished under what is otherwise a construction contract falls outside the sales and use tax definition of a construction contract, where the person furnishing it is not responsible under the contract for its final affixation or installation. The same holds for a contract to sell tangible personal property such as machinery and equipment, with or without installation. A contract to furnish and install a small prefabricated building movable as a unit from its site of installation — a shed or a kiosk — is generally a construction contract only if the contract requires the seller to physically attach the building to realty. A unit sold to rest in place by its own weight is a retail sale of tangible personal property.
On the job
Supply-only work falls outside the construction-contract regime entirely: the consumer-of-materials posture never attaches, and the transaction is an ordinary sale of tangible personal property.
Exact wording
For sales and use tax purposes, the definition of a "construction contract" does not include: a contract for the sale, or for the sale and installation, of tangible personal property such as machinery and equipment; and the furnishing of tangible personal property under what is otherwise a construction contract, where the person furnishing the property is not responsible under the contract for its final affixation or installation. And, generally, a contract to furnish and install a small prefabricated building movable as a unit from its site of installation — a shed or a kiosk — is a construction contract ONLY if the contract requires the SELLER to physically attach the building to realty; a unit sold to rest in place by its own weight is a retail sale of tangible personal property.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
You become the retailer when you bill the customer sales tax on marked-up materials.
On contracts other than with the United States government, you are the retailer of materials you sell and install when the contract both explicitly transfers title to the materials before installation and separately states their sale price, exclusive of the installation charge. On a time-and-material contract, billing the customer an amount for "sales tax" computed on the marked-up materials billing is assumed to make you the retailer, unless you have convincing evidence to the contrary. Where that sale happens before the property is brought into California, the customer is the consumer and owes use tax measured by the sales price, unless otherwise exempt. You must collect that use tax and pay it to the state.
On the job
This is the rule behind the tax line on a T&M invoice: bill "sales tax" on marked-up materials and the state will presume you are their retailer — owing tax on the marked-up price — unless you have convincing evidence otherwise. And where you sell the materials before they cross into California, the customer owes California use tax on the sales price — and you are the one who must collect it and send it in.
Exact wording
On contracts other than with the United States government, a contractor who contracts to SELL materials and also to install them is the RETAILER of the materials where the contract explicitly provides for transfer of title to the materials before installation and separately states their sale price, exclusive of the installation charge; on a time-and-material contract, billing the customer an amount for "sales tax" computed on the marked-up materials billing is assumed, absent convincing evidence to the contrary, to make the contractor the retailer. Where such a sale occurs before the property is brought into California, the customer is the consumer, the customer's use (unless otherwise exempt) is subject to use tax measured by the sales price, and the contractor must collect the use tax and pay it to the state.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
An item counts as a fixture only if it stays an accessory after installation.
The regulation's Appendix B lists the typical items regarded as fixtures. The item must be accessory to a building or other structure, and it must still be recognizable as an accessory once installed — a furnace on the wall, not lumber.
On the job
The fixture test is identity: a furnace on the wall is still a furnace. Materials lose themselves into the structure — lumber becomes wall. Which side of the line an item falls on decides whether you are its consumer or its retailer.
Exact wording
"Fixtures" means and includes items that are accessory to a building or other structure and do not lose their identity as accessories when installed; a list of typical items regarded as fixtures is set forth in the regulation's Appendix B.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
Machinery and equipment is property not essential to the structure and readily removable without damage.
Machinery and equipment is property intended for use in producing, manufacturing, or processing tangible personal property, performing services, or other purposes such as research and testing. It is not essential to the fixed works, building, or structure itself. It may be incidentally attached to realty without losing its identity, and if attached it is readily removable without damage to the unit or to the realty. It never includes junction boxes, switches, conduit and wiring, or valves, pipes, and tubing incorporated into fixed works, buildings, or other structures — even where those items serve the operation of machinery and equipment — nor the contractor's power shovels, cranes, trucks, and hand or power tools used to perform the construction contract. Appendix C of the regulation lists further items that are not machinery and equipment, among them fire alarm systems, street light standards, radio transmission antennas, large tanks over 500-barrel capacity, and cooling towers other than small prefabricated units.
On the job
M&E is the third classification, and its test mirrors a fixture's: not essential to the structure, removable without damage. The carve-out is the trap — the conduit FEEDING the machine is never M&E, even though it exists for the machine.
Exact wording
"Machinery and equipment" means and includes property intended to be used in the production, manufacturing, or processing of tangible personal property, the performance of services, or other purposes such as research and testing — property not essential to the fixed works, building, or structure itself, which may incidentally be attached to the realty without losing its identity and, if attached, is readily removable without damage to the unit or to the realty. It does NOT include junction boxes, switches, conduit and wiring, or valves, pipes, and tubing incorporated into fixed works, buildings, or other structures, even where those items serve the operation of machinery and equipment, nor the contractor's power shovels, cranes, trucks, and hand or power tools used to perform the construction contract. A list of items that are NOT machinery and equipment — fire alarm systems, street light standards, radio transmission antennas, large tanks over 500-barrel capacity, and cooling towers other than small prefabricated units among them — is set forth in the regulation's Appendix C.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1521 ↗
If you over-collect sales tax, you refund it to the customer or pay the state.
If you bill a customer "sales tax" on a non-taxable transaction, on more than the taxable amount, at a higher rate than the law imposes, or overstate it by a math or clerical error on a billing, what the customer actually pays is excess tax reimbursement. You get the chance to refund it to the customers you collected it from. If you fail or refuse, the board makes a determination against you for the excess collected and not already paid to the state, plus applicable interest and penalty. Excess you don't refund is first offset against your own tax liability on that same transaction, transaction by transaction; only the remainder is refunded to the customer or paid to the state.
On the job
Over-collected "sales tax" is not yours to keep. It goes back to the customer — or the state takes it, with interest and penalty on top. This is the consequence behind charging tax on the whole job.
Exact wording
When an amount represented to a customer as sales tax reimbursement is computed on a transaction that is not taxable, on more than the taxable amount, or at a higher rate than the law imposes — or a mathematical or clerical error overstates it on a billing — the amount the customer actually pays is EXCESS TAX REIMBURSEMENT. A person found to have collected it is afforded the opportunity to refund the excess to the customers it was collected from; on failure or refusal, the board makes a determination against that person for the excess collected and not previously paid to the state, plus applicable interest and penalty. Where the excess is not refunded, it is first OFFSET against that person's own tax liability on the SAME transaction — transaction by transaction — and only the remainder must be refunded to the customer or paid to the state.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1700 ↗
The prime contractor pays the state, and that payment offsets the subcontractor's use tax.
