Construction Tax Accounting Methods & Choices: An Overview
Construction Tax Accounting Methods & Choices: An Overview
Accounting for income from construction contracts is not always easy or straightforward. Some methods can accelerate income, while others allow a contractor to legally defer income. As we review the options, consider three overriding issues:
- Is the construction contractor considered “small” for tax purposes?
- Is the contract short-term (i.e., started and completed during the tax year) or long-term?
- Does the nature of the work performed fall within a specialized category (e.g., residential or home construction contracts (HCCs))?
If a contractor’s annual gross receipts average less than $10 million (based on the prior three years of receipts),1 then it is considered a small contractor. While a small contractor can choose which method it uses for regular tax purposes, it may want to use the completed-contract method (CCM) or the cash method to better match profit reporting to cash flow.
Completed-Contract Method
Under the CCM, profits from long-term contracts are reported when the contract is completed. In a typical scenario, if a contractor starts a job in Year 1 and completes the contract in Year 2, then zero profit is reported in Year 1 and 100% is reported in Year 2. For many contractors, profit is typically received at the end of the job when the final retainage payment is received.
Cash Method
Under the cash method, revenues are reported when received (deposits) and expenses are reported when paid (disbursements). The IRS doesn’t usually favor the cash method because of the concern that it may be relatively easy to manipulate by delaying cash deposits and accelerating expense payments at year-end. Regardless, the cash method is available to small contractors.
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