One of the positives that came out of The Tax Cuts and Job Act is the change in the small contractor’s exemption of Average Annual Gross Receipts (AAGR) test from $10,000,000 to $25,000,000. The small contractor exemption says a contractor with long-term contracts (contracts that span more than one tax period) that are not estimated to take longer than 24 months and are under $25,000,000, will not be required to use the percentage of completion method for Tax Reporting.
Other methods that may be used if the small contractor exemption is met are the Completed Contract Method and the Cash basis method.
Both are considered more favorable than the percentage of completion method because they defer paying taxes on income until the cash is received (cash basis taxpayer) or the job is completed (completed contract method).
The AAGR test is the average of the last three years of revenue taken from the last three tax returns, however it is not that simple.
There are several important items every contractor/taxpayer should consider regarding the AAGR test prior to tax planning:
Gross Receipts Test:
Gross Receipts are the total amount, as determined under the taxpayer’s method of accounting, derived from all of the taxpayer’s trades or business.
What Gross Receipts Get Included in a Taxpayer’s AAGR?:
Controlled group of corporations:
- The term used here as “controlled group of corporations” refers to any group of:
- Stock possessing at least 50% of the total combined voting power of all classes of stock entitled to vote or at least 50% of the total value of shares of all classes of stock of each of the corporations—except the common parent corporation—is owned (within the meaning of subsection (d)(1)) by one or more of the other corporations; and
- The common parent corporation owns (within the meaning of subsection (d)(1)) stock possessing at least 50% of the total combined voting power of all classes of stock entitled to vote or at least 50% of the total value of shares of all classes of stock of at least one of the other corporations, excluding, in computing such voting power or value, stock owned directly by such other corporations.
(2) Brother Sister Companies (two-part test):
- Effective Control Test:
- Five or fewer persons own more than 50% of the control attributes of the organization. (only ownership of each person is taken into account only to the extent that person’s ownership is identical with respect to each organization)
- Controlling Interest Test:
- The ownership of the same person meeting the effective control test is predetermined taking into account total ownership in each organization. For purposes of the controlling interest test, the five or fewer persons must own at least 80% of the total control attributes.
- Both tests must be met for brother sister group under common control.
(3) Ownership Between 5% and 50% (no common control):
(4) New Owners:
- The gross receipts of a single employer for the test period include the gross receipts of all group members that are members of the group as of the first day of the taxable year in issue, regardless of whether such persons were members of the group for any of the three preceding taxable years.
(5) Change of Ownership:
- The gross receipts of the single employer for the test period do not include the gross receipts of any member that was a group member for any or all of the three preceding taxable years, and is no longer a group member as of the first day of the taxable year in issue.
(6) The small contractor can take advantage of tax deferral strategy but make sure you are calculating your gross receipts correctly.