IRC Section 460 Long-term Method of Accounting, Partnership 10 million Trip Wire

 

Is a Partnership Required to file Form 3115, Application for Change in Accounting Method, and does 4 year Section 481(a) spread apply?

 

I. Fact Pattern:

 

  1. The company is a LLC taxed as a partnership; sales are comprised solely of commercial contracts (no residential jobs.)
  2. This year, 201X, in accordance with Section 460(e)(1)(B)(ii), the taxpayer must change their method of accounting for long-term contracts to PCM as they solidly tripped over the three year average $10 million gross receipts test in 201X-1.
  3. Their cash basis deferral at Dec 31, 201X-1 was $X million.  They would like to continue with cash basis for non-long-term contracts. The X million is the difference between taxable income and book, where book is full accrual PCM.
  4. Composition of $X million Deferral.  The taxpayer's X million deferral is on the cash basis method of accounting for all contracts, long-term and completed. This is a very important distinction because the bulk of the X million is NOT from long-term contracts, rather they are from completed contracts where revenue was deferred and expenses accelerated.  Thus, only an accrual election would capture those items.  In fact, only $XXX,000 of the $X million was attributable to a long-term contract.  Completed jobs are determined by the measurement of work in the ground, not with regard to method of accounting.  Thus, a job 95% complete in the ground, was not subject to Alternative Minimum Tax (AMT). [under Reg. Sec. 1.460-1(c)(3), a contract is completed at the earlier of when 95% of the costs have been incurred, or when the subject matter of the contract is finally completed and accepted.] Keep in mind that prior to 201X, PCM was only applied for AMT income, so the "in the ground" method of accounting has not been used for regular tax purposes.
  5. As a result, on an accrual PCM basis WITH full accrual method, as of Dec 31, 201X-1, $X.X million of the $X.0 million would have gone into 201X-1 and only XXXk would have been deferred to 201X.
  6. The taxpayer's overall accounting method is cash basis.  However, for AMT purposes where PCM was require, the Simplified Cost-to-Cost Method was elected (i.e. only direct costs used in PCM computations.) Also for AMT computation purposes, the cash basis method was used in the computation of AMT income on a PCM basis.

 

II. Conclusion Summary

 

Based upon the forgoing the following conclusions were reached:

  1. Per Chief counsel's office, no Form 3115 is required and the "cut-off" method (i.e. no Section 481(a) adjustment is permitted) is applied when adopting mandatory Section 460 PCM from an exempt-contract method.
  2. The adoption of Section 460 PCM strictly applies only to long-term contracts and the accrual method must be used on those long-term contracts. HOWEVER, the taxpayer may remain on simplified cost to cost method as long as it does not elect the 10% method  (i.e. no PCM income until 10% of costs are incurred.) In application to 12/31/201X-1, this mean that PCM would have ONLY applied XXXk of the X.0 million deferral. Thus, even if we were to take the position documented below that Section 481(a) adjustment applies, the 4 year spread would ONLY apply to the XXXk, NOT the remaining X.X million.
  3. The taxpayer could apply to change its over all method from cash to accrual. That is known to be an automatic election and would apply at 12/31/201X-1 to X.X million of the deferral. Further, it would be Section 481(a) qualified.  However, the taxpayer would loose its ability to defer on completed jobs at the end of each year, beginning with the year ending Dec 31, 201X.
  4. As for subsidiary transaction, decision to wait until after 201X's audit opinion is issued.

In your CPA firm's experience, what is the most material overlooked deduction in the estate, gift and trust income tax area

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