Small Contractor Exemption
The Tax Cuts and Jobs Act (TCJA) provides relief for small taxpayers by expanding the small contractor exception, thereby allowing more taxpayers to opt out of using the percentage-of-completion method for long-term contracts.
Under the TCJA the exemption for small contractors increases from $10,000,000 in average gross receipts over the last three years to $25,000,000 in gross receipts over the last three years. The old $10,000,000 threshold dates back to the 1980’s and had not been indexed for inflation, so this increase is a welcome relief to many small contractors.
Percentage-of-Completion Method
In general a taxpayer must use the percentage-of-completion method to account for long-term contracts under IRC §460. The small contractor exception under IRC §460 exempts contractors who’s average gross receipts over the last three years falls below the gross receipts threshold. A taxpayer that does not meet the small contractor exception generally must account for their long-term construction contracts under the percentage-of -completion method.
Long-Term Contracts
A long-term contract means any contract for the manufacture, building, installation, or construction of property if such contract is not completed within the taxable year in which the contract is entered into. In other words it applies to any construction contract not completed within the same taxable year. The existing exemptions for home construction contracts remain unchanged.
The increase in the gross receipts is applied on a cut off basis would apply to any contract entered into after December 31, 2017 if the taxpayer meets the small contractor exception. Thus any contractor that had contracts started in a year where they were above the old $10,000,000 threshold must continue to account for those contracts under the percentage-of-completion method while any new contract entered into after December 31, 2017 could use completed contract or any other permissible method.
Cash vs Percentage-of-Completion Method
In addition to the small contractor exception, for tax years beginning after December 31, 2017, the cash method may be used by taxpayers that satisfy the $25,000,000 gross receipts test. Under the right circumstances a small contractor would be able to not only exempt any new contract from the percentage-of-completion method but would also be able elect the cash method of accounting at the same time and potentially recognize a significant deferral of income.
For more information on how to apply the provisions of the TCJA to your construction business, please contact one of our industry experts at (714) 672-0022.
