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Accounting - Tax law impacts accounting

image Scott Allen, CPA, Tax Partner, Cornwell Jackson, Plano, TX

SAN ANTONIO - Many commercial construction projects can extend beyond one year. Federal tax law provides special rules for accounting for these long-term contracts (Internal Revenue Code Section 460). The rules apply to all long-term contracts unless the contract is exempt due to several exceptions provided by the tax law.

 

 

 

Not a Long-term Contract
    These contracts are not considered a long-term contract, and are therefore exempt from the accounting for long-term contract rules.
•    Contracts with architects, engineers •    or construction management
•    Contracts for industrial and commercial painting
•    Contracts completed before the end of the same tax year the contract commenced
•    Contracts with de minimis (minor) elements of eligible construction activities
Exempt for AMT Purposes
    Any individual business owner who is subject to Alternative Minimum Tax (AMT) must use the percentage of completion accounting method on long-term contracts, unless the business structure is a small C Corp (eff. 2018) or engages exclusively in home construction contracts (80% or more of the estimated total costs are expected to be attributable to 1) buildings containing 4 or less dwelling units and 2) improvements to real property located at the building site and directly related to the dwelling unit)
    Talk to your CPA to determine if you will be subject to the increased AMT threshold for single or married filing jointly tax status.
    To track expenses and income on non-exempt long-term contracts, contractors are typically required to use the “percentage of completion” accounting method for income tax reporting. The main disadvantage of this method is the inability to do much tax planning or tax deferment for things like accrued losses, uninstalled materials or retainage receivables, which can result in accelerated taxable income when compared with other accounting methods.
One of the exceptions to the tax law applies to companies with average gross receipts for the prior three years under $10 million. Under the new tax law effective for 2018, that threshold has been raised to $25 million. Now, long-term contracts of companies with average annual gross receipts under $25 million are considered exempt from the restrictive and complicated rules of Code Section 460.
    For companies with average annual gross receipts above $25 million, compliance with the tax rules under Code Section 460 remains your only option.
    If your CPA has not talked to you about the potential tax saving benefits of a different accounting method for your non-exempt long-term contracts — or explored if your company’s long-term contract status is now exempt — this year is a good time to ask about it. Because the accounting method chosen for each long-term contract must remain the same through the life of each contract, choosing the right accounting method is critical for any new long-term construction contract in 2018.
What is a long-term contract?
    Before we explore various accounting methods, here is the simple definition of a long-term contract according to the tax code.
•    Long-term contracts are those that on the contract commencement date are reasonably expected to not be completed by the end of the tax year.
Ironically, under this definition, a contract that is expected to take a week to complete could be a long-term contract.  For example, if a contractor with a calendar year-end begins work on December 27 and expects to end on January 2 – the contract is a long-term contract.
        Due to the complexity of accounting for long-term contracts tax rules — with their exceptions — as well as the variable nature of construction revenue, we often find that contractors are using a catch-all accounting method across all contracts. The key pitfalls of using the same accounting method for all long-term contracts over time may include:
•    paying tax earlier than necessary;
•    potential noncompliance with IRS rules as the company’s revenue grows;
•    and noncompliance discovered during an IRS tax audit, which could result in additional taxes and penalties.
    For more information on Tax Law Changes and how they will affect your company, read November’s Accounting Column.
Scott Allen, CPA, joined Cornwell Jackson as a Tax Partner in 2016, bringing his expertise in the Construction and Oil and Gas industries and 25 years of experience in the accounting field. As the Partner in Charge of the Tax practice at Cornwell Jackson, Scott provides proactive tax planning and tax compliance to all Cornwell Jackson tax clients. Contact him at Scott.Allen@cornwelljackson.com or 972-202-8032.


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