The recently-passed Tax Cuts and Jobs Act (TCJA) represents more changes to the U.S. tax law in more than 30 years, and very few industries remain unaffected. The construction industry is no exception; contractors can expect many changes to their taxes in 2018 and beyond. One of the most impactful changes will be how they account for long-term contracts.
Accounting Method Selection
How contractors account for their long-term construction projects has always been a complex topic – cash and accrual have never been the only two options. There are many more methods contractors can use, including:
- The Completed Contract Method;
- The Exempt Percentage of Completion Method;
- The Percentage of Completion Method; and,
- The Percentage of Completion-Capitalized Cost Method.
Selecting the appropriate accounting method can have a big impact on a company’s financial statements. The optimized method has the potential to delay tax payments until a later year, or even to save a company taxes over time. Having the freedom to choose your accounting method is the ideal scenario for most contractors, which is why this new tax law change may be so beneficial.
The New Law
One requirement that remained unchanged with the passage of the TCJA was that all contractors are required to use the percentage-of-completion accounting method unless (1) they are deemed to be a “small contractor,” and (2) their construction contract is likely to be completed within two years. What the new law did change was the definition of a “small contractor.”
The old law
Under prior tax laws, construction companies were considered “small contractors” when their three-year average annual gross receipts were $10 million or less.
The new law
Under the new TCJA, construction companies are considered “small contractors” when their three-year average annual gross receipts are $25 million or less.
Ultimately, this change to the gross receipts threshold allows more construction companies to classify themselves as small contractors than in years past. In 2018, many contractors who had previously been considered large contractors will no longer be required to use the percentage-of-completion method of accounting. Now, they will have the freedom to choose the accounting method that works best for them and their tax position.
This new-found freedom of choosing the optimal accounting method can be a great tool for many contractors, and if you are one of the companies who will be affected, we recommend that you talk to your CPA to discuss your options. An experienced professional like those in LaPorte’s Construction Industry Group can help you find the accounting method that best suits you and your business, and they can help you with the tax compliance changes that will follow.