Publications

• 30 Second Ideas
• Accounting Updates
• Alerts
• Articles
• Business Surveys
• Construction Edge
• Healthcare Edge
• Insurance Edge
• Legal Talent
• Manufacturing Edge
• Not-for-Profit Edge
• Quick Links & Good Ideas
• SEC Edge
• Strategy Insights Blog
• Surviving the Upturn
• Tax Highlights

Article Author:

Are There Benefits to Being a Small Contractor?

Accounting Methods for Small Contractors

Depending on the type, size, and length of the construction contract, various methods of accounting for long-term construction projects are allowed — each method has its own advantages and disadvantages. Contractors who meet the small contractors’ exception can report long-term contracts through several methods: cash, accrual, accrual excluding retentions, and/or the various long-term methods of percentage-of-completion. 

In the first year that a contract has not been completed by year-end, contractors must choose their tax treatment of accounting for long-term contracts. Once a method has been elected, it must be applied consistently on all subsequent returns; otherwise, under Code Section 481(a), filing for a change in accounting method would be required.

Who Is a Small Contractor?

To qualify as a small contractor, a taxpayer must satisfy two criteria:

1. The $10 million gross receipts test: the taxpayer's average gross receipts for the three taxable years preceding the taxable year of the contract do not exceed $10 million. 
2. The taxpayer must also anticipate, when entering into the contract, that the contract will be completed within two years of the contract’s commencement date. 

The Accrual-Excluding-Retention Method of Accounting

The accrual-excluding- retention method recognizes revenue based on billing entitlement or billings less retainages deferred under the contract. Under Regulation 1.451-1(a), under the accrual method of accounting, income is includible in gross income when all events have occurred that fix the right to receive such income and the amount can be determined with reasonable accuracy. Accordingly, if the events that fix the contractors’ right to receive the retainage do not occur, the contractor is not required to include the retainage in income. With the accrual-excluding-retention method, small contractors can elect to not report or include retainages in gross income until it is billable under the contract. This effectively defers revenue until the end of the contract.

Cost recognition is based on economic performance under Code Section 461(h). Liabilities are incurred and typically taken into account when all the events have occurred that establish the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability. In other words, a small contractor may not accrue (or deduct) an expense the contractor has no legal obligation to pay.  Thus, when a contractor is not legally obligated to pay retainage to subcontractors until the contract is completed and approved, the contractor cannot accrue and deduct the subcontractors’ retainages. 

Tax Planning and Accruals-Excluding-Retention Method

Qualifying as a small contractor can provide an income deferral to the small contractor. The amount of deferral depends on the timing of the billings and the obligations to the subcontractors.  

Questions on the accrual-excluding-retention method of accounting? Contact Cara Hoffman at choffman@BlackmanKallick.com or 312-980-3274 or your Blackman Kallick representative.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.