What Accounting Methods Do Contractors Use?

Jim Fracker | November 1st, 2012

Usually when you hear the words “accounting method,” you think of generally accepted accounting principles (GAAP). However, you should not overlook the impact that accounting methods have in the tax world, especially for construction contractors.

If you’re a construction contractor performing long-term contracts, you probably have two methods of accounting. One for your overall accounting method and one for the way you account for long-term contracts. For example, contractors typically use the accrual method of accounting for their overall method of accounting and use the percentage of completion method (PCM) to account for long-term contracts.

Construction Accounting Method Exemptions

While the IRS recognizes these methods of accounting, you shouldn’t be fooled into thinking these methods need to be the same for tax purposes. Construction contractors meeting certain criterion and/or requirements have flexibility to use various accounting methods for long-term contracts.  These methods can result in significant tax savings or tax deferral potential.

The IRS has established two primary exemptions to the use of the PCM for long-term contracts. These exemptions are for home construction contractors and small construction contractors. To qualify under the small contractor exemption, a contractor’s average annual gross receipts, over its prior three years, cannot exceed $10 million and any contract entered into must be estimated to be completed within a two-year time period.

Tax Deferrals for Contractors

If either of these exemptions apply, a contractor may select other methods of accounting for long-term contracts such as:

  • Cash method
  • Accrual method
  • Accrual method excluding retainages
  • Completed contract method

Often these alternative methods will provide contractors with significant tax deferral by merely changing when taxable income for long-term contracts will be recognized. While a tax deferral is not the same as permanent tax savings, getting a tax deferral when the business is stable and growing will generate savings which can accumulate, preserving cash for investments in the business. Because of this, it’s very important to manage this deferral as you would any other tax planning strategy – as an opportunity to keep cash in the business.

Ohio Construction Accounting Services

Are you a contractor who may qualify for an exemption to the PCM accounting methods?  If so, switching to a new accounting method could provide you with substantial tax saving.  Interested in seeing what the benefits could be?  Contact Rea & Associates.  Our Ohio construction accounting team will help you determine the best accounting method for your business.  We’ll help you find the most tax advantage solution so you can keep your cash where it belongs: reinvested in your business.

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