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Levy
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IRS Tax Liens - continued 2
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Audit Techniques Guide
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Audit Technique Guide – Retail Industry
Accuracy - Audit Techniques Guide
Aviation Tax
Carpentry / Framing
Coal Excise Tax
Cost Segregation
The Examination Audit Process

Audit Techniques Guide

Carpentry / Framing

Introduction

USE OF THIS GUIDE: This is a supplement to the Market Segment Specialization Program's (MSSP) Construction Audit Technique Guide (ATG) and should be used in conjunction with the Construction ATG. This supplement is intended to be a reference for revenue agents and tax auditors in examining returns in the carpentry/framing subsegment, as defined below. Examiners should consult this material in both the planning and development phases of an income tax examination. The potential tax issues addressed may apply to proprietorships, partnerships, corporations, or S corporations.

Audit techniques are shown throughout this supplement. These techniques may or may not be appropriate on any particular case. THE EXAMINER MUST USE PROFESSIONAL JUDGMENT WHEN APPLYING ANY OF THE TECHNIQUES DISCUSSED HEREIN.

THE CARPENTRY/FRAMING SUBSEGMENT: The audit techniques described herein will apply primarily to small businesses engaged in remodeling, home improvement, carpentry, woodworking, framing, and residential building. Since these businesses must work closely with those in other specialty building trades, some aspects of this guide will apply to other trades in the construction industry.

-  -

Chapter 1 - Industry Practices

The Construction Cycle

Generally speaking, the construction industry is characterized by a business cycle which is more pronounced than other market segments. The following extract from William D. Mitchell's Contractor's Survival Manual (Craftsman Book Company, 1986), Chapter 1, "The Basics of Construction Contracting," addresses this point:

Extract

Every construction contractor should understand that there's a cycle of construction activity. This cycle rewards those that can anticipate it and punishes those that can't. The construction cycle can make or break you. And for many it does both.

At the beginning of every upswing in construction activity a fresh new crop of eager young builders surge into the industry. They develop a house or two, sell them off at a nice profit, and then tackle larger projects, making more money and laying bigger plans. After three or four very profitable years, some of these builders are running big construction companies with millions of dollars in assets and several major projects under way. They probably attribute their success to hard work, skill and daring. They're right. But they were also in the right business at the right time. And good times don't last forever.

When recession comes, as surely it will, hard work, skill and daring count for little. The bank loans, heavy investment in materials, equipment, staff, overhead and projects that can't be sold become a crushing burden. Many builders fail and leave the business. Others can salvage enough to remain active, or at least stay in business, until the next upswing comes.

Economic recessions are here to stay. There's no reason to suspect that our economy will be better managed or that recessions will be less severe in the future than they have in the past. Accept the ups and downs in construction activity as an opportunity to improve your competitive position against other contractors. Plan to survive when others can't, and thrive when others can only recover.

Exactly what is a recession? From a builder's standpoint, we're in a recession when construction activity is down. That's usually because owners can't borrow money or would have to pay interest rates that make borrowing unattractive. Nearly all construction work is done on borrowed money. When lenders stop lending, builders stop building. That's a recession.

The pronounced ups and downs of the construction cycle make some tax issues more common in this industry. Two such issues addressed in this supplement which may occur in corporate returns include officers' compensation (more likely to be unreasonably high in "good" times), and loans from pension plans (more likely to occur in downswings). Additionally, the examiner should be mindful of the construction cycle, or environment during the year under consideration since this may affect sales, profit margins, and other items appearing on the return.

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Suppliers' Role in the Building Process

Contents of This Section

• The ratio of lumber/materials expense to gross income;
• Suppliers' role in the construction process - lumberyards and retail warehouses;
• Records maintained by suppliers and potential value to examiner.

The Ratio of Lumber/Materials Expense to Gross Income

In many carpentry/framing businesses, lumber and other building supplies represent the most significant expense incurred by the company. This cost will usually be reported in the Cost of Goods Sold section of the tax return. The amount of this expense alone will often require that it be included in the scope of examination.