A "same transaction" covers all activities in acquiring and disposing of the same property, and it can involve several persons: a vendor, a subcontractor, a prime contractor, and the final customer. The offset works on a lump-sum contract to improve real property where the materials were acquired without tax and the prime contractor paid all collected tax reimbursement to the state. There the subcontractor's use tax on the materials consumed is offset against that reimbursement, and the subcontractor has no further tax liability on that transaction. Reimbursement the prime paid the state above the subcontractor's liability is refunded to the prime contractor only if the prime returns it to the customer. The offset is available where possession of the property has passed to the customer, as in construction contracts and leases.
On the job
The offset follows the property, not the person: the prime's remittance can extinguish the sub's use tax on the same job. And the prime cannot mine a refund out of over-collected tax — the excess comes back only on its way to the customer.
Exact wording
The excess-reimbursement offset runs across the whole transaction: the "same transaction" means all activities involved in the acquisition and disposition of the same property and may involve several persons — a vendor, a subcontractor, a prime contractor, and the final customer — so, on a lump-sum contract to improve real property where the materials were acquired without tax and the prime contractor paid all collected reimbursement to the state, a subcontractor's use tax liability on the materials consumed is offset against tax reimbursement the prime contractor collected and paid to the state on that transaction, leaving the subcontractor no further tax liability on it; and tax reimbursement the prime paid the state in excess of the subcontractor's liability is refunded to the prime contractor only if it is returned to the customer; the offset is available where possession of the property has passed to the customer, as in construction contracts and leases.
Code of Regulations, Title 18 (CDTFA sales & use tax) § 1700 ↗
Take away
23 rules · 13 minEstimated tax and 1099 reporting
You pay estimated tax on income that nobody withholds tax from.
Estimated tax covers both income tax and self-employment tax, so you use it to pay the tax on self-employment income. Unless at least two-thirds of your gross income comes from farming or fishing, payments are generally required when both tests are met: you will owe at least $1,000 after withholding and credits, and your withholding and credits fall below the safe harbor—the smaller of 90 percent of this year's tax or 100 percent of last year's. Expected tax for the year counts all income except tax-exempt income, including wages already subject to withholding.
On the job
With nothing withheld from a sole proprietor's income, the $1,000 test is what makes payments due at all; the safe harbor tells you how much is enough to stay penalty-free.
Exact wording
Estimated tax is how you pay tax on income not subject to withholding, including self-employment income, and it covers both income tax and self-employment tax. For a taxpayer who does not get at least two-thirds of gross income from farming or fishing, payments are generally required when both tests are met: at least $1,000 will be owed after withholding and credits, and withholding and credits fall below the safe harbor of 90 percent of this year's tax or 100 percent of last year's, whichever is smaller. Expected tax for the year includes all income other than tax-exempt income, wages already subject to withholding included.
If last year's adjusted gross income topped $150,000, pay 110 percent of last year's tax.
The prior-year safe harbor bases this year's required estimated tax payments on last year's tax. It is 110 percent of last year's tax, not 100 percent, when last year's adjusted gross income was over $150,000 — or over $75,000 if this year's return is married filing separately — and less than two-thirds of your gross income comes from farming or fishing. You can use it only if last year's return covered all 12 months.
On the job
The 110 percent figure is the trap on the safe-harbor question; the $150,000 line and the 12-month condition are its qualifiers.
Exact wording
For a higher earner who does not get at least two-thirds of gross income from farming or fishing, the prior-year safe harbor is 110 percent of last year's tax instead of 100 percent: it applies when last year's adjusted gross income was over $150,000, or $75,000 where this year's return is married filing separately. The prior-year prong is available only if last year's return covered all 12 months.
You owe no estimated tax for a year that follows a year with no tax liability.
Two more conditions must also hold: you were a U.S. citizen or resident alien for the whole year, and last year's return covered a 12-month period. You had no tax liability only if your total tax was zero or you did not have to file a return.
On the job
The exam asks when a new contractor can skip estimated payments entirely; three conditions, all required.
Exact wording
No estimated tax is required for the year at all if all three are true: you had no tax liability last year, you were a U.S. citizen or resident alien for the whole year, and last year's return covered a 12-month period. You had no tax liability only if your total tax was zero or you did not have to file a return.
You report $2,000 or more paid to a nonemployee for services on Form 1099-NEC.
A nonemployee is an independent contractor or other outside worker, not on your payroll. Payments of $2,000 or more for services, made in the course of your trade or business, are generally reported in box 1a of Form 1099-NEC. That threshold applies to tax years beginning after 2025 and may be adjusted for inflation beginning in calendar year 2027. Include parts and materials only where supplying them was incidental to the service. Do not report merchandise, freight, storage, or similar items, or payments to a tax-exempt organization, the United States, a state, the District of Columbia, a U.S. territory, or a foreign government. Most payments to corporations are not reportable either, as a separate rule describes. For nonemployee entertainers who are nonresident aliens, use Form 1042-S instead. If you withheld federal income tax under the backup withholding rules, file the 1099-NEC regardless of amount.
On the job
Paying an unincorporated sub and skipping the 1099 is a reporting failure, and the threshold catches dropped work, not just big contracts.
Exact wording
Nonemployee compensation of $2,000 or more (the threshold for tax years beginning after 2025, which may be adjusted for inflation beginning in calendar year 2027) paid in the course of your trade or business for services by someone who is not your employee, including parts and materials that went with those services, is generally reported in box 1a of Form 1099-NEC. Materials count only where supplying them was incidental to a service; payments for merchandise, freight, storage, and similar items are not reportable, and neither are payments to a tax-exempt organization, the United States, a state, the District of Columbia, a U.S. territory, or a foreign government; most payments to corporations are also outside it, as a separate rule describes. Payments to nonemployee entertainers who are nonresident aliens are reported on Form 1042-S rather than on Form 1099-NEC, and a Form 1099-NEC is filed regardless of amount for anyone from whom federal income tax was withheld under the backup withholding rules.
You still file a 1099 for attorney fees and medical payments paid to a corporation.
Payments to a corporation — including an LLC treated as a C or S corporation — are generally exempt from Form 1099-NEC. Carve-outs: attorneys' fees of $2,000 or more (the threshold for tax years beginning after 2025, which may be adjusted for inflation beginning in calendar year 2027) go in box 1a of Form 1099-NEC; gross proceeds of $600 or more paid to an attorney go in box 10 of Form 1099-MISC; medical and health care payments go in box 6 of Form 1099-MISC. Those attorney and medical carve-outs apply even where the attorney or provider is a corporation. Payments made by credit card or through a third-party payment network are reported by the processor on Form 1099-K instead. If you actually withheld federal income tax under the backup withholding rules, you file the information return regardless of the payment amount.
On the job
The corporation exemption is the exam's favorite exception, and the attorney and medical carve-outs are the exceptions to the exception; card payments move to the processor's 1099-K.
