accounting for subcontractors


C

CoderMan

One of my clients is a company that provides consulting services to
others. I bill them, they bill the end-user/client. My bill to them
includes travel expenses at a percentage of my agreed rate to them. I
believe their bill to their client includes my travel time calculated
at their (higher) rate.
- Is it ethical or legal for a company to charge a commission on, or
otherwise alter the value of "hours" in travel expense?
- At tax time, don't they need to show my portion as expense but their
commission as profit, as with any other line item? (I don't know if
they plan to claim their entire line item to their client as a
reimbursed travel expense, I'm just curious.)
- Since we're talking about time, is my time in the car simply "hours"
to everyone, or is there special accounting for them and me where
"travel time" is a specific line item in invoices?

I've discounted my rates to them in anticipation of getting
more/regular contracts. On my books, do I show the differential as a
loss or other expense? Example, my established rate is $90/hour and I
discount to $70/hour to them - is that $20 difference shown anywhere
at tax time?

Finally, and maybe I'm asking for an opinion here more than facts:
I've been asked to bill my travel expenses using my client's table,
not my own. For example, they bill travel expenses at 50%, one way,
using their office as the point of origin. My point of origin to some
clients is much farther, and 50% of my discounted rate (per above) is
only $35/hour, so if I'm in the car for 2 hours I may only be able to
bill them for 30 minutes, which is $17.50. At this rate I'd much
rather press for phone time than on-site time. My normal rate is 75%
of actual time, not based on a pre-defined origin, so at my normal
rate, that same trip would be 2*75=150, quite a difference from 17.50.
My rate serves two purposes, first to discourage clients from
requiring excessive travel from me, and second to make sure that if I
am required to incur a lot of "down" time, that I don't take a loss
when prime time would otherwise be spent earning full-rate. The
current arrangement only proves my theory. I'm considering making
arrangements with them for me to bill on a table that isn't tied to
their own table for their clients. They can charge whatever they want
but if they want my services they're going to have to pay my price.
Comments? My question would again be: is there any special accounting
recommended if/when a loss is taken in the interest of getting regular
business - could that differential be a sales/marketing expense?

Thanks!
 
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P

Paul A Thomas

CoderMan said:
I've discounted my rates to them in anticipation of getting
more/regular contracts. On my books, do I show the differential as a
loss or other expense? Example, my established rate is $90/hour and I
discount to $70/hour to them - is that $20 difference shown anywhere
at tax time?
You can not take an expense for an item that you never pay for. Since you
never "paid" that $20 per hour, you can't take a "loss" for it.

You report $70 of income for one hour, and that is that. For the service
business like yours, you report income as it is collected. Don't collect
it? It isn't income.

Comments? My question would again be: is there any special accounting
recommended if/when a loss is taken in the interest of getting regular
business - could that differential be a sales/marketing expense?

If you didn't pay for it in the past, aren't paying for it now, and won't
pay for it in the future, it isn't an expense.

The difference in "could have" and "did" isn't deductible.

I "could have" billed you for $1,000,000 for this advice, but I didn't, does
not create a million dollar deduction for me.
 
G

Gary V. Deutschmann, Sr.

Hi CM

From my understanding (and past experience) it is completely illegal.

It is also illegal to add a service fee or any additional charge for
services/products rendered by others, when an existing firm used by
the customer is handling the taking of orders for the firm supplying
the services or products, in certain businesses. Kickbacks to the
firm taking the order is also illegal in certain businesses.

Because I will get much flack over my above statement, I will give an
example that can be easily checked upon.

Your Local Funeral Home or Undertaker, if they provide the service of
taking orders for the Local Florist from the family for the flowers
used in that service, the Funeral Home MAY NOT mark up the cost of the
flowers NOR charge for this service NOR take a kickback from the
Florist for handling the paperwork for them.
Of course they can charge a higher base charge for their total service
package to make up for it as long as it is not explicity named as one
of the charges.
I don't know if this is a Federal Law, State Law or just applies to
Counties. I do know it is the LAW in St. Louis County, MO and applies
to hundreds of business types.

