The completed contract method (CCM) allows construction companies to delay tax payments for projects that are still underway, in order to mitigate unpredictable costs and ambiguous timelines. This method, along with the percentage completion method (PCM), give builders different revenue reporting options when dealing with the notorious cash flow issues in the industry. They can choose the methods that meet the nature and timeline of their projects, in order to pay taxes when it makes the most financial sense for their company.
We work with companies across the Architecture, Engineering, and Construction industry (AEC), from residential contractors remodeling neighborhoods to investors building new housing developments to the commercial builders developing Austin’s skyline. Construction companies vary with how they hire and staff construction accounting roles. Smaller general contractors may hire an internal accountant for bookkeeping. Medium contractors may outsource to a CPA firm. Large contractors may have a CFO or Controller who is also a licensed CPA. Regardless of how they handle day-to-day accounting, most construction companies lean on CPA firms like ours at some point, whether monthly or annually, for reporting, compliance, and tax strategy discussions. Here’s how we advise our construction clients on project revenue reporting methods.
How do you decide which revenue reporting method to use for construction projects?
How large is your construction company?
In order to use CCM, your construction company must be considered a “small taxpayer” in the eyes of the IRS. This is a company whose average annual gross receipts for the prior three tax years is less than $29 million. (Note: The gross receipts amount changes each year with inflation.)
What is the timeline of the construction project?
In order to use CCM, the project must be completed in less than two years, primarily because the IRS doesn’t want you to defer tax indefinitely. But if the project timeline, as noted in the contract, is less than two years, CCM can be used. We see CCM used most often on large residential or commercial construction projects that are built on undeveloped land. The length of time to develop the land, run the appropriate utility lines, gather all the necessary permits, and then actually erect the structures tends to be longer than one year.
Are costs predictable on the project?
Next, contractors should consider whether there is uncertainty around costs or payments. Since COVID-19, construction supply chains have been notoriously disrupted, causing ongoing material cost volatility. Estimating and reporting building costs throughout a project can be difficult, especially when change orders, weather delays, and other schedule impediments are considered. This is required for the percentage complete method (PCM), the alternative to CCM. So if reporting final costs before the project is complete will be difficult, CCM may be a better choice.
How do you prefer to pay taxes?
Finally, after considering the timeline of the project and the expected costs of the project, contractors should consider how they prefer to pay taxes on the project. CCM allows for one final tax payment after completion of the project. Is this preferable to PCM payments throughout the project? Let’s discuss the downsides further.
What are the downsides to CCM?
When taxes are delayed by using CCM, so is revenue recognition. This could impact the company’s financial statements positively or negatively, depending on the sum total of the projects on their statements. For example, if multiple projects are all completed at the same time, there may be a flurry of revenue recognized in that tax year and a large sum of taxes owed on any profit. This can make a construction company look unfavorable to banks when applying for loans since there isn’t a constant stream of income. Delaying tax payments can also be impacted by changes in tax policy. If tax rates are expected to go up, paying a percentage of taxes on a project sooner, via PCM, may be ideal. Ultimately it’s a financial decision, but also an emotional one. We have clients who prefer to be settled up with the IRS at all times, and use PCM for that reason alone.
It’s no secret that the construction industry is plagued with cash flow and payment problems. Strategic accounting and tax planning can ease some of those burdens for companies, especially through the Completed Contract Method. To mitigate long project timelines, uncertain costs, and inaccurate tax payments, construction companies who fit the above requirements can recognize profit and pay taxes on a project after it’s complete. Once the project is used for its intended purpose and at least 95% of the costs have been incurred, companies can better calculate their earnings and tax obligations, hopefully saving money throughout the process. Companies can maintain a conservative financial outlook until costs, payments, and profit are clear at the end of the project.
Want to better understand your construction company’s revenue reporting options? Schedule a call with us.