Exact wording
Payments to corporations, including an LLC treated as a C or S corporation, are generally exempt from Form 1099-NEC reporting, with carve-outs: attorneys' fees of $2,000 or more (the threshold for tax years beginning after 2025, which may be adjusted for inflation beginning in calendar year 2027) are reportable in box 1a of Form 1099-NEC even where the attorney is a corporation, gross proceeds of $600 or more paid to an attorney go in box 10 of Form 1099-MISC, and medical and health care payments go in box 6 of Form 1099-MISC even where the provider is a corporation. Payments made by credit card or through a third-party payment network are reported by the processor on Form 1099-K instead, and if you actually withheld federal income tax under the backup withholding rules you file the information return regardless of the payment amount.
You withhold 24 percent of payments to a payee whose TIN is missing or wrong.
Form W-9 is how you request a payee's taxpayer identification number, and the information return is prepared from it; reportable payments are the payments that go on that return. Where a payee fails to furnish a TIN, or the IRS notifies you that the payee's TIN is incorrect, you must deduct, withhold, and deposit 24 percent of reportable payments to that payee with the IRS until the cause of the backup withholding is remedied. If you do not collect it as required, you may become liable for the uncollected amount.
On the job
The withholding duty and the liability for missing it both sit on the payor, so an uncooperative sub becomes the contractor's problem rather than the sub's.
Exact wording
Form W-9 is how a business requests a payee's taxpayer identification number, and the information return is prepared from it. Where a payee fails to furnish a TIN, or the IRS notifies you that the payee's TIN is incorrect, the payor must deduct, withhold, and deposit with the IRS 24 percent of reportable payments to that payee until the cause of the backup withholding is remedied. A payor who does not collect backup withholding as required may become liable for the uncollected amount.
Rely on the payee's backup-withholding exemption claim unless you know it's invalid or the form conflicts.
Certain payees are exempt from backup withholding, among them corporations, the United States or its agencies, a state or its political subdivisions, and organizations exempt under section 501(a). You may rely on the payee's claimed exemption unless you have actual knowledge it is invalid, or the exempt payee code and the checked classification conflict. Then you may still use Form W-9 to get the TIN, but treat the payee as non-exempt. If the exempt payee code is blank but the checked classification itself shows an exempt payee, you may accept that classification unless you actually know it is invalid.
On the job
The exam tests who is exempt and how far the payor may rely on the form: the form's own claim, unless the payor knows better or the form contradicts itself.
Exact wording
Certain payees are exempt from backup withholding, among them a corporation, the United States or any of its agencies, a state or its political subdivisions, and an organization exempt from tax under section 501(a). The payor may rely on the payee's claim of exemption unless the payor has actual knowledge that the exempt payee code or classification is not valid, or the code and the checked classification are inconsistent, in which case the payor may still use the Form W-9 to obtain the TIN but treats the payee as non-exempt. Where the exempt payee code is blank but the checked tax classification itself shows an exempt payee, the payor may accept that classification absent actual knowledge that it is invalid.
Keep backup withholding on attorneys' fees even when you pay a corporation.
Medical and health care payments, payments for services by a federal executive agency, and attorneys' fees stay reportable and subject to backup withholding even where the payee is a corporation. A payment not subject to information reporting is not subject to backup withholding either.
On the job
A corporation is exempt, except for the payment types the exam likes to ask about; and no information return means no backup withholding.
Exact wording
The backup-withholding exemption runs to particular payments rather than to the payee across the board: attorneys' fees, medical and health care payments, and payments for services by a federal executive agency stay reportable and subject to backup withholding even when the payee is a corporation. Payments not subject to information reporting are likewise not subject to backup withholding.
Calculate your self-employment tax on 92.35 percent of your net earnings from self-employment.
Net earnings from self-employment are your expected income and profits subject to self-employment tax, minus certain Conservation Reserve Program payments. Multiply that by 92.35 percent. If the result is less than $400, you owe no self-employment tax on those earnings. Otherwise you owe 2.9 percent Medicare on the whole result, plus 12.4 percent social security on the smaller of that result or the social security wage base reduced by expected wages already subject to social security tax or the 6.2 percent portion of tier 1 railroad retirement tax.
On the job
The 15.3 percent everyone half-remembers is two pieces with different caps — Medicare uncapped, social security capped and offset by W-2 wages — applied to 92.35 percent of net earnings, not to gross.
Exact wording
Expected self-employment tax is figured on expected income and profits subject to self-employment tax — after subtracting certain Conservation Reserve Program payments — multiplied by 92.35 percent: if the result is less than $400, no self-employment tax is owed on those earnings; otherwise the tax is 2.9 percent (Medicare) of that amount, plus 12.4 percent (social security) of the smaller of that amount or the social security wage base reduced by expected wages already subject to social security tax or the 6.2 percent portion of tier 1 railroad retirement tax.
Refigure your estimated tax when income, deductions, or credits change mid-year.
Changes in income, adjustments, deductions, or credits after a payment may make a refiguring necessary. Pay the unpaid balance of the amended estimated tax by the next payment due date after the change, or in installments by that date and the due dates for the remaining payment periods.
On the job
April's estimate is not a subscription price. A big job signed in July changes the number, and the law expects the very next payment to reflect it.
Exact wording
After making an estimated tax payment, changes in income, adjustments, deductions, or credits may make it necessary to REFIGURE estimated tax; the unpaid balance of the amended estimated tax must be paid by the next payment due date after the change, or in installments by that date and the due dates for the remaining payment periods.
The underpayment penalty is worked out separately for each payment period.
Payment periods are the estimated tax quarters. If you calculated payments under the regular installment method and recalculate after income rises, a penalty can still apply to periods before the change, and even where the year's return shows a refund.
On the job
Catching up later does not erase an early shortfall — and neither does an April refund. The January payment squares the year's total, never the second quarter's clock.
Exact wording
The underpayment penalty is figured SEPARATELY for each payment period: a taxpayer who figured payments under the regular installment method and refigures them after an income increase may still be charged a penalty for the periods before the change, and a penalty may be charged even where a refund is due on the year's return.
You may figure estimated tax by the annualized income installment method when income arrives unevenly.
The annualized income installment method sets each payment from that installment period's income, so the required payment for one or more periods may be less than under the regular installment method. If you use it, file Form 2210 with that year's tax return.
On the job
Seasonal income is the construction norm. The annualized method is the lawful way to pay less in the slow quarters — with a filing string attached.
Exact wording
A taxpayer who does not receive income evenly throughout the year may figure required estimated tax payments under the ANNUALIZED INCOME INSTALLMENT METHOD, under which the required payment for one or more periods may be less than under the regular installment method; a taxpayer who uses it must file Form 2210 with that year's tax return.
A payee's FATCA exemption does not change backup withholding.
