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Benefits of the Increased Long-Term Construction Contract Exception Limit

Construction
July 23 2018

By Jaime Rodriguez Jr, CPA

Since August 2017, tax rate reductions, business entity selection and the loss of the domestic production activities deduction (DPAD) commandeered most of the headlines under tax reform. However, other changes in the new law will bring added benefit to certain construction company contractors as it relates to the percentage of completion method (PCM) for long-term contracts.

In a nutshell, taxpayers must use either the cash or accrual accounting method for short-term contracts, but for long-term contracts, taxable income is generally determined using either the PCM or the completed-contract method. Under the PCM method, taxpayers must include in gross income for the tax year an amount equal to the product of the gross contract price, and the percentage of the contract completed during the year.

In 2018 tax reform will benefit construction contractors by increasing the gross receipts limit to qualify for the small construction contract exception to the PCM by $15 million. The following information further breaks down these changes.

Former Limit

Under the former law, construction companies with average gross receipts of $10 million or less in the preceding three years were entitled to an exception from the requirement to use the PCM method for long-term contracts as long as they met certain requirements. That means they were able to postpone taxation on income from long-term contracts until they were completed or cash was collected.

Expanded Limit

Tax reform has increased the amount of gross receipts from $10 million or less to $25 million or less. For contracts entered into after Dec. 31, 2017, the exception for small construction contracts from the requirement to use the PCM is expanded to apply to contracts for the construction or improvement of real property if the contract:

1) is expected (at the time such contract is entered into) to be completed within two years of commencement of the contract, and

2) is performed by a taxpayer who (for the tax year in which the contract was entered into) meets the $25 million gross receipts test.

AMT Considerations

Alternative minimum tax (AMT) still requires the use of PCM on all long-term contracts, except for home construction contracts, so there may still be an AMT adjustment required for any contract accounted for using the completed contract method. However, keep in mind that AMT thresholds have increased significantly under tax reform, so fewer taxpayers will be affected. For taxpayers filing as a C Corporation, AMT is repealed for tax years beginning after December 31, 2017.

As a reminder, the exception under AMT for a married filing joint taxpayer increased from $84,500 to $109,400. The income threshold (AMTI) also increased from $160,900 for a married filing joint taxpayer to $1 million. For a single taxpayer, the exception increased from $54,300 to $70,300. The income threshold for single taxpayers was $120,700 and has increased to $500,000.

Have any questions regarding the tax accounting for long-term contracts? Please contact Goldin Peiser & Peiser or Jaime Rodriguez Jr, CPA at 972-818-5300.

Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article. 

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