TTUL
Gary
 
O

OB

Gary V. Deutschmann said:
Hi CM

From my understanding (and past experience) it is completely illegal.

It is also illegal to add a service fee or any additional charge for
services/products rendered by others, when an existing firm used by
the customer is handling the taking of orders for the firm supplying
the services or products, in certain businesses. Kickbacks to the
firm taking the order is also illegal in certain businesses.

Because I will get much flack over my above statement, I will give an
example that can be easily checked upon.

Your Local Funeral Home or Undertaker, if they provide the service of
taking orders for the Local Florist from the family for the flowers
used in that service, the Funeral Home MAY NOT mark up the cost of the
flowers NOR charge for this service NOR take a kickback from the
Florist for handling the paperwork for them.
Of course they can charge a higher base charge for their total service
package to make up for it as long as it is not explicity named as one
of the charges.
I don't know if this is a Federal Law, State Law or just applies to
Counties. I do know it is the LAW in St. Louis County, MO and applies
to hundreds of business types.

TTUL
Gary
Interesting point.... I would love to hear other posters' ideas and
experience on this aspect, especially from the ones that have a legal
background.

One of my clients formed a property management company. He also owns a real
estate agency. From his previous arrangements/partnership agreements he
takes 30% of any business he refers to some contractors (cleaning, painting,
maintenance, etc.)

As a part of his property management business he is expecting to use these
contractors for managing the properties his company manages. He owns/has
controlling interest in some of the properties he manages. Would this
create a LEGAL problem as long as the owners(in some cases himself) of the
properties are aware of the situation and the contractors he uses charge a
fair price (at market value or less). The amount they charge would not be
increased for the commissions they paid for referral. Would this still be
considered a kick-back?
Any ideas are appreciated

OB
 
B

Bob

OB said:
Interesting point.... I would love to hear other posters' ideas and
experience on this aspect, especially from the ones that have a legal
background.

One of my clients formed a property management company. He also owns a real
estate agency. From his previous arrangements/partnership agreements he
takes 30% of any business he refers to some contractors (cleaning, painting,
maintenance, etc.)

As a part of his property management business he is expecting to use these
contractors for managing the properties his company manages. He owns/has
controlling interest in some of the properties he manages. Would this
create a LEGAL problem as long as the owners(in some cases himself) of the
properties are aware of the situation and the contractors he uses charge a
fair price (at market value or less). The amount they charge would not be
increased for the commissions they paid for referral. Would this still be
considered a kick-back?
Any ideas are appreciated

OB
(I'm not a lawyer) but I don't believe this arrangement is illegal as long
as the property owner can choose the contractor or the compensation
arrangement is disclosed. This is similar to the mortgage industry where
mortgage companies use their appraisers, title examiners or pest inspectors,
etc. and mark up the fees and bill (in the closing statement) to the
borrower,
 
P

Paul A Thomas

Bob said:
(I'm not a lawyer) but I don't believe this arrangement is illegal as
long
as the property owner can choose the contractor or the compensation
arrangement is disclosed. This is similar to the mortgage industry where
mortgage companies use their appraisers, title examiners or pest
inspectors,
etc. and mark up the fees and bill (in the closing statement) to the
borrower,


I don't know where you live, but a mark-up on the appraisal fee is
prohibited by law.

Pest inspection (the termite letter) is paid for by the seller directly, or
from the sale proceeds. While it could be possible that the lender (or the
realtor) directs the seller to a certain company, I've never been aware of a
fee being paid back to the realtor or lender for that.

As far as title exam goes, the fees are so small it's impossible to believe
there is some left over to pay back to the lender.

Now, title insurance most likely does pay a sales commission back to the
lender.

I have clients on all sides of the fence (realtors, mortgage brokers, title
examiners, appraisal companies, pest control companies, etc) and just don't
see this.

That in no way means that there isn't "thank you" gifts and lunches being
bought for your best referral sources. But that is common standard in lots
of businesses.
 
