26 USC 460 - Special rules for long-term contracts

U.S Code last checked for updates: Nov 23, 2024

§ 460.

Special rules for long-term contracts

(a)

Requirement that percentage of completion method be used

(b)

Percentage of completion method

(1)

Requirements of percentage of completion method

Except as provided in paragraph (3), in the case of any long-term contract with respect to which the percentage of completion method is used—

(A)

the percentage of completion shall be determined by comparing costs allocated to the contract under subsection (c) and incurred before the close of the taxable year with the estimated total contract costs, and

(B)

upon completion of the contract (or, with respect to any amount properly taken into account after completion of the contract, when such amount is so properly taken into account), the taxpayer shall pay (or shall be entitled to receive) interest computed under the look-back method of paragraph (2).

In the case of any long-term contract with respect to which the percentage of completion method is used, except for purposes of applying the look-back method of paragraph (2), any income under the contract (to the extent not previously includible in gross income) shall be included in gross income for the taxable year following the taxable year in which the contract was completed. For purposes of subtitle F (other than sections 6654 and 6655), any interest required to be paid by the taxpayer under subparagraph (B) shall be treated as an increase in the tax imposed by this chapter for the taxable year in which the contract is completed (or, in the case of interest payable with respect to any amount properly taken into account after completion of the contract, for the taxable year in which the amount is so properly taken into account).

(2)

Look-back method

The interest computed under the look-back method of this paragraph shall be determined by—

(A)

first, allocating income under the contract among taxable years before the year in which the contract is completed on the basis of the actual contract price and costs instead of the estimated contract price and costs,

(B)

second, determining (solely for purposes of computing such interest) the overpayment or underpayment of tax for each taxable year referred to in subparagraph (A) which would result solely from the application of subparagraph (A), and

(C)

then using the adjusted overpayment rate (as defined in paragraph (7)), compounded daily, on the overpayment or underpayment determined under subparagraph (B).

For purposes of the preceding sentence, any amount properly taken into account after completion of the contract shall be taken into account by discounting (using the Federal mid-term rate determined under section 1274(d) as of the time such amount was properly taken into account) such amount to its value as of the completion of the contract. The taxpayer may elect with respect to any contract to have the preceding sentence not apply to such contract.

(3)

Special rules

(A)

Simplified method of cost allocation

(B)

Look-back method not to apply to certain contracts

Paragraph (1)(B) shall not apply to any contract—

(i)

the gross price of which (as of the completion of the contract) does not exceed the lesser of—

(I)

$1,000,000, or

(II)

1 percent of the average annual gross receipts of the taxpayer for the 3 taxable years preceding the taxable year in which the contract was completed, and

(ii)

which is completed within 2 years of the contract commencement date.

For purposes of this subparagraph, rules similar to the rules of subsections (e)(2) and (f)(3) shall apply.

(4)

Simplified look-back method for pass-thru entities

(A)

In general

In the case of a pass-thru entity—

(i)

the look-back method of paragraph (2) shall be applied at the entity level,

(ii)

in determining overpayments and underpayments for purposes of applying paragraph (2)(B)—

(I)

any increase in the income under the contract for any taxable year by reason of the allocation under paragraph (2)(A) shall be treated as giving rise to an underpayment determined by applying the highest rate for such year to such increase, and

(II)

any decrease in such income for any taxable year by reason of such allocation shall be treated as giving rise to an overpayment determined by applying the highest rate for such year to such decrease, and

(iii)

any interest required to be paid by the taxpayer under paragraph (2) shall be paid by such entity (and any interest entitled to be received by the taxpayer under paragraph (2) shall be paid to such entity).

(B)

Exceptions

(i)

Closely held pass-thru entities

(ii)

Foreign contracts

(C)

Other definitions

For purposes of this paragraph—

(i)

Highest rate

The term “highest rate” means—

(I)

the highest rate of tax specified in section 11, or

(II)

if at all times during the year involved more than 50 percent of the interests in the entity are held by individuals directly or through 1 or more other pass-thru entities, the highest rate of tax specified in section 1.

(ii)

Pass-thru entity

The term “pass-thru entity” means any—

(I)

partnership,

(II)

S corporation, or

(III)

trust.

