Construction Contractors – Are You Using the Best Reporting Method?
While over time you will end up with the same total income, your method of accounting will determine in which year you report. If you are a construction contractor, you have several options for reporting your income and expenses: the “Cash Method”, the Accrual Method”, “Completed Contract Methods” and the “Percentage of Completion Method”.
The Cash Method of Accounting is available to C-Corporations with annual gross receipts of less than $5,000,000 and other qualifying taxpayers with less than $10,000,000 in receipts. The Cash Method can be advantageous when a larger amount of receivables is present at year end over payables. Under the Cash Method you generally report income when received, and expenses when paid. So if you have more receivables than payables, you would defer income until you collect your receivables.
Under the Accrual Method of Accounting, you generally record income when billed, and record expenses when incurred, regardless of when the income was received and the expense was paid. The Accrual Method is usually the worst method for contractors to use. Most contractors bill in advance; therefore, the amounts overbilled are taxable income when billed under this method. However, a Retainage Receivable can be excluded from income since they are not true receivables until the contract is accepted. (Retainage is the withholding of payment for a project until its completion, or at other agreed upon stages). The Accrual Method is best if the payables are generally larger than the receivables.
The Completed Contract Method generally results in the greatest deferral of income. No revenue and no costs incurred on a contract are recognized until the contract is completed and accepted by the customer. IRS regulations require completion to be recognized if the contract is 95% complete and the owner occupies the premises.
Contractors with average annual revenues greater than $10,000,000 generally cannot use the Cash Method or the Completed Contract Method. But they still may have options.
The Percentage of Completion Method is generally required on long term contracts. This method recognizes revenue and construction costs on the percentage that a contract is complete by determining the total costs incurred to date divided by the total estimated costs on that particular contract. However, some contracts are potentially exempt from the Percentage of Completion Method. These include home construction contracts, residential contracts, contracts that are less than 10% complete, and non-long term contracts. A Contractor may use its “normal” method of accounting for non-long term contracts and non-construction activity (i.e. accrual excluding retainage). Any contract that has started and completed within the same tax year is not a long term contract. Each contract stands alone to determine the method to be used.
Contact Us: Your Daszkal Bolton Account Manager can help you understand these options and make the best choice for YOUR business. Contact Michelle Bressler, CPA, Tax Services Supervisor, and she can discuss with you the crucial underlying facts of tax planning and cash flow necessary to become a more profitable Contractor! Michelle can be reached at 561-367-1040 or [email protected]