The completed contract method is simple since you don’t have to recognize any profit until the contract is actually complete. There are some important details, but basically you get to wait until the contract is done before you pick up the income or loss. That’s an easy way to defer the income until the project is complete.
One of the keys is the definition of a completed contract. It is defined as a contract that is more than 95% complete. I guess once it gets to 95% complete they figure you have a pretty good handle on the situation and they don’t want you to leave it at 99% done for 3 years just so you can keep deferring the income.
Keep in mind the way you calculate the percentage complete is by looking at the costs. If 95% or more of the estimated costs have been incurred, then the contract is considered to be complete. Whether you have billed out 95% of the revenue yet isn’t a contributing factor.
One key consideration is the Alternative Minimum Tax (AMT). For AMT purposes, contracts are calculated on a percentage of completion method, so if you are using the completed contract method you will have an AMT adjustment. Sometimes this can reduce the benefits of using the completed contract method.
So who can even use this completed contracts method? Well anyone over $25M in average gross receipts must use percentage of completion method, so they are out. Generally starting out, companies will be cash basis and with the new tax bill in Dec 2017 the cash method was expanded for all taxpayers under $25M so with more using the cash method we will see less using the completed contract method. Choosing the right method for your business is critical and finding the right one will depend on your specific circumstances.
Chris Wittich, CPA