(iii)

Closely held pass-thru entity

(5)

Election to use 10-percent method

(A)

General rule

(B)

10-percent method

For purposes of this paragraph—

(i)

In general

(ii)

10-percent year

(C)

Election

(D)

Coordination with other provisions

(i)

Simplified method of cost allocation

(ii)

Look-back method

(6)

Election to have look-back method not apply in de minimis cases

(A)

Amounts taken into account after completion of contract

Paragraph (1)(B) shall not apply with respect to any taxable year (beginning after the taxable year in which the contract is completed) if—

(i)

the cumulative taxable income (or loss) under the contract as of the close of such taxable year, is within

(ii)

10 percent of the cumulative look-back taxable income (or loss) under the contract as of the close of the most recent taxable year to which paragraph (1)(B) applied (or would have applied but for subparagraph (B)).

(B)

De minimis discrepancies

Paragraph (1)(B) shall not apply in any case to which it would otherwise apply if—

(i)

the cumulative taxable income (or loss) under the contract as of the close of each prior contract year, is within

(ii)

10 percent of the cumulative look-back income (or loss) under the contract as of the close of such prior contract year.

(C)

Definitions

For purposes of this paragraph—

(i)

Contract year

(ii)

Look-back income or loss

(iii)

Discounting not applicable

(D)

Contracts to which paragraph applies

(7)

Adjusted overpayment rate

(A)

In general

(B)

Interest accrual period

For purposes of subparagraph (A), the term “interest accrual period” means the period—

(i)

beginning on the day after the return due date for any taxable year of the taxpayer, and

(ii)

ending on the return due date for the following taxable year.

For purposes of the preceding sentence, the term “return due date” means the date prescribed for filing the return of the tax imposed by this chapter (determined without regard to extensions).

(c)

Allocation of costs to contract

(1)

Direct and certain indirect costs

(2)

Costs identified under cost-plus and certain Federal contracts

(3)

Allocation of production period interest to contract

(A)

In general

(B)

Production period

In applying section 263A(f) for purposes of subparagraph (A), the production period shall be the period—

(i)

beginning on the later of—

(I)

the contract commencement date, or

(II)

in the case of a taxpayer who uses an accrual method with respect to long-term contracts, the date by which at least 5 percent of the total estimated costs (including design and planning costs) under the contract have been incurred, and

(ii)

ending on the contract completion date.

(C)

Application of de minimis rule

(4)

Certain costs not included

This subsection shall not apply to any—

(A)

independent research and development expenses,

(B)

expenses for unsuccessful bids and proposals, and

(C)

marketing, selling, and advertising expenses.

(5)

Independent research and development expenses

For purposes of paragraph (4), the term “independent research and development expenses” means any expenses incurred in the performance of research or development, except that such term shall not include—

(A)

any expenses which are directly attributable to a long-term contract in existence when such expenses are incurred, or

(B)

any expenses under an agreement to perform research or development.

(6)

Special rule for allocation of bonus depreciation with respect to certain property

(A)

In general

(B)

Qualified property

For purposes of this paragraph, the term “qualified property” means property described in section 168(k)(2) which—

(i)

has a recovery period of 7 years or less, and

(ii)

is placed in service before January 1, 2027 (January 1, 2028 in the case of property described in section 168(k)(2)(B)).

(d)

Federal long-term contract

For purposes of this section—

(1)

In general

The term “Federal long-term contract” means any long-term contract—

(A)

to which the United States (or any agency or instrumentality thereof) is a party, or

(B)

which is a subcontract under a contract described in subparagraph (A).

(2)

Special rules for certain taxable entities

(e)

Exception for certain construction contracts

(1)

In general

Subsections (a), (b), and (c)(1) and (2) shall not apply to—

(A)

any home construction contract, or

(B)

any other construction contract entered into by a taxpayer (other than a tax shelter prohibited from using the cash receipts and disbursements method of accounting under section 448(a)(3))—

(i)

who estimates (at the time such contract is entered into) that such contract will be completed within the 2-year period beginning on the contract commencement date of such contract, and

(ii)

who meets the gross receipts test of section 448(c) for the taxable year in which such contract is entered into.

