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Accounting Methods – Problems For Small Construction Businesses.

Issues that may cause problems for the owners of small construction businesses include: 1) The Accounting Methods Chosen, 2) The Capitalization of Indirect Costs to Long-Term Contracts, and 3) The classification of worker as Independent Contractor or Employee.

If you have an existing business or just starting one, it is important to understand and comply with the tax laws that affect your business. By recognizing the significance of these issues, small construction business owners can properly file their tax returns and avoid costly problems. Today we’ll discuss the accounting method issues.

Accounting Method Issues

You might be wondering what constitute accounting methods? Accounting methods are basically the set of rules use to determine when and how income and expenses are reported. It includes not only the overall method but also the accounting treatment of any material item.

Examples of accounting methods are cash receipts and disbursementsaccrual, and combinations of both methods. Whichever method is elected, it must clearly reflect income. If your business operates as a C corporation with gross receipts in excess of $5 million, you generally are required to use an accrual method of accounting. If an inventory method is required because merchandise (or materials) is an income producing factor in the business, generally, an accrual method must be used for purchases and sales.

An exception to the requirements to use an accrual method is allowed for most small businesses with “average annual gross receipts” of $10 million or less. Instead the cash method of accounting is permitted. A business whose principal activity is mining, manufacturing, wholesale trade, retail trade or information industries will generally be ineligible to use this exception.

The accounting of inventory items is simplified by revenue procedure allowing their cost to be deducted in the year the merchandise is sold or paid for, whichever is later. Generally, the percentage of completion method is required for long term contracts. A long-term contract is one that is still in process at the end of your taxable year. For example, if work on a contract to construct a building begins in September 2010, and ends in January 2011, and the contractor used the calendar tax year, the contract is a long-term contract.

Home construction contracts are not subject to the percentage-of-completion method. In addition, general construction contracts are not subject to the percentage of completion method if certain completion time and gross receipts tests are satisfied. For all these exempt construction contracts, a taxpayer may use an “exempt contract” method, which includes the percentage of completion method, the exempt-contract percentage-of-completion method, the completed contract method, or any other permissible method.

Whether a method is permissible depends on a number of factors, such as the type of business entity, business activity, level of gross receipts, and existence or absence or merchandise as an income-producing factors in the business.

User | 10/10/2017