The ratio of lumber/supplies expense to gross receipts will vary based on the nature of the business. For example, the cost of materials may represent 50 percent or more of the total costs to build a standard home in a large housing development. Such homes are built in fewer hours as teams of workers move from house to house with only minor variation in plans or work procedures. Under these circumstances, labor, overhead, and other related expenses (per house) would represent a lower percentage of total costs; lumber and direct materials would represent a larger portion of total costs.

On the other hand, materials may represent as little as 25 percent of total costs to build one custom home designed by an architect to meet the needs of a particular customer. This home may involve more complex construction techniques and considerably more labor hours/costs than the standard home in a large development.

Audit Technique: The examiner should determine the nature of the taxpayer's work (that is, standard or custom) to gauge the reasonableness of materials (or labor) as a percentage of gross receipts. Ratios which appear out of line may warrant more in-depth consideration. Part II(D) of this supplement provides guidelines for estimating the reasonable cost of materials and labor expense for framing contractors.

Suppliers' Role in the Construction Process - Lumberyard and Retail Warehouse

Carpentry/framing businesses look to lumber and materials suppliers to obtain essential materials at the best possible prices. Cost, however, is just one factor a builder considers in selecting a supplier. In addition to cost, the following factors may influence a builder's use of a particular supplier:

• Location
• Quality of lumber and other building materials
• Delivery services
• Size of inventory available for immediate use
• Extension of credit
• Knowledgeable staff

Suppliers to carpentry/framing contractors generally consist of two types: lumberyards and retail warehouses. In general, a lumberyard and a retail warehouse compare as follows:

1. Cost: A retail warehouse will generally be less expensive due to volume and economies of scale. Lumberyards, however, commonly offer discounts to a contractor which would not be available to a noncontractor. Contractor discounts can be quite significant, particularly for high-volume buyers.
2. Location: The growth of building supply warehouses has dramatically increased in recent years, and most major metropolitan areas now have one or more such outlets. A close location does offer a convenience which any contractor would desire.
3. Quality: While this area may be subjective, most of the builders contacted in connection with this audit guide stated that lumberyards carry wood products of more dependable quality than warehouses. Exceptions will always exist, of course.
4. Delivery services: Both yards and warehouses deliver materials to the construction site. The quality and timeliness of the delivery will vary among suppliers. Many yards have emphasized delivery and other services to compete successfully with the lower priced warehouses.
5. Size of inventory: A yard will generally carry a wider inventory of lumber in hard-to-find sizes. For example, a yard could often deliver a 2" x 10" x 32' ridge beam to a job site in a relatively short time. On the other hand, a warehouse carries a much wider range of construction products and may be relied on for one-stop shopping to supply all the materials needed for a small job.
6. Extension of credit: Yards extend credit to contractors as an integral part of their business. Warehouses are less likely to do so. For small jobs, carpenters may finance purchases at a warehouse with a general credit card.
7. Knowledgeable staff: This is a subjective category and levels of expertise will vary among suppliers. Contractors interviewed in preparing this audit guide gave a clear advantage to the lumberyard, however. This perception may be influenced by the fact that warehouses are a newer form of business and often have more staff turnover. Lumberyard owners/operators usually have a significant amount of experience in the business and often stay well informed of all events in the local construction community. Yards are accordingly viewed as a reliable source of information and assistance.

A contractor may then rely on a lumberyard or a retail warehouse, depending on how heavily the factors above are weighed.

Generally, the larger business will establish a working relationship with one or more lumberyards to provide the bulk of their material needs. To meet the price competition from retail warehouses, yards have slimmed down, employ the "just in time" concept to keep inventory levels low, and use computers to manage their inventory, accounts payable, billing, and general operations. This has led to greater pricing flexibility by yards, which has produced the industry survivors we have today. Yards also provide detailed purchase records to the contractor when and if they are needed for job cost analyses. Yards often have one or more in-house staff members who work with builders on blueprint review or revisions, bill of material requirements, and the general requirement of pricing the job. Yards may extend credit into the tens of thousands of dollars and traditionally take an active role in the construction process.