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O

OB

Bob said:
(I'm not a lawyer) but I don't believe this arrangement is illegal as long
as the property owner can choose the contractor or the compensation
arrangement is disclosed. This is similar to the mortgage industry where
mortgage companies use their appraisers, title examiners or pest inspectors,
etc. and mark up the fees and bill (in the closing statement) to the
borrower,
Thanks, thats what I thought... In this case there are no price mark-ups. So
I believe we will be OK...
 
B

Bob

Paul A Thomas said:
I don't know where you live, but a mark-up on the appraisal fee is
prohibited by law.

Pest inspection (the termite letter) is paid for by the seller directly, or
from the sale proceeds. While it could be possible that the lender (or the
realtor) directs the seller to a certain company, I've never been aware of a
fee being paid back to the realtor or lender for that.

As far as title exam goes, the fees are so small it's impossible to believe
there is some left over to pay back to the lender.

Now, title insurance most likely does pay a sales commission back to the
lender.

I have clients on all sides of the fence (realtors, mortgage brokers, title
examiners, appraisal companies, pest control companies, etc) and just don't
see this.

That in no way means that there isn't "thank you" gifts and lunches being
bought for your best referral sources. But that is common standard in lots
of businesses.

for commercial loans (to businesses) "mark ups" use to be legal and for
non-commercial (consumer) if it's disclosed it's not prohibited by law
(but I don't know of any and just recently Bank One got in trouble for this)
as I understand it now, banks are more creative in hiding this - another
example- music companies cannot pay radio stations to play certain songs
(payola) -- but they can pay "promotion" fees to the station
 
G

Gary V. Deutschmann, Sr.

Hi OB
Interesting point.... I would love to hear other posters' ideas and
experience on this aspect, especially from the ones that have a legal
background.

One of my clients formed a property management company. He also owns a real
estate agency. From his previous arrangements/partnership agreements he
takes 30% of any business he refers to some contractors (cleaning, painting,
maintenance, etc.)

As a part of his property management business he is expecting to use these
contractors for managing the properties his company manages. He owns/has
controlling interest in some of the properties he manages. Would this
create a LEGAL problem as long as the owners(in some cases himself) of the
properties are aware of the situation and the contractors he uses charge a
fair price (at market value or less). The amount they charge would not be
increased for the commissions they paid for referral. Would this still be
considered a kick-back?
Any ideas are appreciated

OB
In this scenario what is going on is completely legal!

In fact, it falls right in line with the majority of service
businesses.

You call Bob's Place for Service and place an order to have a job
done. Bob calls the company on his list and they go do the work.
That company bills Bob, Bob ups the price and bills you.

Bob technically is NOT in the Service business, he is a BROKER who
finds jobs for those already in the service business, or he may have
his own crew paid at a different hourly rate than you are paying to
Bob.

Regarding the latter part of your question regarding property
management situations. I think I see what you are illuding too, but
it is not as uncommon as one would think.

Bob owns a truck leasing company, he just happens to also own an XYZ
truck dealership as well.
Bob is part owner in a major local parts distributorship also.

As part owner of the parts shop, he suggests leasing their parts
delivery vehicles from Bob's truck leasing since they have offered the
best lease contract to the parts company.

As the leasing agent, Bob suggests using XYZ brand trucks to the parts
company as ABC brand trucks would be slightly higher in cost to lease
and maintain.

As the XYZ truck dealership, Bob sells X number of XYZ brand trucks to
Bob's Leasing company. Bob's Leasing gets a 10% discount for buying
from Bob'x XYZ truck dealership.

Nothing illegal there, XYZ sold the trucks for less, the leasing
company purchased at a 10% discount.

The leasing company leases X number of trucks to the parts company and
also offers them a 5% discount for using XYZ brand trucks instead of
ABC brand trucks.

Nothing illegal there either, the leasing company rented the trucks
for less than normal, the parts company got a 5% discount.