Form W-9 Line 4 carries two codes: the exempt payee code governs backup withholding, and the FATCA code governs Foreign Account Tax Compliance Act reporting. Under the requester instructions, claiming a FATCA exemption gives no relief from backup withholding, and claiming none does not impose backup withholding.
On the job
Line 4 of the W-9 has two boxes doing two different jobs: the exempt payee code governs backup withholding, and the FATCA code governs a separate reporting regime. A filled FATCA box is not an exemption claim from backup withholding.
Exact wording
Under the Form W-9 requester instructions, an exemption from FATCA reporting — or the lack of one — does not affect backup withholding.
Get your 1099-MISC payee statements out by January 31. You file the IRS copy later.
The IRS copy is due February 28 on paper, or March 31 if filed electronically. By contrast, Form 1099-NEC puts both on January 31: payee statements and the IRS filing. A due date falling on a Saturday, Sunday, or legal holiday in the District of Columbia or where the return is filed moves to the next business day.
On the job
Rent and attorney gross proceeds ride the 1099-MISC, and that form's IRS copy has a later due date — but the recipient's copy does not. One form, two clocks.
Exact wording
Form 1099-MISC is filed with the IRS by February 28 on paper, or March 31 if filing electronically, and its payee statements must be furnished by January 31 — unlike Form 1099-NEC, whose payee statements and IRS filing are BOTH due by January 31; — a due date falling on a Saturday, Sunday, or legal holiday in the District of Columbia or where the return is filed moves to the next business day.
Prorate the payment when one contract covers both the machine and the operator.
Proration means the single total counts as two payments, not one: machine rent and operator charge. Report the rent in box 1 of Form 1099-MISC, and the operator's charge in box 1a of Form 1099-NEC.
On the job
The operated rental is everyday construction — a pump truck, a crane — and its one invoice is two payments wearing one total. Splitting it is not optional.
Exact wording
Where an equipment rental is part of a contract that includes both the use of the machine and the operator, the payment must be PRORATED: the rent of the machine is reported in box 1 of Form 1099-MISC, and the operator's charge on Form 1099-NEC in box 1a.
Managing or overseeing the payments makes you the payor even on someone else's money.
For payments reportable under section 6041, the payor is the person who pays out another's funds while performing management or oversight functions over those payments, or while holding a significant economic interest in them, such as a lien.
On the job
The instructions' own example is a construction lender paying trades from a disbursement account. The test — management or oversight of the payments, or a significant economic interest in them — decides who files, not whose money it was.
Exact wording
A person who makes payments on behalf of another person — the source of the funds — is, for payments reportable under section 6041, the PAYOR responsible for information reporting where that person performs management or oversight functions in connection with the payments, or has a significant economic interest in them, such as a lien.
If you skip a Form 1099-NEC, you lose your Section 530 relief.
Section 530 of the Revenue Act of 1978 covers the employment-tax status of independent contractors and employees. To qualify for section 530 relief, you as the employer must file Form 1099-NEC.
On the job
This turns a skipped 1099 from a small late-filing fine into the fact that can forfeit worker-reclassification relief — the standard construction audit exposure — for years of back employment taxes.
Exact wording
Section 530 of the Revenue Act of 1978 deals with the employment-tax status of independent contractors and employees, and to qualify for relief under section 530, employers must file Form 1099-NEC.
Include sales tax imposed on the sub in the payment you report on the 1099.
Whose tax it is decides, not who hands over the money. Tax imposed on the service provider and paid to the provider by the buyer is part of the reportable payment: report it on Form 1099-MISC or Form 1099-NEC, whichever return the payment itself belongs on. Tax imposed on the buyer and merely collected by the provider is not reported.
On the job
Whose tax it is decides whether it counts. Strip a sub's tax line off the total and you can understate the year's reportable payments — or wrongly conclude the sub fell under the threshold.
Exact wording
State or local sales taxes imposed on the SERVICE PROVIDER and paid to the provider by the buyer are reported as part of the reportable payment — on Form 1099-MISC or on Form 1099-NEC, whichever return the payment itself belongs on; where the sales tax is imposed on the BUYER and merely collected from the buyer by the provider, it is not reported on the form.
You never put an employee's expense reimbursements on a 1099. Use Form W-2.
Under a nonaccountable plan, reimbursements to employees are wages, reported on Form W-2, not on Form 1099-MISC or Form 1099-NEC. Under an accountable plan, reimbursements are generally not reportable on Form W-2, except certain per diem or mileage allowance cases detailed in the Form W-2 instructions and Publication 463.
On the job
The rule that pulls a nonemployee's unaccounted expenses onto the 1099 flips for employees — the foreman's truck allowance outside an accountable plan is W-2 wages with withholding, never 1099 money.
Exact wording
Employee business expense reimbursements are not reported on Form 1099-MISC or Form 1099-NEC: payments made to EMPLOYEES under a NONACCOUNTABLE plan are wages, reported on Form W-2. Payments to employees under an ACCOUNTABLE plan are generally not reportable on Form W-2 — except in certain per diem or mileage allowance cases, detailed in the Form W-2 instructions and Publication 463.
You must file information returns electronically once all types together reach 10.
Count every information return of any type you are required to file, all types added into one total. The e-file threshold is 10. It applies to returns required to be filed on or after January 1, 2024.
On the job
A GC with a dozen subs and a payroll crosses ten returns without noticing — and an otherwise timely stack of paper 1099s draws its own penalty.
Exact wording
The e-file threshold for information returns is 10, calculated by AGGREGATING all information returns of any type a filer is required to file; at 10 or more, the returns must be filed electronically (effective for returns required to be filed on or after January 1, 2024).
You report taxable damages of $2,000 or more in box 3 of the claimant's Form 1099-MISC.
The $2,000 threshold applies for tax years beginning after 2025 and may be adjusted for inflation beginning in calendar year 2027, and it reaches only damages paid in the course of a trade or business. Box 3 generally includes all punitive damages and compensatory damages for nonphysical injuries or sickness, such as employment discrimination or defamation. Taxable back pay damages may be wages reportable on Form W-2 instead. Damages that replace capital are not reported — such as what a contractor pays a buyer for failing to complete construction. When you pay taxable damages to the claimant's attorney, you furnish two forms: a 1099-MISC to the claimant reporting the damages, generally in box 3, and a 1099-MISC to the attorney reporting gross proceeds in box 10.
On the job
Construction disputes settle constantly, and the check usually goes to the lawyer. One check, two forms — omit the claimant's and the largest payment of the year goes unreported.
