Construction Contractor Taxes and Accounting

*TAXATION OF CONSTRUCTION CONTRACTORS:

For construction costs you would report income and expense under either the Percentage-of-completion method or the Completed Contract method.
If you begin and complete a construction contract in the same tax year, you would report all income and expense on that year’s tax return. However if the construction period laps over two years, even if the total time is less than a year, you then use a different approach.

PERCENTAGE OF COMPLETION METHOD:
If you choose, or are required to use, the Percentage-of-completion method, you must calculate a percentage to be used in reporting income. The percent is determined by dividing the cost incurred during the year by the total estimated cost to be incurred for the entire contract. Suppose you had a contract to build something for $ 3 million. If you expect the total costs to be $2 million and have incurred $ 1 million in costs during the year, you would report half of the $ 3 million as income for the year. Your income would be $ 1.5 million and your expense would be the $ 1 million cost actually incurred and the profit would be $ 500,000 minus some overhead expense.

COMPLETED CONTRACT METHOD:
A small contractor can use the completed-contract method which seems less complicated. Under the completed contract method, you would report no income or expense until the contract was completed. You would report everything in the year it was completed.

PROGRESS PAYMENTS:
Generally a contractor receives progress payments based on percentage of completion regardless of how he reports his income. These payments would not be income. They would never exceed the total contract price, and would probably be less than the income reported if the percentage-of-completion method were used. If the completed contract method is used, any unused funds would be considered a loan from the buyer until the contract was completed.

A sole proprietor would usually use the completed contract method and have an accounting procedure that only listed income and related expense for each project, then report the completed project figures on his tax return. A corporation with either assets or gross receipts of $ 250,000 or more is requied to provide a balance sheet as well as an income statement, so double-entry accounting would be required. Some of the debits and credits that would be involved are shown below.

Accounting entries to record income and expense:
Percentage-of-Completion method

• Debit Construction in Progress and Credit Cash or Accounts payable to record costs.
• Debit Cash and credit 'Progress Billings' or some similar liability account to record progress payments received.
• Debit Construction in Progress and Credit Income for profits recognized.
  
• Debit 'Progress Payments' and credit 'Construction in Progress' when the contract is completed.

Completed-Contract Method:
The first two entries would be the same.
Upon completion, you would debit a Cost of Sales account and credit Construction in Progress and would Debit Progress Billings and Credit Income. If there were a final payment not included in progress billings, you would debit Cash and Credit the final payment to Income.

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IRS References

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This information is not intended to be advice to the recipient. In compliance with Treasury Department Circular 230, unless stated to the contrary, any Federal Tax advice contained in this Blog was not intended or written to be used and cannot be used for the purposes of avoiding penalties.