As part owner of the Parts Distributorship, BOB will realize an
increase in his income through the lower expenses of vehicle leasing.
As owner of the Leasing Company, Bob will realize his standard 30%
profit less 5% of the lease contract on each vehicle.
As owner of the XYZ Truck Dealership, Bob will earn his regualar
commission on the sale of each truck less the 10% discount he gave to
the leasing company.

This is a win, win, win, win situation all the way around!
The parts company saved money 5%,
The leasing company saved money 10%,
The truck dealership made bulk sales of vehicles,
And Bob made out like a bandit on each transaction of each company.

A lot of companies work internally almost that same way!
Company divisions sell to other company divisions at a profit for each
division. In some companies this would be illegal, but for most large
companies it is common business practice to work this way. Money does
not necessarily have to change hands. Company divisions work within
assigned budgets, their goal is to remain under budget in the product
or part that division is responsible for.
They make deals on raw materials, make deals on equipment and
processes and deliver a component part to the next division at a fixed
value. As the wheel spins, each division is earning or losing budget
points.

I have a question about a situation that I will post separately
regarding my own companies and whether something is legal or illegal.
As far as the IRS is concerned, for business tax purposes it is
perfectly legal to continue as before, even though changes in
ownership of the vendors has taken place.
It's the position of the vendors that now comes into play and the
legality of maintaining them as separate vendors.

TTUL
Gary
 
G

Gary V. Deutschmann, Sr.

Hi Paul

It depends upon HOW the paperwork is handled as to whether it is legal
or illegal in the scenario's you presented below.
I don't know where you live, but a mark-up on the appraisal fee is
prohibited by law.
ABC Bank requires an appraisal to approve the loan, some banks want to
use their own appraisal companies while other will allow registered
appraisals to suffice. You call Bob's Appraisal service to handle the
appraisal, Bob's says this will cost $350.00, but Bob is too busy to
handle it so he calls Amy's Appraisal to do the work and to bill Bob
for the service. Bob sends the appraisal in on his companies papers
and bills on his letterhead for the agreed $350.00. Amy only charges
Bob $250.00 for providing him with Appraisals when he sends orders her
way. Bob is who marked up the appraisal fee! The customers contract
for appraisal to be paid out of closing proceeds is legit at the price
of $350.00

I was a Predication Worker for over 25 years. We went into homes for
sale to bring the minor violations up to code, based usually upon the
inspectors list of requirements. Most if not all of the Realtor's
that requested that I do the work, usually worked through Brokers, I
also did a lot of work for these Brokers as well.
However, many times they would just call me direct and fax me the list
of things to be updated or corrected. More often than not I was told
to invoice through an unknown (to me) Broker rather than directly to
the Realty Office. The addresses of these unknown Brokers were often
the home address of one of the Realty Office's Agents. Who I'm sure
had some company name they used to bill the Realty company for the
Predication work performed at the going rate for Brokers.

Whether it is true or not, I was told that working through a Broker is
perfectly legal, even though it usually cost me more in taxes than
working independently. And that billing by a Broker at the common
brokerage rate is also quite legal, even if that Broker is just a
shell company. The shell company may be operating illegally, but that
is beyond my responsibility as a Predication Worker.

TTUL
Gary
 
O

OB

Gary V. Deutschmann said:
Hi OB
In this scenario what is going on is completely legal!

In fact, it falls right in line with the majority of service
businesses.

Thank you... great write-up :)
 
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D

durand26

To understand whether or not it's illegal, we have to look at the way
the law legislates how we do commerce. There are three places we can
get law from: common law (ie a thousand years of judges' precedents),
from statute law (ie the laws the government make up), and industry
based practices (eg, ethics that govern, say, CPAs. If you break one
of these ethics or practices, the CPA throw you out of the
organisation.)