Exact wording
Taxable damages of $2,000 or more (the threshold for tax years beginning after 2025, which may be adjusted for inflation beginning in calendar year 2027) paid in the course of a trade or business are generally reportable to the CLAIMANT in box 3 of Form 1099-MISC, though taxable back pay damages may be wages reportable on Form W-2 instead, and damages that replace capital, such as those a contractor pays a buyer for failing to complete construction, are not reported — including all punitive damages and compensatory damages for nonphysical injuries or sickness, such as employment discrimination or defamation — and where taxable damages are paid to a claimant's attorney, the payer furnishes TWO forms: a 1099-MISC to the claimant reporting the damages, generally in box 3, and a 1099-MISC to the attorney reporting gross proceeds in box 10.
Leave the damages you pay a buyer for unfinished construction out of box 3.
Any one of four categories keeps damages other than punitive damages out of box 3 of the 1099: received on account of personal physical injuries or physical sickness; not more than the amount paid for medical care for emotional distress; received for nonphysical injuries under a written binding agreement, court decree, or mediation award in effect on or issued by September 13, 1995; or a replacement of capital, such as damages you pay a buyer for failing to complete construction of a building. Emotional-distress damages — including physical symptoms such as insomnia, headaches, and stomach disorders — do not count as received for a physical injury or sickness, so you report them, unless they stay within the amount paid for medical care or fall under an agreement, decree, or award in effect on or issued by September 13, 1995. Emotional-distress damages due to physical injuries or physical sickness are not reportable.
On the job
The instructions' own example of non-reportable damages IS a contractor's payment for a building never completed — capital replacement, not income. Issuing a 1099 for it hands the recipient phantom income to fight on their own return.
Exact wording
Damages other than punitive damages are NOT reportable in box 3 where they are received on account of personal physical injuries or physical sickness; where they do not exceed the amount paid for medical care for emotional distress; where they are received for nonphysical injuries under a written binding agreement, court decree, or mediation award in effect on or issued by September 13, 1995; or where they are a replacement of capital, such as damages paid to a buyer by a contractor who failed to complete construction of a building. Damages received on account of emotional distress — including physical symptoms such as insomnia, headaches, and stomach disorders — are NOT considered received for a physical injury or sickness and ARE reportable, unless they fall within the medical-care or pre-September 13, 1995 categories; emotional-distress damages due to physical injuries or physical sickness are not reportable.
If a payee gives you no taxpayer identification number, withhold 24 percent of the payments.
Form W-9 is how the payer collects a U.S. payee's name and taxpayer identification number for information reporting. A properly completed and signed W-9 can be relied on to avoid backup withholding. Where the payee is not an exempt payee and furnishes no number, the payer must deduct, withhold, and deposit 24 percent of payments subject to information reporting until the failure is remedied.
On the job
Collect the W-9 before the first check: without the subcontractor's TIN on file the contractor cannot prepare the year-end information return and is obliged to hold back 24 percent of what it pays.
Exact wording
Form W-9, Request for Taxpayer Identification Number and Certification, is the form a payer uses to obtain a U.S. payee's name and taxpayer identification number for information reporting; a properly completed and signed Form W-9 can be relied on to avoid backup withholding, and where a payee that is not an exempt payee fails to furnish a taxpayer identification number, the payer must deduct, withhold, and deposit 24 percent of the payments subject to information reporting made to that payee until the failure is remedied.
Take away
22 rules · 13 minPayroll taxes and deposits
Your deposit schedule is set by the four quarters that ended last June 30.
A deposit schedule is monthly or semiweekly, and it holds for the whole calendar year. Total your Form 941, line 12 taxes for the four quarters from July 1 through June 30: $50,000 or less makes you a monthly schedule depositor; more than $50,000 makes you a semiweekly schedule depositor. Quarters before your business started count as zero, so a new employer is a monthly schedule depositor for its first calendar year.
On the job
The schedule is set before the year starts, from a lookback window that ended the previous June; the $50,000 line and the new-employer rule are the tested figures. The $100,000 next-day rule is the only mid-year change.
Exact wording
Whether an employer is a monthly or semiweekly schedule depositor for a calendar year is determined from the total taxes reported on Form 941, line 12, during a four-quarter lookback period that begins July 1 and ends June 30. An employer that reported $50,000 or less for the lookback period is a monthly schedule depositor; more than $50,000 makes it a semiweekly schedule depositor. A new employer's lookback quarters before the business started count as zero, so a new employer is a monthly schedule depositor for its first calendar year.
You may pay the Form 941 tax with a timely filed return instead of depositing it.
The exception applies only if your total Form 941 liability is less than $2,500 for either the current quarter or the prior quarter, and no $100,000 next-day deposit obligation arose during the current quarter. File the return on time. If you are unsure you will stay under $2,500 and the prior quarter was not already under $2,500, deposit under your schedule to avoid a failure-to-deposit penalty.
On the job
The under-$2,500 rule is the small-crew exception to depositing at all; the penalty risk is why the safe move is to deposit when in doubt.
Exact wording
Where total Form 941 tax liability for either the current quarter or the prior quarter is less than $2,500, and no $100,000 next-day deposit obligation arose during the current quarter, the tax may be paid with a timely filed return instead of being deposited. An employer unsure it will stay under $2,500, where the prior quarter was not already under $2,500, should deposit under its schedule to avoid a failure-to-deposit penalty.
Withhold the 0.9 percent Additional Medicare Tax once an employee's wages pass $200,000.
The employee pays the whole Additional Medicare Tax — 0.9 percent — with no employer share. Withholding starts in the pay period wages exceed $200,000 in the calendar year and continues each pay period to year-end. It applies to all wages subject to Medicare tax.
On the job
The exam tests two things: the $200,000 trigger, and that this tax has no employer match.
Exact wording
A 0.9 percent Additional Medicare Tax must be withheld from wages paid to an employee in excess of $200,000 in a calendar year: withholding begins in the pay period in which wages exceed $200,000 and continues each pay period to the end of the year, it applies to all wages subject to Medicare tax, and it is imposed on the employee only, with no employer share.
You skip income tax withholding on elective deferrals. Social security, Medicare, and FUTA still apply.
An elective deferral is pay the employee puts into a 401(k), salary-reduction SEP, or 403(b). That deferral is generally exempt from income tax withholding but taxable for social security, Medicare, and federal unemployment (FUTA) tax. Employer contributions to a qualified plan are exempt from all three.
On the job
The deferral is income-tax deferred, not payroll-tax free; the exam tests the difference.
Exact wording
Elective employee deferrals to a 401(k), a salary-reduction SEP, or a 403(b) are generally exempt from income tax withholding but taxable for social security, Medicare, and FUTA; employer contributions to a qualified plan are exempt from all three.
You pay the whole federal unemployment tax yourself. Withhold nothing from your employee's wages.
Federal unemployment (FUTA) tax is not withheld from the employee's wages: the employer pays all of it out of company funds.