In the case of a home construction contract with respect to which the requirements of clauses (i) and (ii) of subparagraph (B) are not met, section 263A shall apply notwithstanding subsection (c)(4) thereof.

(2)

Rules related to gross receipts test

(A)

Application of gross receipts test to individuals, etc.

(B)

Coordination with section 481

(3)

Construction contract

(4)

Special rule for residential construction contracts which are not home construction contracts

In the case of any residential construction contract which is not a home construction contract, subsection (a) (as in effect on the day before the date of the enactment of the Revenue Reconciliation Act of 1989) shall apply except that such subsection shall be applied—

(A)

by substituting “70 percent” for “90 percent” each place it appears, and

(B)

by substituting “30 percent” for “10 percent”.

(5)

Definitions relating to residential construction contracts

For purposes of this subsection—

(A)

Home construction contract

The term “home construction contract” means any construction contract if 80 percent or more of the estimated total contract costs (as of the close of the taxable year in which the contract was entered into) are reasonably expected to be attributable to activities referred to in paragraph (4) with respect to—

(i)

dwelling units (as defined in section 168(e)(2)(A)(ii)) contained in buildings containing 4 or fewer dwelling units (as so defined), and

(ii)

improvements to real property directly related to such dwelling units and located on the site of such dwelling units.

For purposes of clause (i), each townhouse or rowhouse shall be treated as a separate building.

(B)

Residential construction contract

The term “residential construction contract” means any contract which would be described in subparagraph (A) if clause (i) of such subparagraph reads as follows:

“(i)

dwelling units (as defined in section 168(e)(2)(A)(ii)), and”.

(f)

Long-term contract

For purposes of this section—

(1)

In general

(2)

Special rule for manufacturing contracts

A contract for the manufacture of property shall not be treated as a long-term contract unless such contract involves the manufacture of—

(A)

any unique item of a type which is not normally included in the finished goods inventory of the taxpayer, or

(B)

any item which normally requires more than 12 calendar months to complete (without regard to the period of the contract).

(3)

Aggregation, etc.

For purposes of this subsection, under regulations prescribed by the Secretary—

(A)

2 or more contracts which are interdependent (by reason of pricing or otherwise) may be treated as 1 contract, and

(B)

a contract which is properly treated as an aggregation of separate contracts may be so treated.

(g)

Contract commencement date

(h)

Regulations

(Added Pub. L. 99–514, title VIII, § 804(a), Oct. 22, 1986, 100 Stat. 2358; amended Pub. L. 100–203, title X, § 10203(a), Dec. 22, 1987, 101 Stat. 1330–394; Pub. L. 100–647, title I, § 1008(c)(1), (2), (4), title V, § 5041(a)–(b)(3), (c), (d), Nov. 10, 1988, 102 Stat. 3438, 3439, 3673, 3674; Pub. L. 101–239, title VII, §§ 7621(a)–(c), 7811(e), 7815(e)(1), Dec. 19, 1989, 103 Stat. 2375, 2376, 2408, 2419; Pub. L. 101–508, title XI, § 11812(b)(8), Nov. 5, 1990, 104 Stat. 1388–535; Pub. L. 104–188, title I, §§ 1702(h)(15), 1704(t)(28), Aug. 20, 1996, 110 Stat. 1874, 1888; Pub. L. 105–34, title XII, § 1211(a), (b), Aug. 5, 1997, 111 Stat. 998, 999; Pub. L. 111–240, title II, § 2023(a), Sept. 27, 2010, 124 Stat. 2559; Pub. L. 112–240, title III, § 331(b), Jan. 2, 2013, 126 Stat. 2336; Pub. L. 113–295, div. A, title I, § 125(b), Dec. 19, 2014, 128 Stat. 4016; Pub. L. 114–113, div. Q, title I, § 143(a)(2), (b)(6)(I), Dec. 18, 2015, 129 Stat. 3056, 3064; Pub. L. 115–97, title I, §§ 13102(d), 13201(b)(2)(A), Dec. 22, 2017, 131 Stat. 2104, 2107; Pub. L. 115–141, div. U, title IV, § 401(a)(116), Mar. 23, 2018, 132 Stat. 1189.)

cite as: 26 USC 460

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