Accounting method changes continue to produce positive outcomes
August 17, 2020
Honkamp, P.C. has seen significant benefits for its clients from recent accounting method change strategies, and the construction segment team thought it would be beneficial to revisit this information for those who have not yet taken advantage of these opportunities. Honkamp Krueger sat down with Steve Campana, Honkamp partner and construction practice team leader, to talk further about accounting method changes and the benefits they have seen, and to share some ideas on the topic.
This Q&A was written in response to a previous article published for Honkamp, Changes in Accounting Methods Can Mean Big Savings for Contractors. To read this article, click here.
Q: With the accounting method changes implemented in 2018, clients and the firm have seen significant benefits in the form of tax deferrals and benefits. Can you walk us through what you're finding?
A (Steve): Well, the first point would be looking into the opportunity to report revenues on a different basis for income tax purposes than what is required for the preparation of your reviewed, audited or internal financial statements.
This includes both contractors whose average annual gross receipts (AAGR) are both under $26 million and over $26 million. The mechanics on how to make these changes are different (per IRS guidelines) between the over AAGR thresholds of $26 million; however, opportunities are there for both. We have seen many contractors who recognize revenue and profits on the percentage-of-completion method (PCM) basis for financial reporting purposes find that for certain types of contracts, this method is not required for income tax reporting. For example, if you expected to make $10,000 on a job and it's only 50% complete, you would recognize half of the expected revenues in the financial statement and half that profit of $5,000 in the financial statements. Depending on your process for classifying contracts and the nature of the contracts themselves, many cases offer an alternative method for recognizing revenues for tax reporting, which may significantly defer the timing of when this revenue needs to be reported on your tax returns.
The second point we'd like to make is as a practical matter, most contractors put all jobs on the work in process schedule (or substantially, all significant jobs go on the work in process schedule where revenues are recognized on the percentage of completion basis). However, alternative methods may be available for tax reporting and not all jobs are required to go on that schedule for tax purposes.
Some examples are pure time and material jobs, and short-duration contracts (one that was started and completed within the taxable year) which do not have to be reported for tax purposes on the PCM. This includes many service contracts which are eligible for alternative methods of accounting that often produce a significant deferral.
In addition, even if there is a job that's required for both book and tax to be reported on the PCM, there's an accounting method change in the way subcontractor retainage payables enter into the calculation of the percentage of completion on the job.
A more recent change is taking that same subcontractor retainage concept if your contracts contain pay-if-paid clauses. This can also produce a significant tax deferral.
To be clear, many of these strategies produce tax deferrals and they should not be confused with tax credits. Because you are reporting the income slower for tax purposes, you are delaying the payment of tax and making those funds available for working capital or other uses. As a practical matter in a growing business, the deferral, while not permanent, can remain for an indefinite period of time until you either shrink in size, exit or sell the business.
Q: What is the main point you would like the readers to take away from this?
A (Steve): The range of deferrals have been from $250,000 to over $2.5 million resulting in deferring the remittance of taxes of $100,000 to $1 million. Based on the magnitude of the potential benefits, we recommend that contractors sit down and discuss these options with their tax advisors to determine which strategies might be available to them and what might be beneficial to their situation. Each business situation may be different and you don't know how much money you could be retaining in the company until you've evaluated these opportunities.
For assistance and questions, contact your account manager or Steve Campana at 888-556-0123 or firstname.lastname@example.org.