Accounting Choices For Long-Term Contracts

» Articles » Construction Articles » Article

October 17, 2005

The IRS defines a long-term contract as a contract that lasts beyond the end of the contractor’s tax year. For example, assuming a calendar year-end contractor, a contract started in December that is completed in January of the following year is a long-term contract for tax purposes. As a result, almost all contractors have long-term contracts.

The following methods of accounting are available for long-term contracts:

  • Percentage-of-Completion Method
  • Exempt Percentage-of-Completion
  • Completed Contract Method
  • Percentage of Completed Capitalized Cost

The Completed Contract Method, in effect, defers the recognition of profit on open jobs at the end of the tax year until the year of completion. The Percentage of Completed Capitalized Cost allows for 30% of the job to be treated under the method used prior to the contractor falling under the requirements of Sec 460 which is often the Completed Contract Method.

Long-Term Contract Factors

Continue reading below

FREE Construction Training from Lorman

Lorman has over 37 years of professional training experience.
Join us for a special white paper and level up your Construction knowledge!

Best Practices for Measuring and Documenting Construction Delays

Learn More

There are three main factors to take into account when deciding which methods a contractor is allowed to use:

  • The type of contract
  • The contractor’s average annual gross receipts
  • The timeframe in which the contract occurs

The different types of contracts are home construction, residential construction and all other contracts. Home construction contracts are allowed to use the Completed Contract Method and residential construction contracts are allowed to use Percentage of Completed Capitalized Cost. These types of contract classifications are not limited to the builder alone, they may also expand to include most subcontract jobs such as electrical, plumbing, and landscaping. It is important to use the most advantageous method the first year a contractor performs this type of work because a change can only be made from an existing method with IRS consent.

Contractors who do not have home construction or residential construction jobs can use the completed contract method if they do not exceed the $10 million gross receipts test and the length of the contract does not exceed twenty four months.

Alternative Minimum Tax

It is important to consider the impact of Alternative Minimum Tax when determining what method to use. The rules for Alternative Minimum Tax can be different than Regular Tax depending on the type of entity, the level of gross receipts, and the type of contract involved.

More Construction Articles

The material appearing in this web site is for informational purposes only and is not legal advice. Transmission of this information is not intended to create, and receipt does not constitute, an attorney-client relationship. The information provided herein is intended only as general information which may or may not reflect the most current developments. Although these materials may be prepared by professionals, they should not be used as a substitute for professional services. If legal or other professional advice is required, the services of a professional should be sought.

The opinions or viewpoints expressed herein do not necessarily reflect those of Lorman Education Services. All materials and content were prepared by persons and/or entities other than Lorman Education Services, and said other persons and/or entities are solely responsible for their content.

Any links to other web sites are not intended to be referrals or endorsements of these sites. The links provided are maintained by the respective organizations, and they are solely responsible for the content of their own sites.