McKonly & Asbury Webinar - Mitigating Taxes for Contractors: Section 460 Application
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This document provides an overview of Section 460 of the Internal Revenue Code, which regulates the tax treatment of long-term contracts. It discusses the small contractor exception for contractors with average annual gross receipts under $10 million. It also covers available accounting methods for long-term contracts, including percentage-of-completion for large contractors. The document concludes with a discussion of look-back provisions that recalculate taxes owed based on final contract costs.
McKonly & Asbury Webinar - Mitigating Taxes for Contractors: Section 460 Application
- 1. MITIGATING TAXES FOR CONTRACTORS SECTION 460 APPLICATION LISA M. WHITE, CPA CHRIS T. CARE
- 2. FRAUD ENGAGEMENT FROM A TO Z SAMUEL BOWERCRAFT, MSIS, CISA & DAVID HAMMARBERG, CPA, CFE, CISSP, MCSE, WXYZ
- 3. 11 / / 20 13
- 4. MITIGATING TAXES FOR CONTRACTORS SECTION 460 APPLICATION LISA M. WHITE, CPA CHRIS T. CARE
- 5. INTRODUCTIONS Lisa White • Tax Senior Manager • Real Estate and Construction Focus
- 6. INTRODUCTIONS Chris Care • Staff Tax Accountant • Real Estate and Construction Focus
- 7. ABOUT MCKONLY & ASBURY, LLP • Audit, Tax and Risk Management Firm • Regional presence in Pennsylvania • Variety of clients ranging from construction to manufacturing and other clients • Special capabilities real estate and construction industries • Best Places to Work and Best Accounting Firm
- 8. AGENDA • A definition of Section 460 • Small Contractor Application • Large Contractor Application • Look-Back
- 9. IRC SECTION 460 The section of the Internal Revenue Code that regulates long-term contracts. • Long-term contract is defined as… • Non long-term contract activities • Exemptions: • Small Construction Contracts • Home Construction Contracts
- 10. SMALL CONTRACTOR CONTRACT EXCEPTION Average annual gross receipts for 3 prior tax years are less than $10 Million AND The contract is expected to be completed within a 2-year period
- 11. SMALL CONTRACTOR CONTRACT EXCEPTION $10 Million Test • All trades or businesses under common control • All members of any controlled group of corporations of which taxpayer is a member • Attribution Rules! • Less than 50% ownership, but more than 5%
- 12. SMALL CONTRACTOR CONTRACT EXCEPTION Example • Adam owns the following: • 100% of Build-It Corporation • Average annual gross receipts of $5 Million • 15% of Crafty Corporation • Average annual gross receipts of $50 Million • For the $10 Million Test, Build-It Corporation shows average annual gross receipts (due to attribution rules) of $12,500,000
- 13. SMALL CONTRACTOR CONTRACT EXCEPTION $10 Million Test • Does not include: • Returns and allowances • Interest, dividends, rents, royalties, or annuities, not derived in the ordinary course of a trade or business • Receipts from the sale or exchange of capital assets
- 14. AVAILABLE METHODS Exempt-contact Methods • • • • Cash Accrual Hybrid Accrual with Deferred Retainages • Completed Contract Method (CCM) • Exempt-Contract Percentage of Completion (EPCM) • Percentage of Completion (PCM) • PCM – Simplified Cost Method • PCM – 10% Method • PCM Capitalized Cost Method (PCCCM)
- 15. AVAILABLE METHODS (CONT.) Methods of accounting • Overall and short-term contracts • Long-term contracts – Home Construction • Long-term contracts – Residential Construction • Long-term contracts – General Construction estimated to be completed within two years • Long-term contracts – General Construction estimated to be completed in two or more years
- 16. LARGE CONTRACTORS Required to use percentage of completion • Cost to Cost Method • Simplified Cost to Cost Method • Reduces the number of costs that must be used • 10 Percent Method • Defers recognition on job until greater than 10% complete • Can only choose one!!
