Under the completed-contract method (CCM), the primary issues with dates has generally been determining when a contract ends. However, other circumstances must be considered for long-term contracts reported under the percentage-of-completion method (PCM), as well as contracts required to be reported under the look-back method and where the 10% method is elected. Further, contractors should also be aware of circumstances in which a contract’s start date impacts the contractor’s tax reporting.

This article will review the rules and regulations associated with a contract’s start and end dates, which can significantly affect a contractor’s federal income taxes.

Start-of-Contract Considerations

“Contract commencement” is the date when a contractor first incurs any allocable contract costs, which includes such items as design and engineering costs, but does not include bidding or contract negotiated costs.¹

In certain situations, when a contract is “entered into” – that is, the date when both the customer and contractor are legally bound to perform under the contract, even if there are unsatisfied contractual conditions² – may also have a tax impact.

PCM & the Small Contractor Exception

The small contractor exception to the PCM entails a two-part requirement:

1. The $10 million average annual gross receipts threshold,³ and
2. A contract-by-contract determination.

So, the qualifying status of a small contractor alone doesn’t mean that all contracts will be excepted from PCM reporting.

For instance, IRC § 460(e)(1)(B) states that the required use of the PCM doesn’t apply to “any other construction contract entered into by a taxpayer who estimates (at the time such contract is entered into) that such contract will be completed within the two-year period beginning on the contract commencement date of such contract…”

Regardless of qualifying as a “small contractor,” each contract must be tested to ensure it qualifies under this two-year rule. If the work schedule exceeds two years, then that specific construction contract would not qualify. Theoretically, the taxpayer would have certain contracts with extended construction schedules reported under the PCM, while other qualifying contracts would be reported under a more preferable method, such as the CCM.

The test estimates the contract length starting from when the contract is entered into. The regulations provide that the “taxpayer’s estimate of completion time will not be considered unreasonable if a contract is not completed within the estimated time primarily because of unforeseeable factors not within the taxpayer’s control, such as third-party litigation, extreme weather conditions, strikes, or delays in securing permits or licenses.”⁴

While the regulations indicate that a reasonable estimate should consider anticipated time for delays, rework, and change orders, not all factors can be reasonably estimated and known at the contract’s outset. Therefore, these unforeseeable factors that extend a contract’s actual completion beyond two years do not necessarily preclude the contract from qualifying for the exception to PCM reporting.