Let’s say that your company established the completed contract method of accounting for long-term contracts that are exempt from Code Section 460 because its gross receipts fell under the $10 million threshold.
As the company grew, it continued to use this accounting method. It had two very good years in 2015 and 2016. In 2017 average annual gross receipts for 2014-2016 exceeded $10 million for the first time. For contracts that were open in 2016, the company will continue to report income from those contracts under the completed contract method. For contracts that were started in 2017, the company will be required to report under the percentage of completion method in accordance with Code Section 460 for every year until the contracts are complete.
However, for contracts started in 2018, because the gross receipts threshold was adjusted to $25 million, those contracts are exempt from complying with Code Section 460. The company will report those contracts under the completed contract method since it is the company’s established accounting method for exempt contracts.
Then again, if it was decided that it made sense to report 2018 contracts under a different accounting method other than completed contract, the company will need to file for a change in accounting method with the IRS. The change is not classified as an automatic change; Form 3115 will need to be filed with the IRS prior to year-end. A user fee (currently $9,500) will also need to be paid in order for the Form 3115 to be processed.
The bottom line is that companies with three-year trailing average gross receipts under the $25 million threshold in 2018 should do an analysis to determine if a change in accounting method makes sense. The analysis should include the following factors:
- Whether an overall method of accounting of cash or accrual is the most advantageous;
- The amount of taxable income deferred under the various accounting methods for long-term contracts;
- The effect of AMT on the owners’ returns given the new AMT exemptions and elevated phase-outs;
- The expected growth rate for the company and the length of time before it is expected to reach the $25 million threshold.
With thoughtful consideration and planning, the proper accounting method for long-term contracts can result in the deferral of a significant amount of income tax, which will help your company manage working capital more effectively.
Download the Whitepaper: 2017 Tax Law Impacts Accounting for Long-Term Contracts
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.