- 17. INDIRECT COSTS • • • • • • • • • • • Indirect labor costs Officers’ compensation Pension and other related costs Employee benefit expenses Indirect material costs Purchasing costs Handling costs Storage costs Cost recovery (depreciation) Depletion Rent • • • • • • • • • • • • Taxes Insurance Utilities Repairs and maintenance Engineering and design costs Spoilage Tools and equipment Quality control Bidding costs Licensing and franchise costs Interest Capitalized service costs
- 18. IMPACT OF INDIRECT COSTS Example: • Estimated Total Contract • Revenue: $500,000 • Costs: $400,000 • Gross Profit: $100,000 • Year 1: • Contract Costs Incurred to Date: $300,000 • Percentage Complete: 75% • $300,000/$400,000 • Gross Profit Recognized: $75,000
- 19. IMPACT OF INDIRECT COSTS (CONT.) Determine indirect costs to be allocated to the contract, but do not adjust Total Estimated Contract Costs: • Allocated indirect costs: $80,000 • Percentage Complete: 95% • $300,000 + $80,000/$400,000 • Gross Profit Recognized: $95,000 • (Increase of $20,000)
- 20. IMPACT OF INDIRECT COSTS (CONT.) Determine indirect costs to be allocated to the contract, but only adjust Total Estimated Contract Costs for the same amount: • Allocated indirect costs: $80,000 • Percentage Complete: 79.17% • $300,000 + $80,000/$400,000 + $80,000 • Gross Profit Recognized: $79,167 • (Increase of $4,167)
- 21. IMPACT OF INDIRECT COSTS (CONT.) Determine indirect costs to be allocated to the contract, and adjust Total Estimated Contract Costs for an estimated amount to be incurred over the life of the contract: • Allocated indirect costs: $80,000 • Estimated indirect costs to be incurred: 30% • Percentage Complete: 74.50% • $300,000 + $80,000/$400,000 + $80,000 + $30,000 • Gross Profit Recognized: $74,500 • (Decrease of $500)
- 22. HOME CONTRACT EXCEPTION 80% of the estimated total contract costs are attributable to: • Buildings containing 4 or fewer dwelling units or • Real property directly related to those dwelling units • Dwelling units cannot be used transient basis.
- 23. HOME CONTRACTS (CONT.) “Spec” Homes • No construction contract exists Custom Homes Built on Builder’s Land • Large Contractor – follow Spec Home Rules • Small Contractor – must use CCM Custom Homes Built on Buyer’s Land • Large Contractor – Accrual, PCM, or CCM • Small Contractor – Accrual, Exempt PCM, PCM, or CCM
- 24. RESIDENTIAL CONTRACTS Buildings containing more than 4 dwelling units. Use either PCM or PCCCM • 70% - PCM • 30% - Exempt contract method (Usually CCM)
- 25. LOOK-BACK Hypothetical calculation Uses final contract costs to recalculate percentage of completion and revenue that should have been recognized in each year • 10% deferral year Payment or refund of interest for tax paid during those years • Not a change in tax!
- 26. LOOK-BACK Only applicable to long-term contracts required to use POC • i.e. not home contracts, not small contractors De minimis: • Contract completed within two years of commencement date; and, • Lesser of: • $1,000,000 or • 1% of annual gross receipts of taxpayer for the previous three years
- 27. LOOK-BACK Regular Method • Considers all aspects of taxable income calculations • AMT • Itemized Deductions (AGI Limitations) Simplified Marginal Impact Method (SMIM) • Uses assumed marginal tax rate • Highest in effect for the prior year • Required for domestic contracts for non-closely held partnerships and S-Corps (others may elect this method) • Applied at the entity level • Calculated as hypothetical change in contract gross profit times highest marginal tax rate • No consideration for other limitations on the returns (i.e. itemized deductions)
- 28. LOOK-BACK For corporations, look-back interest due can be deducted as interest expense. For individuals, look-back interest due is considered nondeductible personal interest. For all taxpayers, look-back interest received is considered interest income.
- 29. RECAP • A definition of Section 460 • Small Contractor Application • Large Contractor Application • Look-Back
- 30. THANK YOU If you have questions, please contact us: Lisa White • lwhite@macpas.com Chris Care • ccare@macpas.com
- 31. 11 / / 20 13
- 32. 11 / / 20 13
- 33. FRAUD ENGAGEMENT FROM A TO Z SAMUEL BOWERCRAFT, MSIS, CISA & DAVID HAMMARBERG, CPA, CFE, CISSP, MCSE, WXYZ