12.jpg

The Complete Payroll Blog

Your steady stream of news, insight and analysis into payroll, tax, human resources and more.

The cash method and accrual methods | Tax rules for construction contractors

Posted by Complete Payroll | Jul 13, 2017 7:58:00 AM

The cash method and accrual methods - Tax rules for construction contractors.png

The IRS has rules for just about everything , and construction contracts included. Anyone in the construction industry would do well to review IRS guidance and make sure they're in full compliance, and understand that they have choices in how they address the requirements.

Choosing an accounting method

Contractors must choose an accounting method for their business. The choice depends on three criteria, according to the IRS:

  1. The type of contracts they have.
  2. Their contracts' completion status at the end of their tax year.
  3. Their average annual gross receipts.

Contractors are not limited to one method. The IRS states that many companies use one method for long-term contracts and another for everything else. "long-term" contract is defined as any project started in one year and completed in another.

The cash method

One method that some construction contractors can use for all contracts is the cash method. 

A contractor using the cash method of accounting reports cash receipts as income when received and deducts expenses when paid. If an expense benefits the business for more than one tax year, it must be spread out over the period the benefit is received.

It's fairly straightforward, but businesses may not use the cash method "if your business is a corporation or a partnership with a C corporation as a partner, whose average annual gross receipts exceed $5 million," according to the IRS. 

And there's another limitation. Businesses may be prohibited from using the cash method if its merchandise purchases are substantial compared to its gross income. How are "merchandise" and "substantial" defined? It's best to discuss that with your tax professional.

Accrual methods

The IRS says if contractors can't use the cash method, they must choose an accrual method - and construction companies have several specialized accrual methods available, each with its own rules.

According to the IRS, "In general, all accrual methods attempt to match the expenses that relate to a specific contract to the income from that contract."

Accrual methods aren't as simple as the cash method. Here's some of the paperwork that must be completed before the business decides which accrual method to use...

  • Classify all construction contracts as either short term or long term.
  • Classify all long-term contracts as either home construction or general construction contracts.
  • Classify yourself as either a small or large contractor.

Large construction companies must use the percentage of completion method, while small companies have a choice of the PCM, standard accrual, exempt percentage of completion or completed contract method.

Click here to ask our tax department a question. 

Topics: Taxes, Labor law

Written by Complete Payroll

Loving life in Payroll Country!

Are you using our free resources?

We're constantly publishing free tools to help with payroll, HR and other administrative objectives.

Free Guide: Preparing for New York Paid Family Leave
The Timekeeping Savings Calculator

Subscribe to instant blog email notifications

General Disclaimer

The materials and information available at this website and included in this blog are for informational purposes only, are not intended for the purpose of providing legal advice, and may not be relied upon as legal advice.  The employees of Complete Payroll are not licensed attorneys. This information and all of the information contained on this website are provided pursuant to and in compliance with federal and state statutes. It does not encompass other regulations that may exist, including, but not limited to, local ordinances. Complete Payroll makes no representations as to the accuracy, completeness, currentness, suitability, or validity of the information on this website and does not adopt any information contained on this website as its own. All information is provided on an as-is basis.  Please consult an attorney to obtain advice with respect to any particular question or issue.