On the job
This is the one payroll tax with no employee half, which makes it the answer to 'which one comes entirely out of company funds'. It also means a contractor who thinks of payroll taxes as something deducted from workers will under-budget by the whole of it.
Exact wording
Only the employer pays federal unemployment (FUTA) tax; it is not withheld from the employee's wages.
Pay state unemployment tax in full and on time to earn the maximum FUTA credit.
FUTA is federal unemployment tax, and paying into state unemployment funds generally earns a credit against it of as much as 5.4 percent of FUTA taxable wages. For 2026 FUTA is 6.0 percent on the first $7,000 of wages paid to each employee during the year, so the maximum credit leaves a rate after credit of 0.6 percent. You claim that maximum only if you paid the state in full, on time, and on all the same wages subject to FUTA tax, and only while your state is not a credit reduction state.
On the job
Six percent is the headline and 0.6 percent is what almost every employer actually pays, because the state credit does most of the work — but the credit is earned by paying the state in full and on time, so a late state filing raises the federal bill.
Exact wording
For 2026 the FUTA tax rate is 6.0 percent, applied to the first $7,000 paid to each employee as wages during the year — the federal wage base. An employer may generally take a credit against FUTA tax for amounts paid into state unemployment funds; the credit may be as much as 5.4 percent of FUTA taxable wages, so an employer entitled to the maximum credit pays a FUTA rate after credit of 0.6 percent. The maximum credit is available only if the employer paid its state unemployment taxes in full, on time, and on all the same wages that are subject to FUTA tax, and only so long as the state is not determined to be a credit reduction state.
You deposit FUTA tax for a quarter only if the liability runs over $500.
FUTA is federal unemployment tax. A quarter's liability of $500 or less need not be deposited: you may carry it forward and add it to the next quarter's liability to see whether a deposit is then required. Once a quarter's liability, including any carryforward, is over $500, you must deposit it by electronic funds transfer. You stop depositing on an employee's wages once that employee's taxable wages reach $7,000 for the calendar year.
On the job
These are the 'own deposit requirements' the monthly and semiweekly schedules do not cover: a $500 quarterly threshold with carryforward below it, and an EFT deposit above it.
Exact wording
If an employer's FUTA tax liability for a calendar quarter is $500 or less, it does not have to deposit the tax and may instead carry it forward and add it to the liability figured in the next quarter to see whether a deposit is then required; if the FUTA tax liability for a quarter is over $500, including any FUTA tax carried forward from an earlier quarter, the employer must deposit the tax by electronic funds transfer. Depositing FUTA tax on an employee's wages stops when the employee's taxable wages reach $7,000 for the calendar year.
You file a Form 941 for every quarter even when you paid no wages.
Form 941 is the Employer's Quarterly Federal Tax Return, filed by an employer required to file federal employment tax returns quarterly. A quarter with no wages paid and no tax due still needs one. That quarterly duty ends only where the employer has filed a final return, is a seasonal employer that checks the seasonal box, or has been told to file Form 944. By contrast, federal unemployment tax is reported once a year on Form 940, the Employer's Annual Federal Unemployment (FUTA) Tax Return.
On the job
Two forms on two different cycles: income tax withholding and FICA on the quarterly 941, FUTA on the annual 940. Filing is separate from depositing, which runs on its own clock.
Exact wording
An employer required to file federal employment tax returns quarterly files Form 941, the Employer's Quarterly Federal Tax Return; federal unemployment tax is reported annually on Form 940, the Employer's Annual Federal Unemployment (FUTA) Tax Return. A Form 941 is due for every quarter even where no wages were paid and no tax is due, unless the employer has filed a final return, is a seasonal employer that checks the seasonal box, or has been told to file Form 944.
You skip no-wage quarters only by checking the seasonal-employer box on every Form 941.
Form 941 is the quarterly federal employment tax return. A seasonal employer that misses the seasonal-employer box on even one Form 941 must file a return for every quarter. A properly filed final return also ends quarterly filing. An employer the IRS notifies to file Form 944, the annual return for employers whose annual employment tax liability is $1,000 or less, files that annual return instead of quarterly Forms 941.
On the job
The three ways out of a quarterly 941: the seasonal box on every return, a final return, or an IRS notice to file the annual 944.
Exact wording
A seasonal employer that pays no wages in some quarters may skip those quarters' Forms 941 only by checking the seasonal-employer box on every Form 941 it files; otherwise the IRS expects a return for each quarter. The quarterly duty ends with a properly filed final return, and an employer the IRS has notified to file Form 944, the annual return for employers whose annual employment tax liability is $1,000 or less, files that annual return instead of quarterly Forms 941.
Start withholding under a replacement W-4 by the first payroll period ending 30 days after receipt.
Withholding under the replacement Form W-4 must begin no later than the start of the first payroll period ending on or after the 30th day from the date you received it.
On the job
The deadline is a ceiling, not an instruction to wait: an employer may apply a new W-4 sooner, and the clock runs from receipt, not from the date the employee signed it.
Exact wording
Where an employee gives the employer a Form W-4 that replaces an existing Form W-4, the employer must begin withholding under the replacement no later than the start of the first payroll period ending on or after the 30th day from the date the employer received it.
If a new employee gives you no Form W-4, withhold as Single with no adjustments.
A new employee includes a former employee rehired in 2026. Without a completed 2026 Form W-4, treat the employee as checking Single or Married filing separately in Step 1(c), with no entries in Steps 2, 3, or 4 of that form, effective with the first wage payment.
On the job
Not receiving a W-4 is not a reason to withhold nothing or to wait for the form: the default is the single-filer computation with no adjustments, applied from the first check.
Exact wording
If a new employee — including an employee who previously worked for the employer and was rehired in 2026 — does not give the employer a completed Form W-4 in 2026, the employer must treat the employee as if they had checked the box for Single or Married filing separately in Step 1(c) and made no entries in Step 2, Step 3, or Step 4 of the 2026 Form W-4, and make the form effective with the first wage payment.
If the IRS sends you a lock-in notice, disregard a later Form W-4 that withholds less.
A lock-in or modification notice is an IRS letter setting one named employee's withholding. Honor a later Form W-4 only if it withholds more than the notice; otherwise withhold under the notice unless the IRS says otherwise. The notice applies even when the employee performs no services: wages still paid for prior services, a return expected within 12 months, or a leave of absence of 12 months or less. It survives termination — keep withholding under it on wages you still pay, and apply it again on a rehire within 12 months.
On the job
The lock-in notice beats the employee's form unless the form withholds more; the 12-month rules keep it alive through leave, termination, and rehire.
