Many provisions of tax law are indexed for inflation and adjusted frequently. For example, the following are inflation indexed and adjusted when inflation requires an adjustment:
- Standard deduction
- Marginal tax rate schedule
- Annual gift exclusion
- Estate tax exclusion
The Internal Revenue Service (IRS) published Revenue Procedure 2022-38 on October 18, which includes inflation adjustments for many items for 2023:
- The annual gift exclusion of $17,000 is up from $16,000 in 2022
- The exclusion from the estate tax of $12.9 million is up from $12.06 million for 2022
Of particular interest to contractors is the increase in the threshold amount of the gross receipts test for § 448(c). This is the calculation of the average annual gross receipts for the use of the cash method, and the point at which a small contractor is required to begin using the percentage-of-completion method (PCM) for long-term contracts. That amount will be $29 million for 2023, which is a $2 million increase from 2022.
A contractor that has average annual gross receipts under the $27 million for 2022 can now have more room for growth while staying under the limitation for 2023. The calculation is based on three years prior.
For example, if the total gross receipts is under $81 million — an average of $27 million a year for 2020, 2021, and 2022 — a change to the PCM is not required for contracts entered into in 2023.
If the total gross receipts is under $87 million for 2021, 2022, and 2023, a change to the PCM is not required for contracts entered into in 2024.
The average annual gross receipts is expressed in terms of the three-year average, but the individual years are very important to the calculation. For example, if a contractor had a very high 2020 and a very low 2021, the 2022 calculation may be significantly different when 2020 drops out of the 2023 calculation. Then, once 2023 is included for the 2024 calculation, this could cause a possible change to the PCM.
For example, say the three years for that contractor are $45 million, $10 million, $20 million — which add up to $75 million — are under the total of $87 million. When the first year of $45 million drops out for the next year’s calculation, in order to stay below the threshold, the third year can be as high as $57 million (to be at the $87 million total) and the $29 million average for 2021, 2022, and 2023.