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This entire site is for educational or informational purposes only. You are not to use the forms, concepts, strategies, or knowledge without assistance from a professional. The author, the corporation, the ISP, Bob Parrish CPA, Bob Parrish CPA, P.C. or other parties related to those or this site do not guarantee or warrantee in any manner the suitability, usefulness, accuracy, timeliness, or results of any portions of this site, nor the links contained in this site which link to other areas. At times, information is taken from other sources and is believed to be accurate, but no verification or confirmation is performed. Furthermore, if any federal or state law invalidates a portion of this disclaimer, the other portions still apply. In addition, any allegations or actions are restricted to arbitration only and must be arbitrated by the Better Business Bureau in Sarasota Florida. Reading of these pages constitutes complete acceptance and agreement with all disclaimer provisions on all pages of this site. .......
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Long-term contracts (except for certain
real property construction contracts) must generally be accounted for using the
percentage of completion method described in section 460. See section 460 for
general rules on long-term contracts. they may be needed for the administration
of any provision of the Internal Revenue Code.
Long-Term Contracts --[In General]
The percentage of completion method must
be used to determine taxable income from long-term contracts entered into on or
after March 1, 1986, for regular income tax purposes1 and for alternative
minimum tax (AMT) purposes.2 See Chapter K:12. However, there is an exemption
from the requirement to use the percentage of completion method for home
construction contracts that are expected to be completed within two years and
are entered into after June 20, 1988 (or resulting from the acceptance of a
binding bid made after that date), by taxpayers with average annual gross
receipts of $10 million or less for the preceding three years.3 For regular
income tax purposes, other construction contracts entered into after June 20,
1988, by taxpayers with average annual gross receipts of $10 million or less for
the preceding three years that are expected to be completed within two years are
exempt from the rule requiring use of the percentage of completion method.4 This
exemption does not apply for AMT purposes, even if the contracts are exempted
from the requirement to use the percentage of completion method for regular
income tax purposes.5 However, home construction contracts entered into in tax
years beginning after September 30, 1990, are exempt from the rule requiring use
of the completed contract method for AMT purposes regardless of the taxpayer's
gross receipts or the duration of the contract.6 Thus, the percentage of
completion method must be used to determine alternative minimum taxable income (AMTI)
from all long-term contracts except:
1 IRC §460(a).
2 IRC §56(a)(3).
3 IRC §460(e)(1)(A); IRC §56(a)(3),
prior to amendment by Pub L No 101-239, 101st Cong, 1st Sess, §7612(c)(1) (Dec
19, 1989).
4 IRC §460(e)(1)(B).
5 Notice 89-15, 1989-1 CB 634.
6 IRC §56(a)(3).
l home construction contracts entered into
in tax years beginning after September 30, 1990; and
l home construction contracts entered into
after June 20, 1988, and before the beginning of the first tax year that begins
after September 30, 1990, that meet the gross receipts and duration tests.7
7 Reg §1.460-6(b)(4).
Home construction contracts are contracts
of which 80 percent or more of the contract costs relate to building,
construction, reconstruction or rehabilitation of dwelling units in buildings
containing four or fewer dwelling units.8
8 IRC §460(e)(6).
For contracts entered into before July 11,
1989, taxpayers could report 90 percent of the income from most contracts using
the percentage of completion method and could use the completed contract method
for the remaining 10 percent.9 The completed contract method could be used for
30 percent of the income from most contracts entered into before June 21,
1988.10 See Chapter K:12 for discussion of reporting income from long-term
contracts.
9 IRC §460(a), prior to amendment by Pub
L No 101-239, 101st Cong, 1st Sess, §7621(a) (Dec 19, 1989).
10 IRC §460(a)(1), prior to amendment by
Pub L No 100-647, 100th Cong, 2d Sess, §5041(a)(1), (2) (Nov 10, 1988).
Under the percentage of completion method,
income from a long-term contract must be reported each year in an amount
proportionate to the percentage of the contract costs that are estimated to have
been incurred during the year. See Chapter K:12. The percentage of completion is
determined by comparing costs allocated to the contract and incurred before the
close of the tax year with estimated total contract costs.11 Rules for
allocating costs to contracts are prescribed.12 For AMT purposes, taxpayers
whose average annual gross receipts for the three tax years preceding the tax
year in which a construction contract is entered into use a simplified method of
allocating costs called the cost-to-cost method. Under this method only direct
material costs and direct labor costs, and depreciation, amortization and cost
recovery allowances on equipment and facilities directly used to construct or
produce the subject matter of the long-term contract are used in determining
costs allocated to the contract and total estimated contract costs.13 See
Chapter K:12.