A smaller operator, such as a self-employed remodeler, may find the warehouse to be a more convenient and cost effective supplier of a wide range of construction materials purchased on an as-needed basis. For example, in addition to lumber, a retail warehouse would carry a wide range of plumbing, electrical, flooring, painting, and other products as well as tools and adhesives.

Audit Technique: Supplier relationships should be established in the initial interview to gain insights into the operation of the business. Suppliers can be valuable sources of information as explained later in this section.

Records Maintained by Suppliers - Potential Value to Examiner

Interviews with suppliers revealed that while record keeping practices vary, nearly all maintained certain basic records for contractor accounts. These basic records are described below, with comments on potential use to the examiner. All of the lumberyards contacted retain records described below for a minimum of five years.

For discussion purposes, records are separated into two broad categories: permanent files and transaction files. Permanent files include information secured or maintained on credit accounts. A permanent credit folder will be established and updated for as long as a customer maintains a credit account. Transaction files document ongoing purchases, payments on account, account balances, etc., by year.

Permanent Credit Files

A significant service offered by most suppliers is the extension of credit to carpenters/framers. Customary terms permit the builder to have materials delivered on account, and to make monthly payments on the liability. Standard terms provide for no interest charges on any purchases paid for within 30 days of delivery.

This arrangement allows the builder to initiate a construction project with a minimal up-front investment. Frequently, the terms of a construction contract will require the end customer to make progress payments to the builder as materials are delivered and applied. These terms allow the builder to make timely payment to the materials supplier and thereby avoid finance charges.

Before extending credit, a lumber supplier will evaluate the contractor's credit worthiness. Information the supplier secures will commonly include a credit application and related documents.

The amount of detail on a credit application will generally be based on the amount of credit desired. Many suppliers will secure a report from a credit bureau and retain the report in the contractor's permanent file. The application for credit generally asks for various information which may be of value to the examiner, including:

• Location of applicant's residence and other real estate owned;
• Mortgages;
• Employer(s);
• Ownership interests in partnerships or corporations;
• Persons authorized to charge the account;
• Bank and credit card accounts;
• Loans outstanding;
• Other credit references.

For active accounts, a supplier may ask the contractor to update the above information annually.

For larger projects or credit lines, a supplier may require audited financial statements attesting to the contractor's financial condition. The builder may also be required to secure a payment bond guaranteeing satisfaction of liabilities incurred. (See the MSSP Construction ATG for a discussion of bonding.)

Transaction Files

Transaction files would generally include details of purchases, deliveries, merchandise returns and credits, payments on account, and finance charges. The extent to which these records are maintained and sorted by customer will vary by supplier. Many suppliers have automated record keeping, which facilitates the sorting of records by contractor, job number, or delivery site.

In cases where the need for supplier contact exists, the examiner should begin by determining what types of records the supplier maintains. Many suppliers record customer information only for purchases on account and do not record the identity of a customer making a cash purchase.

A supplier may be able to provide the following transaction records:

• Account ledger card (account summary): lists the purchases on account, payments and credits, interest charges, and outstanding account balances.
• Invoices: show the date and amount of a particular charge, job site or lot number, and an itemization of materials provided.
• Delivery tickets: record the customer's receipt of materials. Tickets may itemize materials provided, date and delivery site, and the signature of the customer or representative acknowledging receipt.

Audit Technique: Examiners should use professional judgment to determine if a third-party request to secure a taxpayer's credit application and other relevant documents is an appropriate audit technique. In general, the contact should be carefully considered in cases where one or more of the following factors apply:

• Taxpayer cooperation is lacking or nonexistent;
• Books/records are lacking or nonexistent;
• Internal controls are weak;
• The examination of other line items on the return reflect a pattern of noncompliance.

