for LONG-TERM CONTRACTS
For example, under §460(e), the IRS allows exceptions to the PCM requirement
for small contractors, home construction
contracts (HCCs), and residential construction contracts.
THE SMALL CONTRACTOR
IRC §460(e)( 1)(B) provides an exception to the PCM requirement if:
• the taxpayer anticipates, when entering
into the contract, that the contract will
be completed within two years of the
contract’s commencement date, and
• the taxpayer’s average annual gross
receipts for the three taxable years
preceding the taxable year of the contract do not exceed $10 million.
Let’s consider a contractor with the following gross receipts: $5 million in Year 1,
$12 million in Year 2, $10 million in Year 3,
$14 million in Year 4, and $4 million in
GAAP requires contractors to base financial statements
on the percentage-of-completion method of account-
ing (PCM) for long-term contracts.
For contracts entered into during Year 4,
the contractor would apply the “gross receipts test” for Years 1-3 to get average
gross receipts of $9 million. In this case,
the contractor meets the $10 million
gross receipts test – and, for tax purposes,
the PCM is not required for any contracts
entered into during Year 4.
However, for tax purposes, some contractors can
choose a different method of accounting for long-term
contracts, depending on the amount of revenue and
the types of contracts performed.
For contracts entered into during Year 5,
the PCM must be used because the contractor fails the gross receipts test with
$12 million in average gross receipts.
However, in Year 6, the contractor meets
the $10 million average gross receipts test