11 IRC §460(b)(1)(A).
12 See IRC §460(a).
13 Notice 89-15, 1989-1 CB 634.
Taxpayers can elect to determine the
percentage of completion of a contract for AMT purposes using the methods of
accounting and costs applied in computing their regular tax. Thus, for example,
in computing the percentage of contract costs they have incurred, taxpayers can
use their regular tax depreciation deductions, rather than the adjusted
depreciation deductions allowed for the AMT.14 This election allows taxpayers to
treat the same percentage of a contract as complete for AMT purposes as for the
regular tax. A taxpayer who does not make the election must use the methods of
accounting and costs required for the AMT to determine the percentage of
completion.15 The election is made on the income tax return for the first year
in which the taxpayer is subject to the AMT and to the requirement to use the
percentage of completion method, and can only be revoked with the consent of the
Service.16 It affects only the determination of the percentage of completion;
taxpayers must reflect all adjustments and preferences in reporting their income
from the contract for AMT.17 See Chapter K:12 for discussion of this election.
For small contractor real property
contracts, 182 the degree of contract completion must be determined using the
simplified cost-to-cost method. 183 As described above, under the simplified
cost-to-cost method, the degree of contract completion is determined solely by
reference to selected costs -- generally direct material and labor costs and
depreciation. 184 Presumably, minimum tax depreciation would be used in this
calculation unless the corporation elected to use regular methods and costs (see
discussion above), in which case regular depreciation would be used in the
simplified cost-to-cost calculation. 185 For small contractor real property
contracts the percentage of completion method must be used for AMT purposes even
though such contracts are not subject to the regular tax restrictions on the
method of accounting for long-term contracts. 186
/Footnote/ 182 A "small contractor
real property contract" is one entered into by a taxpayer who estimates
that the contract will be completed within two years of the date of the
contract, and whose average receipts over the previous three years does not
exceed $10 million. §460(e)(1)(B).
/Footnote/ 183 §56(a)(3) (as amended by
1988 TAMRA, §1007(b)(1)); Notice 89-15, 1989-1 C.B. 634 (Q & A 46). Before
enactment of this provision, a taxpayer could elect to use this simplified
method for such contracts. See Notice 88-66, 1988-1 C.B. 552, Section VII. It is
unclear whether the simplified cost-to-cost method applies to home construction
contracts that are subject to the AMT (i.e., pre-Oct. 1, 1990 contracts). The
legislative history refers only to small contractor real property contracts. See
H.R. Rep. No. 795, 100th Cong., 2d Sess. 88 (1988). The statutory language,
however, is broad enough to include such home construction contracts. See §56(a)(3)
and §460(e)(1).
/Footnote/ 184 See Notice 89-15, 1989-1
C.B. 634 (Q & A 22).
/Footnote/ 185 If the contract is not a
small contractor real property contract, the degree of completion apparently can
be determined under the simplified cost-to-cost method only if the regular
methods and costs election is made and only if such cost-to-cost method is used
for regular tax purposes. See Notice 87-61, 1987-2 C.B. 370, Sec. IX.
/Footnote/ 186 Notice 89-15, 1989-1 C.B.
634 (Q & A 46).
In addition, home construction contracts
187 are excepted from the general rule requiring AMTI accounting. This rule is
effective for any home construction contract entered into in tax years beginning
after September 30, 1990. 188
/Footnote/ 187 A "home construction
contract" is a contract where 80% of the estimated contract costs are
reasonably expected to be attributable to construction of dwelling units in a
building with four or fewer units, and/or improvements to real property related
to such units on the site of such units. §460(e)(6)(A) and 460(e)(4).
/Footnote/ 188 §56(a)(3). Under pre-1989
RRA §56(a)(3) (for contracts entered into after June 21, 1988, and before the
beginning of a tax year that begins after Sept. 30, 1990), the home construction
contract exception was more limited because it applied only if the taxpayer had
annual gross receipts of $10 million or less for the preceding three tax years
and if the contract was expected to be completed within two years.
An exemption from the general rules is
provided for "construction contracts" entered into by certain small
contractors who estimate that the construction contracts will be completed
within two years from the commencement date. 83 A "construction
contract" is a contract for the building, construction, reconstruction, or
rehabilitation of, or the installation of any integral component to, or
improvements of, real property. 84
/Footnote/ 83 See §460(e)(1).
/Footnote/ 84 §460(e)(4).
An eligible small contractor is one whose
average gross receipts for the three taxable years preceding the taxable year in
which the contract is entered into do not exceed $10,000,000. 85 To prevent
taxpayers from circumventing the statute by using multiple entities, in
calculating the $10,000,000 limitation, a contractor's gross receipts include
the gross receipts of any incorporated or unincorporated trade or business under
common control with the taxpayer 86 and any member of a controlled group of
corporations 87 that includes the taxpayer. Regulations are to prescribe
attribution rules that will count the gross receipts of certain partnerships,
joint ventures and corporations in which the taxpayer is a member and which
enter into construction contracts. 88
/Footnote/ 85 §460(e)(1)(B)(ii).
