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

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Bob owns 100% of Building Corporation, which has average annual gross receipts of$8,000,000. Bob also owns 10% of Construction Corporation, which has averageannual gross receipts of $25,000,000. The aggregate gross receipts, for IRC § 460purposes, of Building Corporation are $10,500,000 ($8,000,000 + (25,000,000 x 10%)).Therefore, Building Corporation would be required to account for its long-termconstruction contracts under the percentage of completion method.Determining The Proper Method Of Accounting For Small ContractorsIt is important to note that within the construction industry, a contractor will normallyhave, as a minimum, at least two methods of accounting: an overall method ofaccounting (cash, accrual, or hybrid) and one or more methods for its long-termcontracts (completed contract, percentage of completion, percentage of completioncapitalized cost method). The small contractor’s exception must be determined on acontract-by-contract basis.Example of Several Methods of Accounting Used by One Contractor:A small contractor uses the accrual method of accounting as its overall method toaccount for short-term contracts and the income and expenses not related to long-termcontracts. The contractor uses the completed contract method for its exempt contractsand must use the percentage of completion method for the contracts that are estimatedto exceed 2 years.Rev. Rul. 92-28 I.R.B. 1992-15,41, (Apr. 13, 1992) - IRC § 460(e)(1) permits a taxpayerto use different methods of accounting for exempt and nonexempt contracts within thesame trade or business.General Rule for Accounting MethodsIRC § 446 provides for the general rule for the methods of accounting that are availableto the taxpayer.IRC section 446 General Rule for Methods of Accounting446(a) GENERAL RULE.--Taxable income shall be computed under the method of accounting onthe basis of which the taxpayer regularly computes his income in keepinghis books.446(b) EXCEPTIONS.--If no method of accounting has been regularly used by the taxpayer, or ifthe method used does not clearly reflect income, the computation oftaxable income shall be made under such method as, in the opinion ofthe Secretary, does clearly reflect income.446(c) PERMISSIBLE METHODS.--3-5
Subject to the provisions of subsections (a) and (b), a taxpayer maycompute taxable income under any of the following methods ofaccounting--446(c)(1) the cash receipts and disbursements method;446(c)(2) an accrual method;446(c)(3) any other method permitted by this chapter; or446(c)(4) any combination of the foregoing methods permitted underregulations prescribed by the Secretary.IRC § 446 allows the cash method of accounting and the accrual method of accounting.The other methods that IRC § 446(c)(3) references for construction contracts would be,namely, the completed contract method and the percentage of completion method.Methods of AccountingBecause long-term methods of accounting are determined on a contract-by-contractbasis, a taxpayer potentially could be reporting long-term contracts under severalmethods of accounting. The choice of a proper method of accounting for long-termcontracts is complex. The methods available to a contractor to account for the incomeand expenses of a long-term contract are as follows:CashAccrualHybridAccrual with deferred retainagesCompleted contract method (CCM)Exempt-contract percentage of completion method (EPCM)Percentage of completion method (PCM) (cost-to-cost) as required byIRC § 460*Percentage of completion simplified cost method *Percentage of completion 10% method *Percentage of completion capitalized cost method (PCCM) **These methods are discussed in Chapter 4 Large Construction ContractorsSelecting an Accounting MethodIf a contractor is exempt from the percentage-of-completion method under IRC3-6
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
Page 12 and 13: plants are classified in this categ
Page 14 and 15: measured. The object of the cost co
Page 16 and 17: Time and material contracts are con
Page 18 and 19: Chapter 1 / Table of Contents / Cha
Page 20 and 21: job. Even though the average annual
Page 22 and 23: contract would be classified as a s
Page 24: Non-Long-Term Contract Activities (
Page 27 and 28: • An S corporation and a C corpor
Page 29 and 30: ConclusionThe construction industry
Page 31 and 32: 460(e)(1)(B) any other construction
Page 33: oth businesses are considered when
Page 37 and 38: method would normally be required b
Page 39 and 40: Rev. Proc. 2002-28 Section 6 Exampl
Page 41 and 42: Example 18 of Revenue Procedure 200
Page 43 and 44: • When payment is due• When pay
Page 45 and 46: Example of Retainage Payable:A cont
Page 47 and 48: (approx. the remaining 3% of total
Page 49 and 50: Revenue Code. Other employee benefi
Page 51 and 52: Generally contractors meeting the
Page 53 and 54: Assume a calendar-year corporation
Page 55 and 56: 2000 2001 2002Job 1 - in process in
Page 57 and 58: completed during the taxable year.
Page 59 and 60: specific “facts-and-circumstances
Page 61 and 62: Year 1: At year end, the taxpayer
Page 63 and 64: Subcontracted costs represent eithe
Page 65 and 66: 1.460-2(d), the applicable percenta
Page 67 and 68: • Verify that warranty expenses a
Page 69 and 70: If the contractor had billed and re
Page 71 and 72: Example of hypothetical computation
Page 73 and 74: commencement date, and (2) has a gr
Page 75 and 76: (A) first allocating income under t
Page 77 and 78: Percent Complete 11.6 % 60.00% 100.
Page 79 and 80: The income tax liability, computed
Page 81 and 82: Hypothetical Overpayment of Tax 300
Page 83 and 84: 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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