Potential issues to be developed based on the above records include:

• Unreported receipts: Invoices and or delivery tickets may disclose a job site not appearing in the taxpayer's sales journal.
• Undocumented labor: Delivery tickets may reveal that the person acknowledging receipt of materials is a worker for the taxpayer for whom Form W-2 or 1099 is not submitted. This development may indicate noncompliance, which would support expansion of the examination's scope and depth.
• Unsatisfied liabilities: For an accrual basis taxpayer, liabilities which are unsatisfied for extended periods of time may warrant consideration of IRC section 461 and the all-events test (did all events take place to fix the liability?). An adjustment to materials expense may be pursued if the taxpayer accrued an expense but has no intention of satisfying the liability because of a dispute with the supplier.
• Cash payments on account: If cash payments are reflected on the taxpayer's credit account, the examiner should determine if these payments represent income from a job(s) not reflected in the books and records.
• Undisclosed bank accounts: The examiner should be alert for payments on account made with checks from an undisclosed bank account(s). In such instances, deposits to such account(s) should be considered in the testing of income.

Notwithstanding the above issues, the need to secure information directly from a supplier is a decision to be based on all facts and circumstances in the case. Some of the issues above can be identified by analyzing books and records provided by the taxpayer. Also, these issues are not intended to represent a complete list, but rather are provided as a reference point for the examiner.

When case circumstances warrant contact with suppliers, the examiner may first call the supplier to determine the nature of the records maintained and to determine if a summons or an informal request will suffice. A sample request for information is shown below.

While information provided by a supplier may prove valuable to the examiner, such information may not provide a complete picture of the taxpayer's transactions. Most suppliers of building materials will be able to provide specific taxpayer information only with respect to credit transactions. In cases where suppliers are contacted, the examiner should determine whether the taxpayer's noncredit transactions (if any) are retrievable. The supplier may also be able to provide testimony about the existence of cash or noncredit transactions.

Sample Request for Records From Construction Materials Supplier

1. Credit applications, including all attachments and related documents
2. Financial statements
3. Credit agreements
4. Ledger cards or monthly statements showing account transactions
5. Details of sales transactions, including the dates and amounts of all sales, both cash and credit sales
6. Details of all payments, including the date, amount, and method of payment (cash or check)
7. Amounts of purchase discounts provided to the customer
8. Amounts of interest charged and paid each month
9. Details of liens filed on property owned by the customer
10. Records relating to any amounts the customer owes which have been uncollectible or written off as bad debts
11. Sales invoices and delivery tickets for all sales to the customer for the following months.

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The Role of State and Local Government - Licenses, Registrations, and Building Permits:

Licenses and Registrations

The license/registration requirements for carpenters and their business entities (that is, sole proprietorship, joint venture, partnership, or corporation) vary from state to state. Most states, however, do require those in the carpentry/framing business to register or obtain a license.

Typically, a carpenter seeking to obtain a license or registration must fill out an application to do business in a particular state. Some states require applicants to take a test before granting a license. On being licensed or registered, the individual or business organization is typically granted a document which indicates the contractor's license or registration number.

A summary of the licensing/registration requirements for each state or jurisdiction is included in Appendix A. This summary lists the basic requirements for licensing in each of the 52 jurisdictions. Some contractors are exempt from these basic requirements. For example, most states do not require a license or registration for owners who improve their residences. To determine if a contractor should be licensed or registered in a particular state, the examiner should contact the state agency listed in Appendix A.

Audit Techniques:

1. Contact the state agency in the jurisdiction(s) in which the carpenter does business. Ask if the agency has any reports or other information about the taxpayer from the year(s) under audit. At a minimum, the state agency will usually confirm the existence of an active license or registration. Many states receive and file complaints (for example, Department of Consumer Protection) against a contractor by dissatisfied customers. Inclusion of any such job(s) in income should be verified.
2. Determine the state and local town filing requirements for the contractor who is under examination. If the contractor is required to be licensed or registered with the state, the state agency may use this license or registration number for other purposes. The license/registration number may be used to tie into other filing requirements imposed by the state. These filing requirements may include:
1. Annual corporation permit fee
2. State income tax/corporate franchise tax
3. Local tax
4. Sales and use tax
5. Fuel tax
6. Property tax

If applicable, the examiner may be able to obtain copies of these returns through an information sharing agreement that the IRS has with that particular state.

