By John Valle, Senior Manager – Tax John Valle head shot

Accounting methods available to construction contractors can be a very complex and a confusing issue if you’re not aware of the methods to use and how they may impact your overall operations.  One area that becomes particularly confusing is that a contractor actually has two methods of accounting to use:
•    An overall method of accounting (elected when the company files their first income tax return)
•    A method of accounting for long-term contracts.

A long term contract generally involves the building, installation, construction or manufacture of property if the contract is not completed within the tax year that the contractor enters into the contract. For example – a contractor enters into a contract on December 28th of 2011 and does not complete it until January 3rd of 2012. For tax purposes this is classified as a long-term contract.
Internal Revenue Code Section 460 requires that the percentage completion method be used for determining taxable income for long term contracts.  However, there are two exceptions to the requirement to use the percentage completion method.

The first exception is for home construction contracts. The home construction contract exception applies to any construction contract for which 80% or more of the estimated total contract costs are reasonably expected to be attributable to the building, construction, reconstruction, or rehabilitation of dwelling units in buildings containing four or fewer dwelling units.
The second exception to the percentage completion requirement is for contractors that qualify under the small contractor exception. The small contractor exception is for contractors with long-term contracts that meet the following two conditions:

•    Contracts that will be completed within two years
•    Average annual gross receipts for the three taxable years preceding the taxable year in which the contract is entered into do not exceed $10,000,000.

Contractors qualifying under the Small Contractor Exemption are allowed more options to choose a method of accounting for long-term contracts, including:
•    The cash method
•    The accrual method
•    The accrual less retainage method
•    The completed contract method (CCM)

Selecting an overall accounting and long-term contract accounting method is a very big decision for contractors and can have a great impact on after-tax cash flow due to the timing of income recognition on contracts. The construction team at Apple Growth Partners has extensive experience working with construction contractors.  We can look at your business and operations and assist you in determining the most advantageous method for your situation.  Call 330-867-7350.