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Alternative
Minimum Tax (AMT) on Long-Term Contracts
Contractors Beware of the AMT's Impact on Tax Planning by William Brighenti, Certified Public Accountant, Certified QuickBooks ProAdvisor Accountants CPA Hartford, LLC: Construction Accountants of Hartford, Connecticut  Even
though your annual revenues are less than $10 million, entitling you to
report your long-term contract revenues on the completed-contract
method, you may be subject to the alternative minimum tax on your
long-term construction contracts. The alternative minimum tax is
precisely what the name implies: it is another tax established to
ensure that your company pays at least some taxes every year.
Since the completed-contract method allows you to defer all taxable
income on contracts incomplete as of the year-end, it was considered a
tax preference item in the Tax Reform Act of 1986 and included as a
component in the calculation of alternative minimum taxable
income. As long as your C corporation's average annual receipts do not surpass $5 million in your first year of operations and $7.5 million in every year thereafter, you do not have to worry about the AMT tax. But once your average annual receipts exceed $7.5 million, then your C corporation needs to compute the alternative minimum tax and determine its additional tax liability--if any--over and above its regular corporate tax. Although small C corporations are exempt from the alternative minimum tax, S corporations and partnerships are not. Even though they do not pay taxes, the AMT adjustments from long-term contracts pass through to the shareholders and partners, respectively, and would be reported on their individual tax returns. Sole member limited liability companies, sole proprietors, and individuals as shareholders and partners would report the AMT adjustment from long-term contracts on line 23 of Form 6251, Alternative Minimum Tax—Individuals, whereas C corporations would report it on line 2f on Form 4626, Alternative Minimum Tax—Corporations. To compute your AMT preference amount from long-term contracts, calculate taxable income on long-term contracts using the percentage-of-completion method as described in the Internal Revenue Code section 460(b), which requires that you determine each contract’s percentage of completion by comparing costs to-date to total estimated contract costs. Next compare the taxable income on all of your long-term contracts based on the percentage-of-completion method of accounting to the taxable income based on the completed-contract method of accounting (or whatever method used other than the percentage-of-completion method of accounting). If taxable income is greater under the percentage-of-completion method, enter the difference as a positive amount on the long-term contracts tax preference line of the AMT tax form; if taxable income is less under the percentage-of-completion method, enter the difference as a negative amount on that same line. A simple example of the use of the completed-contract method for tax reporting of long-term contracts will illustrate its impact on the alternative minimum tax as well as the total tax liability of the contractor. Assume a contractor has taxable income of $100,000 by using the completed-contract method for its long-term contracts. Now assume that if the construction company had used the percentage of completion method on its long-term contracts, it would have reported an additional $175,000 in taxable income. This additional amount of $175,000 is what the contractor would report on line 2f on Form 4626 for the tax preference from long-term contracts, as shown below.  As evident in lines 7 through 9, $40,000 of alternative minimum taxable income not exceeding $150,000 is exempt from taxation; however, the $40,000 exemption is phased out pro-rata over $160,000 above the $150,000 AMTI threshold. Here, since $125,000 exceeds the $150,000 limit for taking full advantage of the $40,000 exemption from the alternative minimum tax, phasing out 78.125% of the full exemption, only 21.875% of the $40,000 exemption, or $8,750, can be excluded from alternative minimum taxable income in our example. On line 12 is the "tentative minimum tax", derived by taking 20% of the alternative minimum taxable income after deducting any eligible exemption. At this point, the contractor would compare this tentative minimum tax (TMT) to the corporation's tax liability based on the regular tax rules, excluding the AMT calculation. Since TMT of $53,250 exceeds the contractor's regular tax liability of $22,250, the $31,000 excess is the construction company's alternative minimum tax, and would be added to the regular tax liability of $22,250, for a total tax liability of $53,250. This $31,000 also would be reported on Form 1120, Schedule J, line 3. As you can see, the alternative minimum tax can mitigate the tax benefits of the completed contract method, particularly if profits on long-term contracts are material and profits on other contracts are insignificant in comparison. In our simple example, the alternative minimum tax was 139.33% of our regular tax liability. Often contractors fail to include the alternative minimum tax on its long-term contracts in its estimates of taxes; however, to do so could be fatal in terms of arranging sufficient cash flow. Hopefully this article has presented sufficient evidence to persuade contractors and others that it is imperative to include the effects of the alternative minimum tax from long-term contracts in all tax planning before year-end, otherwise the construction company may be in for an unpleasant surprise upon the preparation of its tax return after the end of the year. This article is provided for informational purposes and is not intended to be construed as legal, accounting, or other professional advice. For further information, please consult appropriate professional advice from your attorney and certified public accountant. Have a tax, a QuickBooks, or an accounting question? Please feel free to submit it under "Comments" on our blog, Accounting, QuickBooks, and Taxes by William Brighenti, Certified Public Accountant, Accountants CPA Hartford, LLC. For information and assistance on any tax, QuickBooks, or accounting issue, please visit our website: Accountants CPA Hartford, LLC. If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. The above tax advice was written to support the promotion or marketing of the accounting practice of the publisher and any transaction described herein. The taxpayer recipients of this offering memorandum should seek tax advice based on their particular circumstances from an independent tax advisor. |
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