Long-Term Contracts and AMT: Some Construction Contractors May Miss Making a Crucial Adjustment

By Swilley, Wayne | Journal of Accountancy, December 2017 | Go to article overview

Long-Term Contracts and AMT: Some Construction Contractors May Miss Making a Crucial Adjustment


Swilley, Wayne, Journal of Accountancy


Certain construction contractors may be eligible to use the cash or completed-contract method of accounting for regular income tax. However, these taxpayers may also be liable for alternative minimum tax (AMT), in which case they may be required to make an adjustment for the percentage-of-completion method that may be overlooked, as well as pay an interest charge under the lookback method upon completion of a long-term contract. This column describes the adjustment and interest charge and when they apply.

Taxable income from a long-term contract is determined under the percentage-of-completion method (Sec. 460(a)). However, any home-construction contract or any construction contract entered into by a taxpayer that estimates that the contract will be completed within two years and whose average annual gross receipts for the three previous years do not exceed $10 million is exempt from the percentage-of-completion method in determining regular taxable income (Sec. 460(e)(1)).

THE AMT ADJUSTMENT

Rev. Proc. 2002-28 allows construction contractors that are otherwise required to use an accrual method under Sec. 446 because they are required to account for inventories under Sec. 471 to use the cash method for regular income tax, unless prohibited under Sec. 448, if their average annual gross receipts, as defined under Section 5 of Rev. Proc. 2002-28, do not exceed $10 million for the three previous tax years. Additionally, construction contractors qualified under Sec. 460(e)(1) may use the completed-contract method, as outlined in Regs. Sec. 1.460-4(d), to account for exempt contracts. The cash method or the completed-contract method, however, cannot be used to determine AMT income (AMTI) for a long-term contract, except for a home-construction contract (Sec. 56(a)(3)).

Sec. 460(f)(1) defines a "long-term contract" as any contract for the manufacture, building, installation, or construction of property that is not completed within the tax year in which the contract is entered into. For example, if a contract is entered into on Dec. 29 of year 1 and completed on Jan. 5 of year 2, the contract is deemed to be a long-term contract. Under Regs. Sec. 1.460-4(f)(l), a taxpayer must use the percentage-of-completion method to determine AMTI from any long-term contract entered into by the taxpayer on or after March 1, 1986, that is not a home-construction contract, as defined in Regs. Sec. 1.460-3(b)(2). Accordingly, any long-term contract that is not a home-construction contract in progress at year end is deemed to be a long-term contract subject to the AMT, even if the taxpayer uses the cash or completed-contract method to report income for regular income tax. Small C corporations are exempt from the AMT (Sec. 55(e)).

The AMT adjustment is illustrated in the following example:

Example: Z, a construction contractor, elected to use the cash method to report regular taxable income. Z had one contract totaling $1 million, with projected costs totaling $800,000 and estimated profit totaling $200,000. During year 1, Z incurred $400,000 in construction costs (50% completion, based on total projected costs) and recognized $500,000 (50% of the contract price) in revenue using the percentage-of-completion method. Z billed its client $500,000 and received $400,000 at the end of year 1. Z paid off $400,000 in construction costs by the end of year 1. Accordingly, Z had zero regular taxable income for year 1 (collection totaling $400,000, less disbursements totaling $400,000).

However, Z must make a positive AMT adjustment for the difference between its regular taxable income, which is zero, and AMTI based on the percentage-of-completion method, which is $100,000 ($500,000 minus $400,000) for the long-term contract. The contract was completed in year 2, and Z billed the remaining $500,000 on the contract, collected $600,000 (including accounts receivable totaling $100,000 at the end of year 1), and paid off the other $400,000 in contract costs incurred in year 2. …

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