Building Permits

Contractors (including carpenters or their business organizations) are typically required to file an application for a building permit with the town or municipality in which they have contracted to improve real property. Building permits generally serve to ensure that construction work complies with structural, safety, and zoning standards. Nearly all towns employ a building inspector who will review building or remodeling plans and make on-site inspections to ensure that work is completed in accordance with local building codes. On satisfactory completion of the job, a homeowner will be provided a certificate of occupancy or certificate of completion.

Generally, building permit applications require among other things that the contractor list the cost of the improvement being made to the real property. A homeowner may apply for a building permit for work to be done on his or her property, even if a contractor is hired to complete the work. In such case, the contractor may not be listed on the permit.

Local government will also increase the assessed value of real property for taxing purposes based on improvements to that property. This fact may provide an incentive for one to understate the value of an improvement when completing an application for building permit.

Just as the licensing and permit requirements for each state and town may differ, the way each municipality files these documents is also different. Some states and towns may have fully automated filing and document generation and retrieval systems, while others may use a manual system.

Audit Techniques:

1. Call or visit the building inspector in the town(s) in which the contractor does business. The inspector may be able to provide information about jobs done, specialties pursued, or associates with whom the contractor works. This technique may be particularly appropriate in cases where records are lacking or financial status is a concern.
2. Determine where the taxpayer does most business. Visit local town or municipal offices to search for building permits in which the taxpayer is shown as the contractor. Is it possible to get a printout of all permits for jobs completed by the contractor (via license or registration number) for a particular year? Maintenance of automated records will make this technique more feasible. If warranted, the assistance of a paraprofessional should be considered if records are not automated. Inclusion of any such jobs in income should be verified.
3. Inspect the underlying building permit for jobs disclosed in the taxpayer's records. Compare the value of the job as shown on the permit to the amount of income recorded in the books. Any discrepancy in which the amount on the building permit exceeds the amount of income recorded in the books should be investigated. A discussion with the taxpayer or customer may be warranted.

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Estimating Labor and Materials For Framing Contractor

Framing is the process of constructing the shell of a building and includes those components shown in Figure 1-1 below. A frame does not include the foundation, windows, doors, siding, drywall, interior molding, or roofing shingles.

This section is divided into three components:

1. Estimating framing labor costs
2. Estimating framing materials costs
3. Possible explanations for a variance, and potential audit techniques to address a variance.

Caution: The techniques set forth in this section should not be relied on as a basis for supporting an adjustment to a filed return where books and records are available. The technique is an indirect estimate applied to adjust the depth of examination for labor or materials expenses. Also, the formulas and estimates in this section are subject to numerous exceptions. The techniques in this chapter should be applied only after careful consideration of the time required to complete any analysis.

Audit Technique: This section presents an audit technique that can be used to determine if labor or materials expenses claimed for a particular framing job are "reasonable" in relation to industry standards. THESE TECHNIQUES ARE APPLICABLE ONLY TO THE WOOD FRAMING OF A NEW BUILDING OR THE FRAMING OF A NEW ADDITION TO AN EXISTING BUILDING.

This technique may prove worthwhile under the following circumstances:

• As a preliminary test check. Should the test check indicate that labor and or materials expense claimed by the taxpayer are in line with the examiner's estimate, the "depth" of audit for this item may be contracted. If the test check indicates that labor expenses claimed is not in line with the examiner's estimate, additional audit procedures may be warranted.
• To reconstruct expenses for a nonfiled return.
• To reconstruct expenses for a filed return when cooperation or books and records are lacking.

