Construction Industry - Audit Technique Guide - Uncle Fed's Tax ...

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Chapter 2 / Table of Contents / Chapter 4Internal Revenue Code Search / Revenue Ruling Search / Treasury Regulations SearchChapter 3: Small <strong>Construction</strong> ContractorsIntroductionIRC § 460 was enacted as part of the <strong>Tax</strong> Reform Act of 1986, which requires theuse of percentage of completion method for long-term construction contracts.However, as with many Code sections, there are exceptions to the required use ofthe percentage of completion accounting method and to the application of “look-back”interest rules. The exceptions are the home construction contract and the smallconstruction contract. This chapter will provide an overview of the methods ofaccounting that are available to small construction contractors ─ cash, accrual,completed contract, and exempt percentage of completion. Specific accountingmethods for home construction contracts and large construction contracts (i.e.,contracts that do not meet one of the two exceptions of IRC § 460) will be discussedin later chapters.Exceptions to the Required Use of the Percentage of CompletionAccounting Method and Look-back InterestIRC § 460(e) provides two exceptions to the required use of the percentage ofcompletion accounting method and application of the look-back interest rules applicableto certain construction contracts. (These exceptions do not apply to long-termmanufacturing contracts.)1. The home construction contract.2. The small contractor exception. In order to meet the small construction contractexception contained in IRC §460(e)(1)(B), two requirements must be met:− At the time the contract was entered, it was estimated that the contractwould be completed within a 2-year period beginning on thecommencement date of the contract; and− The contractor’s average annual gross receipts for the 3 taxable yearspreceding the year in which the contract was entered did not exceed $10million.IRC § 460(e) EXCEPTION FOR CERTAIN CONSTRUCTION CONTRACTS.--460(e)(1) IN GENERAL.--Subsections (a), (b), and (c)(1) and (2)shall not apply to--460(e)(1)(A) any home construction contract, or3-1
460(e)(1)(B) any other construction contract entered into by ataxpayer--460(e)(1)(B)(i) who estimates (at the time such contract is enteredinto) that such contract will be completed within the 2-year periodbeginning on the contract commencement date of such contract,and460(e)(1)(B)(ii) whose average annual gross receipts for the 3taxable years preceding the taxable year in which such contract isentered into do not exceed $10,000,000.In the case of a home construction contract with respect to whichthe requirements of clauses (i) and (ii) of subparagraph (B) are notmet, section 263A shall apply notwithstanding subsection (c)(4)thereof.Example of 2-year requirement not being met:The taxpayer’s average annual gross receipts are less than $10,000,000 for the prior 3taxable years. The taxpayer enters into two different jobs, which are not homeconstruction contracts. Job 1 is expected to last 18 months. Job 2 is expected to last 3years. The taxpayer would account for Job 1 under its normal method of accounting forlong-term contracts (accrual, completed contract, or percentage of completion).However the taxpayer must account for Job 2 using the percentage of completionmethod as required by IRC § 460.Production Period InterestEven though small contractors are otherwise exempt from the requirements of IRC §460 (i.e. reporting using PCM and applying the look-back interest rules) the interestcapitalization rules of IRC § 460(c)(3) are applicable to all contractors. IRC § 460(e)(1)only exempts the small contractor from subsections (a), (b), and (c)(1).$10 Million Gross Receipts TestIncome from all trades or businesses (whether or not incorporated) that are under thecommon control with the taxpayer are considered in determining the gross receipts test.This is an area that is often overlooked with small construction contractors. Eachreturn of a related group of tax returns may appear to qualify for the small contractorsexception, but, once the gross receipts of all related entities are aggregated, theexception is not met. Therefore, the IRC § 460 requirements of the use of thepercentage of completion method and application of “look-back” may apply to each“small contractor”.IRC §460(e)(2) DETERMINATION OF TAXPAYER’S GROSS RECEIPTS.--Forpurposes of paragraph (1), the gross receipts of--3-2
Page 1 and 2: Internal Revenue ServiceConstructio
Page 3 and 4: De minimis Construction Activities.
Page 6 and 7: Tax Issues.........................
Page 8 and 9: Table of Contents / Chapter 2Intern
Page 10 and 11: through project managers and onsite
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Page 20 and 21: job. Even though the average annual
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Page 29: ConclusionThe construction industry
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Page 43 and 44: • When payment is due• When pay
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Hypothetical Overpayment of Tax 300
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Simplified Marginal Impact Method (
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determined in this step may be limi
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liability or a tax refund. Treas. R
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Balance Sheet AccountsWhen accounti
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Revenue RecognitionAs discussed abo
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XYZ CorporationStatement of Income
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XYZ CorporationSchedule 2 - Contrac
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Chapter 6 / Table of Contents / Cha
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(A) Dwelling units, as defined in s
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Treas. Reg. § 1.263(a)-2 sets fort
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into a long-term contract and would
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B. Contracts which are expected to
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Normally each house is a separate c
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• Developer’s identifying infor
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Commissioner may use her statutory
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) All obligated common improvement
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contractor owned 51% of the joint v
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advice of the construction manager,
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Homebuilder Building for Speculatio
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will frequently reveal an interest
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expense. Revenue Procedure 2003-80,
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Examiners should consider the “do
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• Reg. §1.446-1(c)(1)(ii) - Unde
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• Homebuilders - IRC § 56(a) app
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The initial interview is the best t
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• Tour the business sites and rec
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• A high percentage of cash expen
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• A review of the taxpayer’s pr
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Clearly, the examiner’s judgment
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Chapter 9 / Table of Contents / Cha
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classified as either (1) a partners
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Liquidation/Distribution Issues•
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work, but also the means and detail
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• In Publication 1779, Independen
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for other tax purposes. For further
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Chapter 11 / Table of Contents / Ch
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• Availability of IRS and taxpaye
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Fast Track Mediation works best for
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Chapter 12 / Table of ContentsInter
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eturns with taxable years ending on
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EFTPS EnrollmentTo participate in E
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Appendix 1 - Applicable Federal Tax
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Available Accounting Methods for Lo
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Appendix 3 - Construction Industry
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Plumbing, Heating,Cooling Contracto
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June 1953October 1955July 15, 1981A
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PRODUCTION PERIOD INTEREST IS ALLOC
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elated costs• Productionperiod in
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TermBONDING CAPACITYBONUSBRIDGE LOA
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COMMITMENT FEECOMPLETED-CONTRACT ME
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CONTRACTto the actual construction
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HARD DOLLARCOSTSHISTORICSTRUCTUREHO
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MECHANIC’S LIENNEGOTIATED BIDOFFS
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PROGRESSPAYMENTSPROGRESSSCHEDULEPRO
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