Part I in our Tax Planning Opportunities for the Construction Industry series
One of the most comprehensive changes included in the TCJA is the changes in tax accounting methods available for contractors. Methods previously only available to smaller contractors are now available for contractors with average annual gross receipts of receipts of up to $25 million. In addition, IRS revenue procedures issued in 2018 provide that most of the allowable changes will be considered automatic.
Although automatic changes will still require a submission of Form 3115 to the IRS, the amount of detail and documentation is significantly reduced, user fees of up to $9,500 are not applicable and prior approval of the IRS before adoption is not required so the form can is submitted with the tax return for the year. This provides additional time to analyze the impact of a potential change as well having available the actual year end numbers that will be affected while performing the analysis.
Since accounting methods only impact the timing of when income or deductions are reported it is considered revenue neutral. The timing changes however can result in deferral of tax liabilities. Some amount of deferral or increasing deferrals can result in permanent or at least long-term tax savings to companies: theoretically a win-win for the government and the taxpayers.
As noted above, under pre-TCJA regulations large contractors were considered to be those with average annual gross receipts of $10 million and above. That limit is now raised to $25 million and above. Contractors meeting those revenue limits are still required to use the percentage of completion method (with some variations) to account for all long-term contract revenues. However, the IRS issued revenue procedures issued in 2018 that now include the ASC 606 Revenue Recognition Standards as an acceptable percentage of completion method. Contractors will need to analyze the impact of the standards on the timing of their revenues. If the implementation of the new standards for financial statement purposes generally results in reporting revenues later rather than sooner, a switch to this method for taxes also will result in deferred \ reduced tax liabilities. An ancillary benefit would also be to minimize book / tax reconciliation differences.
Revisions to IRC Section 451(b) regarding timing of income recognition and new 451(c) related to advance payments should also be considered. Click here to view an overview of these new provisions, as well as the other accounting methods that have not been changed and are allowable for large contractors.
The small contractor exception requiring the use of the percentage completion method has been expanded from contractors with average annual gross receipts of less than $10 million to $25 million. Contractors not exceeding the $25 million limitation and previously using the percentage completion method to account for revenues from long term contracts now have broad range of choices for tax accounting methods.
In addition, IRC Section 448 has also been expanded to allow the cash method of accounting for companies with receipts of less than $25 million. Revisions to IRC Section 471 eases accounting for inventories also allowing the cash basis for smaller companies.
Previously, changes in accounting for long term contracts would require advance notification and approval by the IRS. Changes for contractors no longer meeting the requirements for percentage completion or accrual basis of accounting requirements are now considered automatic. Form 3115 is still required but is submitted with the tax return for the year of change, no user fees apply, and the information required is significantly reduces. Changes from the percent complete method are made on the cut-off method so revenues from contracts in progress prior to the year of change will still be accounted for under the old method. Changes in overall methods, i.e. from accrual to cash, are made through a 481(a) adjustment. I.e. the effect of the change is determined at the beginning of the year of change and taken into income over four years if a positive adjustment and deducted in the year of change if negative.
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