The American Job Builders Tax Reform Act of 2010 (H.R. 6097) is a bipartisan bill that was introduced in August 2010 that would be very beneficial to small contractors if passed into law. The bill makes a lot of sense for the several reasons. Before I go into those reasons, I will provide some background on revenue recognition for contractors under current law.
Under current tax law, a small contractor that has average annual gross receipts over the past three years of $10 million or greater must report their revenues and income on the percentage of completion method. This method requires contractors to estimate their income on open projects and pay taxes on the estimated income. For small contractors that average gross receipts below $10 million, current tax law allows them to report revenue and income on the completed contract method. Therefore, they do not have to report income until the job is complete (therefore, deferring income into the future) and the actual profit is known. The completed contract method has obvious tax advantages over the use of the percentage completion method.
Under the proposed tax law, the definition of a small contractor would change to average annual gross receipts less than $40 million. More contractors would therefore qualify to use the completed contract method. The current $10 million figure has not been adjusted since it first came into law in 1986. The proposed law would also allow for future inflation indexing on the gross sales requirement. The proposed law would allow more contractors to defer gross profit on open jobs until jobs are complete and the income is known.
An important part of the proposed bill is a provision that would provide Alternative Minimum Tax relief. Current law does not allow a small contractor to defer gross profit for AMT purposes, so most small contractors today do not ultimately benefit from the completed contract method. That would make the completed contract method a more beneficial tax reporting method, should the bill become law.
My hope is that this bill is passed as it would provide some tax relief to contractors during a period of rising energy, labor and material costs in addition to tightening margins that are the result of less work and more competition.
For more information contact the CPAs, business and financial advisors in our Real Estate & Construction Group at 440-449-6800.