1. Estimating Framing Labor Costs

Details below set forth methods to estimate standard labor costs to frame a new home with 1,000 square feet of living space. It is important for the examiner to understand these methods because adjustments may be necessary to reflect regional labor rates and the effects of inflation. The following concepts must be addressed to apply this technique:

• Worker hours required to frame 1,000 square feet of living space: This is the total hours required by a skilled carpenter to frame a basic structure of this size.
• Hourly labor cost: This includes the basic wage, employer's contribution to welfare, pension, vacation, apprentice funds, and all tax and insurance charges for a skilled carpenter.
1. WORKER HOURS: The handbook Carpentry Estimating was relied on to arrive at applicable estimates. Figure 1-1 below itemizes the components included in a typical framed structure along with the worker hours necessary to measure, cut, and install the wood for that component in the structure. These estimates should remain constant from year to year unless new framing techniques are developed. As shown in fig. 1-1, it takes a skilled carpenter about 221 worker hours to frame a 1,000 square foot (SF) building. An example of how this information may be used in a specific case will be given later.

Figure 1-1

3.       HOURLY LABOR COSTS: The hourly framing labor costs will vary from year to year and from state to state. Below are details used to compute the Connecticut hourly labor cost of $29 for 1995. This cost was arrived at using the National Construction Estimator. The hourly labor cost of a Connecticut carpenter is computed as follows:

4.                     25.46   Price per hour for a building carpenter

5.                     x1.12   Area modification factor for 

Bridgeport
, 
CT

6.                     -----

7.                     28.51   Total carpenter labor cost per hour (est.) for 1995

8.                             in the 

Bridgeport
, 
CT

, area (rounded to $29)

A new edition of the National Construction Estimator appears each year and can be obtained at your local library to secure details for years other than 1995. This reference may be particularly useful when reconstructing the income of a nonfiler, or in the case of a filed return but a lack of adequate books and records.

When considering a return which includes carpenter costs and adequate records are provided to the examiner, a more accurate way to determine the hourly labor cost is to look at applicable payroll records for actual data. Note, however, that labor rates set forth in the National Construction Estimator include all benefits. Accordingly, the examiner would have to add employment taxes, health insurance, and the other identified applicable benefits so that the wage expense estimated in the audit is computed on the same basis as shown in the reference book.

Note that in an examination of a sole proprietor who does not claim labor costs, it would be appropriate to estimate material costs only since a fair labor charge should be reflected in the net profit on Schedule C.

To compute the average hourly labor costs per SF of framing, the information above is used as follows:

 Work hours to frame 1,000 SF of living area (est.)     221

 Carpenter's labor rate per hour (est.)               x $29

                                                      -----

 Labor cost to frame 1,000 SF of living area (est.)  $6,409

 Divided by number of SF framed                       1,000

                                                      -----

 Cost of labor per SF of framing (est.)              $ 6.41

The number arrived at is an industry average of the carpenter's labor cost to construct 1 square foot of residential living space in the Bridgeport, CT, area during 1995. To use this information, multiply the hourly rate by the number of square feet of living space framed by a carpenter for either the entire year or for a specific job. This will give you an estimate of the labor cost which should have been incurred for the project(s).

A reasonable error factor is deemed to be 10 percent. If actual labor charged on the return is within 10 percent of the estimated amount, further inquiry may be limited. The scope and depth of each audit must be based on all facts and circumstances, however. If labor costs charged exceed the estimate by more than 10 percent, additional testing may be warranted. Application of this technique is shown in the following example.

Example 1:

A review of contracts shows that two houses were framed, with each home consisting of 2,000 SF. Using the formula provided above, you estimate the cost of labor (framing only) at $25,640 (4,000 SF x $6.41 labor per SF). Review of the taxpayer's job cost file shows framing labor expense of $38,750 for these jobs. A 10 percent error factor is added to the labor estimate, bringing it to $28,204. Actual labor charged exceeds the estimate by $10,546, which is significant enough to warrant further consideration of this expense.