Exact wording
Where the IRS has notified the employer of the withholding required for an employee, a lock-in or modification notice, a later Form W-4 is honored only if it results in more withholding than the notice; otherwise the employer disregards it and withholds per the notice unless the IRS says otherwise. The notice must be applied even for an employee not currently performing services, where wages are still being paid for prior services, the employee is expected back within 12 months, or the employee is on a leave of absence of 12 months or less, and it survives termination: withholding continues under it on wages still paid, and it applies again on a rehire within 12 months.
If you hit $100,000 in payroll taxes on one day, you go semiweekly the next day.
The monthly and semiweekly schedules govern when an employer deposits social security, Medicare and withheld federal income tax. A monthly schedule depositor that accumulates a $100,000 liability for those taxes on any day during a deposit period becomes a semiweekly schedule depositor on the next day, and stays one for at least the rest of that calendar year and the following calendar year. These deposit rules do not apply to FUTA tax, which has its own deposit requirements.
On the job
The lookback rule sets your schedule before the year begins; this rule can change it mid-year without warning. A contractor that lands a large job and runs a big payroll can cross $100,000 in a single day, become semiweekly the next day, and stay semiweekly through the following year. It is the one payroll deadline that moves because business got better — and note it counts employment tax, not FUTA.
Exact wording
The monthly and semiweekly deposit schedules govern when an employer deposits social security, Medicare and withheld federal income tax. A monthly schedule depositor that accumulates a $100,000 liability for those taxes on any day during a deposit period becomes a semiweekly schedule depositor on the next day, and remains one for at least the rest of that calendar year and for the following calendar year. These deposit rules do not apply to FUTA tax, which has its own deposit requirements.
You can personally owe 100 percent of the unpaid withheld payroll tax. Incorporating changes nothing.
Federal income tax, social security tax, and Medicare tax that an employer must withhold are trust fund taxes. If the employer does not withhold them, or does not deposit or pay them to the U.S. Treasury, the trust fund recovery penalty may apply: 100 percent of the unpaid trust fund tax. If the unpaid taxes cannot be collected immediately from the employer or business, the IRS may impose the penalty on all persons it determines were responsible for collecting, accounting for, or paying over those taxes and who acted willfully in not doing so. A responsible person can be an officer or employee of a corporation, a partner or employee of a partnership, an accountant, or anyone who signs checks for the business or otherwise has authority to cause business funds to be spent. Willfully means voluntarily, consciously, and intentionally: a responsible person acts willfully by knowing the taxes are not being paid over, or by recklessly disregarding obvious and known risks to the government's right to receive them.
On the job
Using withheld payroll tax as working capital in a cash squeeze reaches the owner personally, entity or not — a corporation does not shield the person who signed the checks.
Exact wording
Federal income tax, social security tax, and Medicare tax that must be withheld are trust fund taxes. If they are not withheld, or are not deposited or paid to the U.S. Treasury, the trust fund recovery penalty may apply: it is 100 percent of the unpaid trust fund tax, and if the unpaid taxes cannot be immediately collected from the employer or business it may be imposed on all persons the IRS determines were responsible for collecting, accounting for, or paying over those taxes and who acted willfully in not doing so. A responsible person can be an officer or employee of a corporation, a partner or employee of a partnership, an accountant, or anyone who signs checks for the business or otherwise has authority to cause business funds to be spent; willfully means voluntarily, consciously, and intentionally, and a responsible person acts willfully by knowing the taxes are not being paid over or by recklessly disregarding obvious and known risks to the government's right to receive them.
A next-year Form W-4 does not change this year's withholding.
The employer keeps withholding under the Form W-4 already on file for the rest of the current calendar year. A form handed in during December for next year does not change December's payroll; it starts with the next calendar year.
On the job
The counterpart to the 30-day rule, and it cuts the other way. A W-4 handed in during December for next year's circumstances is not applied to December's payroll, so an employer trying to be accommodating by using it early is withholding on the wrong basis.
Exact wording
A Form W-4 that makes a change for the next calendar year does not take effect in the current calendar year.
You owe no social security or Medicare on your child's wages until age 18.
The social security and Medicare exemption for a child under 18 applies only where the parent's business is a sole proprietorship or a partnership in which each partner is a parent of that child. Payments for a child's services are not subject to federal unemployment tax until age 21. Wages paid to your spouse in your trade or business are subject to income tax withholding and to social security and Medicare, but not to federal unemployment tax.
On the job
Family-run construction is the modal small contractor, and the cutoffs do not match: FICA exemption to 18, FUTA to 21, spouse FICA-yes-FUTA-no.
Exact wording
Wages paid to the employer's own family follow entity-and-age rules: payments for the services of a child under age 18 working for a parent's trade or business are not subject to social security and Medicare taxes where the business is a sole proprietorship or a partnership in which each partner is a parent of the child; payments for a child's services are not subject to FUTA tax until age 21; and wages of an individual who works for their spouse in a trade or business are subject to income tax withholding and social security and Medicare taxes but not FUTA tax.
Once you incorporate, treat your child's or spouse's wages like any other employee's.
The family-employee exemptions otherwise keep a child's or spouse's wages out of social security, Medicare, or FUTA. None applies where the employer is a corporation — even one the parent or spouse controls — a partnership with a partner who is not the child's parent, or an estate. For a spouse's wages, any partnership is the employer, even where the other spouse is a partner. Those wages are then subject to income tax withholding, social security, Medicare, and FUTA in full.
On the job
Incorporating ends all of it. Applying the sole-proprietor rules inside an S corp underwithholds across the board.
Exact wording
None of the family-wage exemptions applies where the employer is a corporation, even one controlled by the parent or spouse, a partnership with a partner who is not the child's parent (for a spouse's wages, any partnership counts as the employer even where the other spouse is a partner), or an estate: there the family member's wages are subject to withholding, social security, Medicare, and FUTA in full.
You generally still withhold income tax from a child of any age on your payroll.
The exemption for a child's services in a parent's trade or business reaches social security, Medicare, and FUTA only. A parent employed in a child's trade or business owes income tax withholding, social security, and Medicare, but no FUTA, regardless of the type of services provided.
On the job
The exam's second family trap: the child exemption never reaches income tax withholding, and the parent-employed-by-child case is FUTA-exempt only.
Exact wording
The child exemptions reach social security, Medicare, and FUTA only: payments for the services of a child of any age working in a parent's trade or business are generally subject to income tax withholding. A parent employed by their child in the child's trade or business is subject to income tax withholding and social security and Medicare taxes, but payments to a parent employed by their child are not subject to FUTA tax regardless of the type of services provided.
You owe 2026 FUTA only if 2025 or 2026 wages or headcount crossed a threshold.
The two tests: wages of $1,500 or more in any calendar quarter of 2025 or 2026, or one or more employees for at least some part of a day in 20 or more different weeks in 2025 or 2026. Meeting either makes you subject to FUTA for 2026 on wages paid to employees who are not farmworkers or household workers; the farmworker and household-employee tests are separate and different.