/Footnote/ 86 Regs. §1.52-1(b) contains
the applicable definition of "common control." See §460(e)(2)(A).
/Footnote/ 87 Section 460(e) borrows the
definition of "controlled group" from §1563(a). In applying the
controlled group definition, however, a more-than-50% control requirement
applies, rather than the more-than-80% control level of §1563(a)(1).
/Footnote/ 88 §460(e)(2) (flush
language).
With respect to the application of the
$10,000,000 limitation to members of a controlled group of corporations, the IRS
maintains that if a taxpayer is a member of a controlled group on the first day
of the taxable year in which a construction contract is entered into by the
taxpayer, the gross receipts of the controlled group for the preceding three
years count towards the $10,000,000 limitation regardless of whether the
taxpayer was a member of the controlled group for any of the three years.
Conversely, if a taxpayer is not a member of a controlled group on the first day
of the taxable year in which a construction contract is entered into, the fact
that the taxpayer may have been a member of a controlled group during the
three-year period is ignored. 89
/Footnote/ 89 Notice 89-15, 1989-1 C.B.
634, Q & A-45. The Notice does not provide guidance on this issue with
respect to commonly-controlled businesses.
Contracts qualifying for the small
construction contract exception are eligible for the pre-1986 rules (i.e., the
regulations applicable to non-extended period, long-term contracts). 90 Because
such contracts involve the construction of real property, however, they are
subject to the interest capitalization rules, regardless of their duration. 91
For discussion of the pre-1986 TRA rules, see ¶3610.03.
/Footnote/ 90 H.R. Rep. No. 841, 99th
Cong., 2d Sess. at II-312 (1986).
/Footnote/ 91 Id.
2. Home Construction Contracts
Certain home construction contracts are
also exempted. 92 A "home construction contract" is a construction
contract with respect to which 80% or more of the estimated total contract costs
(as of the close of the taxable year in which the contract was entered into) are
reasonably expected to be attributable to the building, construction,
reconstruction, or rehabilitation of: (1) dwelling units 93 in buildings
containing four or fewer dwelling units; and (2) improvements to real property
directly related to such dwelling units and located on the site of such dwelling
units. 94 All costs attributable to the building, construction, reconstruction,
or rehabilitation of the dwelling units, and allocable to the contract,
including the costs of materials and raw land, are includible for purposes of
the 80% test. 95 The cost of roads, sewers and other "off-site" common
facilities are also includible. 96 Finally, for purposes of defining a
"dwelling unit," a townhouse or rowhouse is treated as a separate unit
regardless of the number of such structures that may be attached. 97
/Footnote/ 92 §460(e)(1), as amended by
P.L. 100-647, §5041(b)(1), §5041(e), effectively generally to contracts
entered into after June 21, 1988.
/Footnote/ 93 As defined in §168(e)(2)(A)(ii).
See Notice 89-15, 1989-1 C.B. 634, Q & A-43.
/Footnote/ 94 §460(e)(6)(A).
/Footnote/ 95 Notice 89-15, 1989-1 C.B.
634, Q & A-43.
/Footnote/ 96 Id., Q & A-44.
/Footnote/ 97 §460(e)(6)(A) (flush
language).
3. Residential Construction Contracts
A special provision permits taxpayers to
use a 70/30 split (rather than 90/10) in applying the percentage of
completion-capitalized cost method to "residential construction
contracts." 98 A residential construction contract must meet the same
requirements as a home construction contract, except that the limitation of no
more than four dwelling units per building is inapplicable. 99
/Footnote/ 98 §460(e)(5). The pre-1986
TRA rules are not available for such contracts.
/Footnote/ 99 §460(e)(6)(B).
In applying the requirement that 80% of
the total contract cost be attributable to constructing the portion of the
property comprised of dwelling units to a mixed-use building (e.g., one
containing both apartments and retail or office space), the cost attributable to
"dwelling units" are the sum of: (1) the costs attributable solely to
the dwelling units; and (2) a pro rata amount of the other costs not
attributable solely to the dwelling units (but which are not attributable solely
to the other uses). This allocation must be based on the relative amount of
space devoted to the dwelling units and the other uses. 100 Consequently, if 75%
of the space in a building will be used for apartment units and 25% for retail
space, 75% of the contractor's land cost is attributable to the apartments. The
cost of all appliances installed in the apartments is attributable to the
apartments, however, since this cost is solely attributable to the apartments.