2. Estimating Framing Materials Costs

Two key components are needed to estimate the standard industry costs to frame a structure: Amount of wood used and costs of wood. While the amount of wood needed to frame a standard structure is fairly consistent nationwide, costs will vary from region to region.

Figure 1-2 computes the costs of wood to frame 1,000 square feet of floor space. By dividing the total material cost amount shown in column D by 1,000, we arrive at the cost of material per square foot.

Figure 1-2

Costs of Wood to Frame 1,000 SF of Floor Space:

^* The various requirements have been converted to an estimated dollar amount.

(A) "Lumber per 1,000 SF of floor" provides the lumber and plywood requirements in BF (board feet) and SF (square feet) for each framing component.

(B) "Lumber and plywood sizes" are national standardized building requirements for lumber sizes.

(C) "National avg. material prices on 1/1/95" were obtained from Means' Repair and Remodeling Cost Data 1995 (Kingston, MA, R.S. Means Co.)

These prices should be updated for the years under consideration. Means' Repair and Remodeling Cost Data 1995 (Kingston, MA, R.S. Means Co.) provides national price figures and average prices for 30 cities. The extract below explains computation of lumber volume in terms of board feet.

Extract

From: W.P. Jackson, Carpentry Estimating (Craftsman Book Co., third printing, 1994), Chapter 2, "Estimating Rough Carpentry"

The cost of lumber is higher for thick and wide planks than for thin and narrow ones. Lengths longer than 16 or 20 feet may require special orders. Unless you request otherwise, the yard will usually quote lumber prices for random lengths to 20 feet. Longer pieces and specified lengths will cost more.

Lumber is sold by the board foot. A nominal 1 x 12 board that's 12 inches long has one board foot. A nominal 2 x 6 that's 12 inches long also has one board foot. The term is abbreviated BF. Here's a quick way to figure the number of board feet in any length of lumber: Write the nominal dimension (width and thickness in inches, length in feet) over 12 in the form of a fraction. Then reduce the fraction to get the board footage. For example, figure the board feet in a joist 2 x 8 x 16' long:

    2 x 8 x 16 = 256 = 21-1/3 bf

                 ---

                 12      12

When figuring more than one piece, simply multiply the board footage in one piece by the number of pieces. For example, if there are 40 joists 2 x 8 x 16', the number of board feet would be:

    40 x 2 x 8 x 16 = 853 bf

    ---------------

          12

Guidelines for estimating the costs of framing materials follow, along with an example of its use.

The formula to estimate framing material costs is: Cost of material per square foot x square foot framed = Total cost of material (est.).

The cost of material per square foot will vary with the year considered and the region in which the framer works. Figure 1-2 above illustrates that the national standard costs to frame 1,000 SF of floor space totals $6,065. Dividing this amount by 1,000 yields a cost of material per square foot of $6.07.

The examiner may estimate costs for one job, a series of jobs, or any reasonable combination.

Tips on Securing Necessary Information:

Lumber Prices: To secure realistic material prices for the period(s) under audit, the examiner can look to the information provided in exhibits to this supplement. These exhibits reflect pricing trends on January 1, 1995. When considering other time periods, pricing information may be estimated by reference to the following:

• Review taxpayer purchase records for the prices charged for various types of lumber.
• Refer to a copy of the Means' Repair and Remodeling Cost Data for the year under consideration. This reference should be available in most public libraries.
• Use estimates provided by the taxpayer.
• Contact local lumberyards for pricing information.

Number of Square Feet Framed:

The examiner must determine the total square feet framed by the taxpayer for a particular job or series of jobs. This information can be obtained from contracts, job cards, or blueprints provided by the taxpayer. Alternative sources may include building permits, interviews with the homeowner/customer, or discussions with the taxpayer.

