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Construction Insights

Are Your Accounting Methods Offering Maximum Benefit?

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The end of another year can be a time of excitement to enjoy the holidays and look forward to a new year with endless possibilities. But for many financial executives and business owners, it also signals the dreaded year-end task of tax planning. Most are aware of and will be reminded of the well-understood ways to reduce taxes: Do I spend money on fixed assets to take advantage of Section 179 (expensing of fixed assets) and bonus depreciation (50% write-off of new fixed assets) this year? How can income be deferred? Should I accelerate deductions this year? How can I accelerate deductions?

What contractors need to consider

While those planning techniques warrant consideration for many companies across a wide spectrum of industries, construction contractors should add another question to the list: What are the optimum accounting methods I should be using for my construction contracts? Not quite as exciting as the holidays, but if changes are needed, most require IRS consent and must be requested before year-end.

IRS guidance issued May 5, 2016, removed the ability to change to certain accounting methods for long-term construction contacts under the “automatic” change provisions. Now, change applications must be filed before the taxpayer’s tax year end. That means calendar-year-end taxpayers must file for accounting methods changes by Dec. 31 of their year-end, instead of waiting to file by September 15 of the next year (depending on the type of taxpayer and the filing of an income tax return extension). If not, the change will have to be postponed to the following tax year.

Why change your accounting method? To understand that, let’s step back to explain why it’s important. Generally speaking, an accounting method is how income and expenses are reported. The Internal Revenue Service prescribes methods it allows for purposes of calculating and reporting taxable income, which often vary from those used for book and financial reporting purposes. The IRS requires taxpayers to choose methods that accurately reflect their income. Once chosen, the method must be used consistently unless IRS approval is applied for and granted to change methods.

What options are there?

The two primary overall accounting methods are accrual and cash basis; both methods are available to construction contractors depending on their size and entity structure. In addition, construction companies who are involved in long-term construction contracts (contracts that span more than one tax year) have a plethora of other options available for the reporting of taxable income from these types of contracts. Applicable methods include percentage of completion and the completed contract method. Within these types are still more options, depending on the size of the contactor and type of contract. Examples include the ability to defer income on contracts that are 10% or less complete at year-end, the 70/30 rule available for residential contracts, and variations on calculating percent complete. One variation often overlooked is the ability to exclude retainages payable from the percent complete until the retainages are actually paid.

Good tax planning for contractors should involve a detailed review of the jobs-in-progress schedules to evaluate the best available methods for the taxpayer. Otherwise, opportunities may be missed. For example, commercial contractors who generally do not perform residential work may overlook a new apartment complex or college dormitory project that they could account for differently than the percentage of completion method they may typically use. What about backlog? Are there jobs that will be mostly completed in the following year that are likely to be less than 10% complete at year-end? Have the taxpayer’s gross receipts changed significantly over the past three years such that new method opportunities or requirements would be available or required?

Take Action

We urge you and your tax advisor to consider tax accounting methods in your year-end planning meetings. Overlooking this can be costly and push beneficial changes to subsequent years. Why wait until next year’s holiday season? For more information and questions, contact AGH construction team leader Eric Thummel using the information below.

Eric Thummel

Vice President,
Tax Services
Eric Thummel leads the firm’s construction team and he also has experience serving manufacturing and agribusiness clients as well as providing individual and trust tax services. Eric is a certified public accountant who serves on the board of the Greater Wichita Area Construction Financial Management Association chapter. He’s also a member of the Agribusiness Council of Wichita, Kansas Society of Certified Public Accountants and the American Institute of Certified Public Accountants.
Eric Thummel
Eric Thummel
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