101
/Footnote/ 100 Notice 89-15, 1989-1 C.B.
634, Q & A-41.
/Footnote/ 101 Id.
SEC. 460. SPECIAL RULES FOR LONG-TERM
CONTRACTS. Subsec. (e) Exception for Certain Construction Contracts.--
460(e)(1) In general.--Subsections (a),
(b), and (c)(1) and (2) shall not apply to--
460(e)(1)(A) any home construction
contract, or
460(e)(1)(B) any other construction
contract entered into by a taxpayer--
460(e)(1)(B)(i) who estimates (at the time
such contract is entered into) that such contract will be completed within the
2-year period beginning on the contract commencement date of such contract, and
460(e)(1)(B)(ii) whose average annual
gross receipts for the 3 taxable years preceding the taxable year in which such
contract is entered into do not exceed $10,000,000.
In the case of a home construction
contract with respect to which the requirements of clauses (i) and (ii) of
subparagraph (B) are not met, section 263A shall apply notwithstanding
subsection (c)(4) thereof.
460(e)(2) Determination of taxpayer's
gross receipts.--For purposes of paragraph (1), the gross receipts of--
460(e)(2)(A) all trades or businesses
(whether or not incorporated) which are under common control with the taxpayer
(within the meaning of section 52(b) ),
460(e)(2)(B) all members of any controlled
group of corporations of which the taxpayer is a member, and
460(e)(2)(C) any predecessor of the
taxpayer or a person described in subparagraph (A) or (B), for the 3 taxable
years of such persons preceding the taxable year in which the contract described
in paragraph (1) is entered into shall be included in the gross receipts of the
taxpayer for the period described in paragraph (1)(B). The Secretary shall
prescribe regulations which provide attribution rules that take into account, in
addition to the persons and entities described in the preceding sentence,
taxpayers who engage in construction contracts through partnerships, joint
ventures, and corporations.
460(e)(3) Controlled group of
corporations.--For purposes of this subsection, the term "controlled group
of corporations" has the meaning given to such term by section 1563(a) ,
except that--
460(e)(3)(A) "more than 50
percent" shall be substituted for "at least 80 percent" each
place it appears in section 1563(a)(1) , and
460(e)(3)(B) the determination shall be
made without regard to subsections (a)(4) and (e)(3)(C) of section 1563 .
460(e)(4) Construction contract.--For
purposes of this subsection, the term "construction contract" means
any contract for the building, construction, reconstruction, or rehabilitation
of, or the installation of any integral component to, or improvements of, real
property.
460(e)(5) Special rule for residential
construction contracts which are not home construction contracts.--In the case
of any residential construction contract which is not a home construction
contract, subsection (a) (as in effect on the day before the date of the
enactment of the Revenue Reconciliation Act of 1989) shall apply except that
such subsection shall be applied--
460(e)(5)(A) by substituting "70
percent" for "90 percent" each place it appears, and
460(e)(5)(B) by substituting "30
percent" for "10 percent".
460(e)(6) Definitions relating to
residential construction contracts.--For purposes of this subsection--
460(e)(6)(A) Home construction
contract.--The term "home construction contract" means any
construction contract if 80 percent of the estimated total contract costs (as of
the close of the taxable year in which the contract was entered into) are
reasonably expected to be attributable to activities referred to in paragraph
(4) with respect to--
460(e)(6)(A)(i) dwelling units (as defined
in section 168(e)(2)(A)(ii) ) contained in buildings containing 4 or fewer
dwelling units (as so defined), and
460(e)(6)(A)(ii) improvements to real
property directly related to such dwelling units and located on the site of such
dwelling units.
For purposes of clause (i), each townhouse
or rowhouse shall be treated as a separate building.
460(e)(6)(B) Residential construction
contract.--The term "residential construction contract" means any
contract which would be described in subparagraph (A) if clause (i) of such
subparagraph reads as follows:
"460(e)(6)(B)(i) dwelling units (as
defined in section 168(e)(2)(A)(ii) ), and"
Law (commentary and citation)
Regs (commentary and citation)
Cases (commentary and citation)
§§§ Law §§§
§274(d)
§§§ Regs §§§
§§§ Cases §§§
This is about Activity Based Taxplanning - maximizing deductions, minimizing cash outlay and maximizing the amount of cash retained and the net worth.
Tax is a subject that many view in order to cut costs. Taxes are a cost just as any other cost. It happens this cost is somewhat intangible and is defined by legislation without a tangible item to view and control. The money is spent and the control of the expenditure is more appropriately administered by someone trained in the law.
This is about Activity Based Costing - methods to cut costs, management accounting, management information systems, decision support systems - in general about being a manager.
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