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Minimizing the Minimum Tax
The best way to minimize the effect of the alternative minimum tax is to reduce the percent complete reported on jobs in progress. The more the job is complete the more gross profit the percentage of completion method will recognize. Several techniques exist that taxpayers can utilize in minimizing their alternative minimum tax
• Evaluating the usage of materials on jobs in progress.
• Control subcontractor front loading.
• Explore the usage of the simplified cost method.
• Exercise the all-events test and economic performance.
• Re-evaluate the estimated costs to complete.
These strategies are explained in more detail below.
Evaluating the Usage of Material on Jobs in Progress
The accounting treatments for uninstalled materials on construction jobs are very different between generally accepted accounting principles and the tax law. Generally accepted accounting principles requires you to capitalize uninstalled materials that have been dedicated to the project as inventory.
The tax law requires that these uninstalled materials are to be included in the costs incurred to date. Under the percentage of completion formula, such inclusion of the uninstalled materials as costs incurred recognizes more income for the tax payer. This is a harsh tax treatment that may cause dollars and profits to be taxable before they are earned or become billable.
The focus of this issue is uninstalled materials; therefore, the objective would be for the contractor to avoid having uninstalled materials on the job site. As part of the tax advisor's planning tools, the professional should be stressing to the contractor to minimize material shipments prior to year-end.
Many times this problem occurs more from the suppliers' end of inventory management. Many suppliers are trying to move materials prior to the suppliers' year-end for their tax situations as well. If this be the case, the contractor may want to buy in bulk, but not charge the materials to a particular job. Instead, the contractor should inventory the stock and requisition the materials as they are needed.
Control Subcontractor Front Loading
The impact of material vendors as discussed above and subcontractors' billings affect a general contractor in very similar ways. Invoices billed to the contractor are included in costs incurred for that project, thereby recognizing the revenue through the percentage of completion formula. The control the general contractor must put into place is over the performance of the subcontractor.
Every contractor attempts to "front load" every contract they are awarded. Whether or not they are paid for their "front loading" efforts depends on the subcontractor management. To minimize the impact of revenue recognition for tax purposes, the contractor must "true up" the subcontractor's billings to the work performed. By disallowing certain completion percentages being billed by the subcontractor, the general contractor lowers the costs incurred and in turn reports less revenues earned on projects in progress.
Explore the Usage of the Simplified Cost Method
As mentioned previously, the implementation of the simplified cost method is not all that simple. However, it is a method that affects both the numerator and denominator in determining percentage of completion.
Usage of the simplified cost method is best utilized in the event the contractor has substantial indirect costs on the job. These costs may be incurred in the early stages of the contract at a time when the inflow of cash may not be as great. Due to the fact that indirect costs are not factored into the simplified cost method, the percentage of completion is minimized.
Exercise the All-Events Test and Economic Performance
As a more aggressive approach, one might consider arguing the treatment of retentions and materials under the all-events test and economic performance. For retentions, the contractor may consider reducing the treatment of retentions payable from costs incurred. The contractor's position would be that the retentions cannot be included because all the events have not occurred to fix the liability and the amount is not determinable. This position is supported with Revenue Ruling 69-314, 1969 C.B. 139 and in Shepherd Construction Co. v Commissioner, 51 T.C. 890.
The taxpayer may elect to treat economic performance for materials as being provided when the property is "accepted" under Reg. 1.461-4(d)(6)(iii). The key to upholding this position is for the contractor to take a reasonable position as to the time that acceptance of materials occurs with respect to an unpaid invoice. For example, it is unreasonable in most circumstances for the taxpayer to contend that acceptance of materials does not occur until the job is completed and accepted.
Re-Evaluate the Estimated Costs to Complete
The final strategy is one that may be the easiest to implement. The costs estimated to complete a contract has a direct effect in determining the percent complete. However, the contractor does not typically estimate the costs to complete as defined by the tax code.
Since the costs allocated for alternative minimum tax purposes are considered extended-period costs, the contractor will find that a substantial amount of its general and administrative expenses as defined by indirect costs must be allocated to the contracts. Therefore, if the indirect costs must be included in the costs incurred, one must add the estimated indirect costs to the estimated costs to complete. In most cases, this will result in a higher estimated cost to complete and in turn lower the project's percent complete.
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