Example 2:

The taxpayer is a home builder in a New England state. During the year 1994/95, the taxpayer's records reflect that in addition to other jobs, the company was engaged as a subcontractor to frame 17 homes in a housing development. The examiner confirms with the taxpayer that finish carpentry work was not provided on any of these homes. Review of the contract reveals that each home consisted of 2,000 square feet of living space. Review of taxpayer job cost files indicates that total lumber costs charged on the books for this project was $211,000. Figure 1-2 above estimated material prices for this time period and location at $6.07 per SF. Our total cost estimate to frame 34,000 SF is $206,380 ($6.07 x 34,000). It is reasonable to conclude that lumber costs charged ($211,000) are in line with our estimate (that is, within 10 percent) and that additional consideration of this cost will be limited. Let's assume that material costs charged to this project totaled $272,000. This amount exceeds our estimate by $66,000 (32 percent). This discrepancy does not necessarily mean that the return is inaccurate, but additional consideration of this cost may be warranted. The final section of this chapter sets forth potential reasons for a discrepancy, and suggests appropriate examination steps to address discrepancies.

3. Possible Explanations for a Variance/Follow-up Audit Techniques

A finding that the labor or materials expense charged on the return (of a framer) exceeds the examiner's estimate may be due to the following:

• Gross receipts are understated. Additional testing of income may be warranted.
• The expense claimed for labor or material is overstated. This would necessitate expanding the depth of audit for these items to include an analysis of source documents, such as cancelled checks, invoices, payroll records, delivery tickets, etc. Contact with the worker or materials supplier to verify the authenticity of the transaction may be appropriate, depending on the case facts and circumstances.
• The job was more difficult or costly than the taxpayer anticipated. A discussion with the taxpayer may be useful.
• The taxpayer is not a skilled framer and generated excessive waste material. Perhaps the taxpayer (or work crew) is inexperienced and still learning the trade.
• Lumber was stolen from the job site. If significant, the taxpayer may be able to support this with a police report.
• Labor and or materials expense charged to the job(s) may have been applied to a different job(s). The strength of internal controls should be considered. Also, the possibility that expenses were diverted to an unreported job should be considered. Third-party contacts or a discussion with the taxpayer may be useful, depending on case facts and circumstances.
• The taxpayer's activities went beyond standard framing to include finish carpentry work or other tasks necessary to build a home. A discussion with the taxpayer to clarify this point may be helpful. The examiner may also want to review the contract(s) for the work in question to determine the nature of the services provided.
• Another technique to consider when an estimate for labor or materials is substantially less than the amount charged is to discuss the discrepancy with the taxpayer and ask for possible explanations. Perhaps the cost of lumber, amount of lumber, or hours devoted to a particular job were much higher than the estimate due to factors peculiar to that job. Data provided as the basis for estimates (labor hours, volume of wood) assumes a "standard" method of architecture. A more complex or custom method of architecture would result in a higher labor and materials cost. If this is the case, however, gross receipts from the job should reflect the additional expense incurred by the framer, and a positive gross profit should be realized.

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Metal Framing

Metal framing has increased in popularity in recent years. When the cost of lumber increases, metal products may be increasingly looked on as an alternative. Suppliers of metal framing products now provide training at various sites around the country. In addition to possibly lower costs, there are several differences between metal and wood. Some of the advantages and disadvantages are as follows:

Advantages:

1. Metal is stronger and lighter.
2. Since metal is much stronger than wood, a builder may use less of it to frame a whole house.
3. Termites and other insects will not destroy metal.
4. Metal is more resistant to fire damage, earthquakes, and hurricanes.
5. Metal products do not rot.
6. Consistent dimensions mean straighter, stronger walls and floors.
7. Metal products are cut to length, thereby reducing waste.
8. Environmentally friendly; easy to recycle or reuse. Saves trees and wildlife.

Disadvantages:

1. Metal products may rust.
2. With steel studded walls, insulation is more difficult.
3. Metal framing is viewed as a new trend. Many builders and their customers prefer the traditional qualities of wood.
4. The use of metal for framing requires special skills. Most carpenters/framers have little or no experience working with metal.

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