On the job
FUTA has a front door: a contractor whose one helper worked a few weeks and earned under $1,500 in every quarter is not a FUTA taxpayer at all that year. The coverage test is the number a growing sole operator crosses first.
Exact wording
An employer is subject to FUTA tax for 2026 on wages paid to employees who are not farmworkers or household workers only if it paid wages of $1,500 or more in any calendar quarter of 2025 or 2026, or had one or more employees for at least some part of a day in any 20 or more different weeks in 2025 or in 2026; the farmworker and household-employee tests are separate and different.
You pay unemployment contributions yourself. Never deduct any part of them from a worker's wages.
Unemployment contributions accrue and become payable for each calendar year on the wages you pay for employment. You remit them to the department for the Unemployment Fund. Every employer owes them unless section 676 excludes that employer.
On the job
Unemployment insurance is the employer's cost alone; the exam asks which state payroll taxes come out of the employee's check and which do not.
Exact wording
Employer contributions to the Unemployment Fund accrue and become payable by every employer, other than an employer the code defines out in section 676, for each calendar year with respect to wages paid for employment; they are paid to the department for the fund and may not be deducted in whole or in part from the wages of the individuals employed.
You must make every federal tax deposit by electronic funds transfer.
An electronic funds transfer can run through the Electronic Federal Tax Payment System, IRS Direct Pay, or your own IRS business tax account. You may instead arrange for a tax professional, financial institution, payroll service, or other trusted third party to deposit on your behalf, or have your financial institution initiate a same-day wire payment.
On the job
Depositing is a separate act from filing, and where a deposit is owed there is no paper route: a check mailed with the quarterly return is a late deposit plus a filing, and the deposit penalty runs regardless of the return being on time. The third-party options change who presses the button, not who owes the money — the employer stays responsible for the deposit being made and being on time. (When no deposit is owed at all, a separate rule in this guide governs paying with the return.)
Exact wording
All federal tax deposits must be made by electronic funds transfer. An EFT can be made through the Electronic Federal Tax Payment System, IRS Direct Pay, or the employer's IRS business tax account; an employer may instead arrange for a tax professional, financial institution, payroll service, or other trusted third party to make the deposits on its behalf, or for its financial institution to initiate a same-day wire payment.
Take away
Important numbers to know
Practical example
Take the $100,000 kitchen-and-bath remodel you priced in the markup-vs-margin claim: $80,000 of direct cost at a 20 percent margin. Now run its money.
Bid: the 20 percent margin is $20,000 of gross profit — and your home-office (G&A) overhead budget runs 12 percent of revenue, so $12,000 of that margin is spoken for before profit starts. Build: partway in, the job-cost report shows the tile line at 80 percent of budget but only 60 percent installed — find the cause now. Here the answer turns out clean: $3,000 of the plumber's invoice was coded to the tile line by mistake. Recode it and the $80,000 estimate holds, with the job's total cost unchanged. If the cause had instead been waste or a bad takeoff, the revised estimate would replace $80,000 in everything below. Bill: with $48,000 of cost in against an unchanged $80,000 estimate, you are 60 percent complete ($48,000 actual cost ÷ $80,000 estimated cost). Note that cost-to-cost measures COST incurred, so material bought and not yet installed would push this number up without any more of the job being built. Percent complete applies to the CONTRACT PRICE, so you have earned $60,000 of revenue (60 percent × $100,000). If you have billed $70,000, the extra $10,000 is overbilling — a liability, not extra profit. Collect: the customer holds retention, so part of every billing arrives later than the work; your aging report warns you the gap is coming, and a line of credit is what carries it between paying your subs and seeing the money.
Where people go wrong
Sounds right: "The job is profitable, so we're fine"
Where’s the catch?
Easy to mix up: Markup vs. margin
Which is which?
Sounds right: "I charge my customer sales tax on the whole job"
Where’s the catch?
Sounds right: A contractor can never become the retailer of the materials it installs.
Where’s the catch?
Sounds right: Labor is never taxed on a construction job.
Where’s the catch?
Sounds right: "We billed it, so we earned it"
Where’s the catch?
Sounds right: "Depreciation is just an accounting fiction"
Where’s the catch?
Sounds right: "Retention is our money, so count it"
Where’s the catch?
Easy to mix up: Current ratio vs. quick ratio
Which is which?
Sounds right: "I thought the 1099 limit was $600?"
Where’s the catch?
Sounds right: I hold a seller's permit, so I buy everything tax-free.
Where’s the catch?
Sounds right: My sub is an LLC, so no 1099 is needed.
Where’s the catch?
Sounds right: You rent a bulldozer from an unincorporated equipment yard for the month. That is a 1099-NEC.
Where’s the catch?
Sounds right: Your sub hands back a W-9 with “Applied For” in the TIN box, so you hold off on withholding until the grace period runs out.
Where’s the catch?
Sounds right: A single-member LLC sub puts the LLC’s name on line 1 of the W-9, so you file the 1099 that way.
Where’s the catch?
Sounds right: "Every settlement check gets a 1099 — or none do"
Where’s the catch?
Sounds right: "The truck allowance is a reimbursement, not pay"
Where’s the catch?
Glossary
Every term this guide defines, in one place. Each is also defined where it first appears.
- Accrual accounting
- Recording revenue when it is EARNED and costs when they are INCURRED — not when cash moves.
- AR aging
- A report of unpaid customer invoices grouped by how old they are.
- Margin vs. markup
- Margin is profit as a share of the PRICE; markup is profit as a share of the COST. The same dollar profit is a smaller percentage as margin than as markup.
- Materials vs. fixtures
- Materials lose their separate identity when built in — lumber, drywall, paint. Fixtures stay recognizable accessories after installation — a furnace, a water heater. Sales tax treats the two differently.
- Overbilling
- Billings ahead of the revenue earned to date. It sits on the balance sheet as a liability.
- Retention
- A slice of each payment the customer holds back until it comes due. Earned, but not yet collectible.
Keep going
- Practice questions for Law & Business — Business Finances is 15% of the exam.
- Job scenario: The Tax Line
- Every number on one page — this guide’s figures alongside every other Law & Business guide’s.
Test yourself: 11 questions for this guide
A paid account adds more ways to practice and prepare: study questions after every chapter, practice questions for every topic, timed practice exams, and job scenarios drawn from real jobs. A free account gets you one timed practice exam and saves your progress across devices. Here is one of this guide's questions:
Direct costs are $60,000 and you want a gross profit equal to 25 percent of the contract price. What do you bid?
Answer$80,000. Costs are the other 75 percent of the price: $60,000 ÷ 0.75 = $80,000. Adding 25 percent to cost would give only $75,000 — and a margin of 20 percent, not 25.
Standard trade practice
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