Large construction contractors must generally recognize income for tax purposes on the percentage of completion method, which recognizes income and costs as the contract is completed. But is there any leeway here? There sure is! Enter the 10% election.
With a 10% election, taxpayers do not recognize income or take into account any costs from long-term contracts until the contract is greater than 10% complete. Thus, they are able to postpone recognizing any income in the first year(s) of a contract. Gross profit on these contracts is deferred until the first year that the 10% threshold is met. This is a deferral of income taxes and what we in the tax world would refer to as “temporary difference.” You’ll pay taxes on this contract eventually once you hit that 10% threshold. You’re just kicking the can down the road for a bit. However, this can be a great planning opportunity for construction contractors.
Who Does the 10% Election Apply To?
Any contractor using the percentage of completion method (PCM) is eligible. Large contractors – any contractor with $25 million or more in gross receipts for the three preceding tax years – this applies to you! If, however, you are using the simplified cost-to-cost method for allocating costs, you cannot make this election.
How is the Election Made?
The election is made by simply applying the 10% method for all long-term contracts entered into during the tax year. A separate election statement is not required. Once the election is made, it applies to all future contracts and can only be revoked with permission from the IRS.
Are Taxpayers Required to Make this Election?
No, it’s not a requirement to make the 10% election.
What if I Don’t Want to Make the Election? Are There Any Other Planning Opportunities Available to Me?
Yes, there are other planning opportunities available. Taxpayers who are “small contractors” (i.e., less than $25 million of gross receipts for the preceding 3 tax years) have more flexibility in the method they use to account for long-term contracts. The completed contract method (CCM) is a great choice for smaller contractors because it allows taxpayers to wait to recognize any income until the contract is considered complete (over 95% complete). Other options available are the percentage of completion/capitalized cost method (PCCM) and exempt-contract percentage-of-completion method (EPCM).
Construction contractors have more options to choose from than many taxpayers. Please consult your tax advisor for advice on which method is right for your business.