§ 460. Special rules for long-term contracts
(a)
Requirement that percentage of completion method be used
In the case of any long-term contract, the taxable income from such contract shall be determined under the percentage of completion method (as modified by subsection (b)).
(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 [1] 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
In the case of any long-term contract, the Secretary may prescribe a simplified procedure for allocation of costs to such contract in lieu of the method of allocation under subsection (c).
(B)
Look-back method not to apply to certain contracts
Paragraph (1)(B) shall not apply to any contract—
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—
(ii)
in determining overpayments and underpayments for purposes of applying paragraph (2)(B)—
(B)
Exceptions
(C)
Other definitions
For purposes of this paragraph—
(i)
Highest rate
The term “highest rate” means—
(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.
(iii)
Closely held pass-thru entity
The term “closely held pass-thru entity” means any pass-thru entity if, at any time during any taxable year for which there is income under the contract, 50 percent or more (by value) of the beneficial interests in such entity are held (directly or indirectly) by or for 5 or fewer persons. For purposes of the preceding sentence, rules similar to the constructive ownership rules of section
1563
(e) shall apply.
(5)
Election to use 10-percent method
(A)
General rule
In the case of any long-term contract with respect to which an election under this paragraph is in effect, the 10-percent method shall apply in determining the taxable income from such contract.
(B)
10-percent method
For purposes of this paragraph—
(C)
Election
An election under this paragraph shall apply to all long-term contracts of the taxpayer which are entered into during the taxable year in which the election is made or any subsequent taxable year.
(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—
(B)
De minimis discrepancies
Paragraph (1)(B) shall not apply in any case to which it would otherwise apply if—
(C)
Definitions
For purposes of this paragraph—
(i)
Contract year
The term “contract year” means any taxable year for which income is taken into account under the contract.
(D)
Contracts to which paragraph applies
This paragraph shall only apply if the taxpayer makes an election under this subparagraph. Unless revoked with the consent of the Secretary, such an election shall apply to all long-term contracts completed during the taxable year for which election is made or during any subsequent taxable year.
(7)
Adjusted overpayment rate
(A)
In general
The adjusted overpayment rate for any interest accrual period is the overpayment rate in effect under section
6621 for the calendar quarter in which such interest accrual period begins.
(B)
Interest accrual period
For purposes of subparagraph (A), the term “interest accrual period” means the period—
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
In the case of a long-term contract, all costs (including research and experimental costs) which directly benefit, or are incurred by reason of, the long-term contract activities of the taxpayer shall be allocated to such contract in the same manner as costs are allocated to extended period long-term contracts under section
451 and the regulations thereunder.
(2)
Costs identified under cost-plus and certain Federal contracts
In the case of a cost-plus long-term contract or a Federal long-term contract, any cost not allocated to such contract under paragraph (1) shall be allocated to such contract if such cost is identified by the taxpayer (or a related person), pursuant to the contract or Federal, State, or local law or regulation, as being attributable to such contract.
(3)
Allocation of production period interest to contract
(B)
Production period
In applying section
263A
(f) for purposes of subparagraph (A), the production period shall be the period—
(C)
Application of de minimis rule
In applying section
263A
(f) for purposes of subparagraph (A), paragraph (1)(B)(iii) of such section shall be applied on a contract-by-contract basis; except that, in the case of a taxpayer described in subparagraph (B)(i)(II) of this paragraph, paragraph (1)(B)(iii) of section
263A
(f) shall be applied on a property-by-property basis.
(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—
(6)
Special rule for allocation of bonus depreciation with respect to certain property
(A)
In general
Solely for purposes of determining the percentage of completion under subsection (b)(1)(A), the cost of qualified property shall be taken into account as a cost allocated to the contract as if subsection (k) of section
168 had not been enacted.
(d)
Federal long-term contract
For purposes of this section—
(e)
Exception for certain construction contracts
(1)
In general
Subsections (a), (b), and (c)(1) and (2) shall not apply to—
(B)
any other construction contract entered into by a taxpayer—
(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)
whose average annual gross receipts for the 3 taxable years preceding the taxable year in which such contract is entered into do not exceed $10,000,000.
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)
Determination of taxpayer’s gross receipts
For purposes of paragraph (1), the gross receipts of—
(A)
all trades or businesses (whether or not incorporated) which are under common control with the taxpayer (within the meaning of section
52
(b)),
for the 3 taxable years of such persons preceding the taxable year in which the contract described in paragraph (1) is entered into shall be included in the gross receipts of the taxpayer for the period described in paragraph (1)(B). The Secretary shall prescribe regulations which provide attribution rules that take into account, in addition to the persons and entities described in the preceding sentence, taxpayers who engage in construction contracts through partnerships, joint ventures, and corporations.
(3)
Controlled group of corporations
For purposes of this subsection, the term “controlled group of corporations” has the meaning given to such term by section
1563
(a), except that—
(A)
“more than 50 percent” shall be substituted for “at least 80 percent” each place it appears in section
1563
(a)(1), and
(B)
the determination shall be made without regard to subsections (a)(4) and (e)(3)(C) of section
1563.
(4)
Construction contract
For purposes of this subsection, the term “construction contract” means any contract for the building, construction, reconstruction, or rehabilitation of, or the installation of any integral component to, or improvements of, real property.
(5)
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—
(6)
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
The term “long-term contract” means any contract for the manufacture, building, installation, or construction of property if such contract is not completed within the taxable year in which such contract is entered into.
(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—
(g)
Contract commencement date
For purposes of this section, the term “contract commencement date” means, with respect to any contract, the first date on which any costs (other than bidding expenses or expenses incurred in connection with negotiating the contract) allocable to such contract are incurred.
(h)
Regulations
The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section, including regulations to prevent the use of related parties, pass-thru entities, intermediaries, options, or other similar arrangements to avoid the application of this section.
[1] So in original. Probably should be followed by a comma.