Under common law, most commerce is dealt with under the law of
contract. No-one has to disclose anything under contract law - not
markups, not how many hours work was done, nothing. All contract law
is concerned about can be boiled down to: Did someone make an offer
for something? Did the other person accept it? For instance, if you go
to a shop that sells bottles of Coke, you can be sure that the
shopkeeper has added on a markup to the price he bought it for. But
he's not obligated to tell you what that is. This area of law is
covered bycontract law. The shopkeeper says "I will sell this to you
for $1", and if you say "Ok", then it's yours. This is very simple,
because the shopkeeper can make an offer of a particular price, and
you can either choose to accept it or not.

However, what happens when neither party knows how much it's going to
cost? For instance, if I'm an accountant doing someone's tax return, I
don't know how long it's going to take me to prepare it. If I guessed
and said "I'll do your tax return for $200", then what happens if I
find some weird thing about their situation that could save them
thousands in tax if I only could be bothered to look up my tax book?
If I'd quoted them a flat fee, I wouldn't pursue it because hey, I'm
getting paid the same anyway. Therefore, we need a new body of law to
cover these sort of situations, otherwise no-one would trust
professionals to do quality work. It's called The Law of Agency.
Instead of quoting an agreed fee, I get appointed to apply my skills
in my client's best interests. I'm allowed to charge by the hour,
charge a commission on expenses, even charge a markup ... whatever
method of payment we can agree on ... but I have a "fiduciary duty" to
my client, which means I have to act with the highest level of ethics,
honesty, and in their best interests.

Of course, sometimes conflicts of interest arise. For instance, if
you're relying on me for advice about which shares to buy, what
happens if I already own some of those shares? If I say "buy them",
your buying them will put the price of my own shares up, which means
I'm biased toward recommending them. If this was allowed to happen,
no-one would trust professionals to give them good advice. So to
maintain my integrity to my fiduciary responsibilities to my client, I
therefore have to disclose all the material facts that might bias my
opinions. The idea is, if the client knows about my potential biases,
and hires me anyway, then at least they're can judge how fair my
opinions are and how well I'm going to act on their behalf.

Okay, let's apply this stuff to the original question about the
subcontractor who realised his client was bumping up the number of
hours worked in the end user client's bill. We have three parties
here: an end user client, a fixer (the one the end user turned to to
solve the problem), and the sub-contractor (who actually went out to
the client's place to solve the problem). I imagine that this case
isn't one where a fixed fee was agreed upon at the beginning. It was
probably one that needed specific skills on site to even work out what
the problem was. Therefore, the law of agency comes into play, and the
fixer (and the subcontractor) have a fiduciary responsibility to act
in the client's best interest if they decide to take on the job.
Therefore, if they give a false account of what hours were worked, or
what the expenses were, then that's a breach of their duties. Totally
illegal. Release the hounds. But if the hours and expenses are
recorded correctly, and they'd made an agreement beforehand about what
markups and hourly rates would be charged, then that's perfectly okay.

Having said that, why do funeral homes not mark up the cost of
flowers? Well, it could be because the funeral industry is regulated
by the government, which means that if you run a funeral home, you're
bound by certain government made laws in addition to the law of
agency. So for instance, the government might ban mark ups there.
Alternatively, the local association of Funeral Directors might have
an industry-wide agreement not to mark up flowers, and will ban you
from receiving their monthly newsletter or attending their events if
you do. In some industries, belonging to the industry association is
important enough that this acts as a deterrent!

And as for real estate businesses ... check with a realtor in the same
state about what the obligations are in this industry. But if it's
common practice to charge a markup for employing a gardener, I guess
it'll be alright as long as markups etc are disclosed beforehand.

Regards,

Durand :)

PS: There's a potential loophole here. The realtor could make sure
they hire the most expensive gardener in town to mow the lawn. That
way, their 30% markup is worth more actual dollars. When the question
is asked in court about whether this is in the client's best
interests, the realtor could argue that they provided the client with
the highest possible quality of lawn snipping they could find, and
leave it to the judge to work out whether the price charged was
reasonable. This is an example of how to be unethical without
necessarily being illegal. But in the end, if we get a reputation for
doing that sort of stuff, it becomes harder to find clients later.
 

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