Ryan Slenicka is a supervisor in the tax department at Corrigan Krause.
The Tax Cuts and Jobs Act of 2017 brought forth many changes to tax laws, including the elimination of the alternative minimum tax (AMT) for c-corporations beginning in 2018. However, AMT has not been eliminated for individuals. This post will focus on pass through entities where business income flows through and is taxed at the individual level, such as S-Corporations.
Long-Term Contracts and AMT
When reporting regular tax calculations, contractors that have average gross receipts under $25 million are able to account for their long-term contracts using the completed contract method (CCM) or another method like the cash or accrual methods. Otherwise, the percentage of completion method (PCM) must be used. For AMT purposes, PCM must be used to account for long-term contracts, however, home construction contracts are able to be accounted for using the CCM or the cash method under AMT.
Small contractors that use accounting methods other than PCM are required to recalculate their long-term contracts using PCM to determine AMTI. This allows contractors to use a more favorable method for regular tax reporting but must use PCM for AMT reporting. This also reduces the tax benefit of CCM but does not eliminate it, which is why contractors are willing to preform AMT calculations.
Effects of AMT on Contractors
To show the impact AMT can have on a contractor, I have created an example using the CCM for regular tax and PCM required by AMT.
XYZ Contracting, a hypothetical company, has one current long term contract for $1 million with $700,000 of projected costs leaving an estimated gross profit of $300,000.
As of 12/31/18, XYZ Contracting pays construction costs of $385,000 and bills and collects $400,000. Under the CCM, XYZ Contracting does not have any taxable income for regular tax purposes because it recognizes revenue it receives and the costs paid only when the contract is considered completed.
Under PCM, XYZ Contracting would recognize 55% of the contract as revenue because the contract is 55% complete ($385,000 costs incurred divided by the total estimated contract cost of $700,000).
The AMT effect in year one would be a positive adjustment of $165,000. This is the difference between regular taxable income of zero under the CCM and the $165,000 AMTI under the PCM at year-end.
In year two, we assume that XYZ Contracting completed its long-term contract. XYC Contracting paid the remaining construction costs of $315,000 and billed the remaining $600,000. Assuming no changes to estimates, XYZ Contracting AMTI is 45% which is the remainder of the contract. Their regular taxable income for year two is $300,000 which is the total contracts gross profit under the CCM.
In year one, XYZ Contracting had a positive AMT adjustment of $165,000 which they recognized as income for AMT purposes. In year two, XYZ Contracting will report a negative AMT adjustment of $165,000, which will be applied as a credit to their regular tax when their regular tax is higher than AMT.
The AMT credit cannot be carried back and cannot reduced regular tax below the current year’s minimum tax. The credit can only reduce regular tax to the point where AMT tax would equal regular tax. The balance of any unused credit will continue to carry forward.
For any additional questions about Alternative Minimum Tax or the example provided above, feel to reach out to Ryan.