Internal Revenue Code (IRC) Section 460(b)(5) allows taxpayers to defer the gross profit on contracts under the percentage-of-completion method of accounting until 10% of the total estimated contract costs are incurred. As a result, taxpayers can defer the recognition of gross profit on contracts that are less than 10% complete at the end of their tax year.
If a taxpayer is not currently utilizing this accounting method, adoption is very easy. The Internal Revenue Service does not require taxpayers to file the Form 3115 to elect this method of accounting. A simple election attached to the taxpayer’s tax return is the only requirement.
If a taxpayer elects this method, it is important to note that the election applies to all contracts less than 10% complete for that tax year, and all tax years after the electing year. After electing this method, the taxpayer would be required to obtain permission from the Internal Revenue Service to change to another method. In addition, the election is unavailable if the taxpayer elected to use the simplified method for allocating costs under IRC Section 460(b)(3)(A).
Finally, in addition to the potential federal income tax deferral opportunity, taxpayers considering the election should also consider the potential state income tax savings that may be realized from the deferral.
If you have any questions regarding the utilization of the deferral opportunity on your tax return, do not hesitate to contact Mark A. Di Pietrantonio of our offices.
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