Major construction contractors typically follow the percentage of completion method for tax purposes, which involves recognizing income and costs as the construction project advances. However, is there any flexibility here? Yes! The 10 percent method is a financial management approach that involves setting aside 10 percent of the project's budget or revenue for specific purposes. Contractors typically work closely with project owners and stakeholders to establish how it will be used to ensure transparency and clarity in the financial management of the project.
Under this method, taxpayers do not recognize income or account for expenses related to long-term contracts until the completion of the project surpasses 10 percent. This ensures a construction contractor can cover various costs and contingencies throughout the project. The gross profit derived from these contracts will be due on the contract once you hit that 10 percent threshold. In essence, it is a temporary postponement of tax obligations. However, this presents an excellent strategic financial and risk management opportunity for construction contractors.
Who Does the 10 Percent Method Apply To?
Any construction contractor utilizing the percentage of completion method (PCM) is eligible. If you are a large contractor, defined as one with gross receipts totaling $25 million or more over the past three tax years, this option is available to you. However, if you use the simplified cost-to-cost method for allocating costs, you are not eligible to exercise this election.
How is the Election Made?
To make this election, you apply the 10 percent method for all long-term contracts entered during the tax year. The exact breakdown of how the 10 percent is allocated can depend on the specific contract terms, the type of project, and the contractor's financial strategy. A separate election statement is not required. Once the election is in effect, it automatically covers all future contracts and can only be revoked with approval from the IRS.
Are Taxpayers Required to Make this Election?
No, it is not a requirement.
It is important to note the 10 percent method is a guideline and can vary from one project to another and from one contractor to another.
Are There Any Other Planning Opportunities Available?
Yes! Additional planning opportunities are available for small contractors with less than $25 million in gross receipts for the preceding three tax years. The completed contract method (CCM) is a favorable alternative because it intentionally delays income recognition until contract completion. Furthermore, small contractors can consider alternative methods such as the percentage of completion/capitalized cost method (PCCM) and the exempt-contract percentage-of-completion method (EPCM).
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