To the detriment of contractors, on Sept. 15 the Internal Revenue Service (IRS) issued a directive telling its auditors to ignore its own proposed regulations regarding contractors’ use of the completed contracting method (CCM). The CCM, when applicable, enables contractors to report profits at the completion of a job when profits are known and all payments are likely to be received. The CCM is arguably the best method for tax reporting because estimates are not utilized and profits are generally received at that time.
The action modifies and supersedes a 2007 IRS directive requiring auditors to examine issues involving the use of the method. The IRS is specifically focused on site and utility contractors constructing common area improvements to residential developments. The directive impacts two main groups of contractors:
- small contractors with average revenues below $10 million that choose to use the CCM; and
- large contractors using the CCM for specific qualified jobs, such as work on home developments.
Industry Issue Resolution Program and Proposed Regulations
Associated Builders and Contractors (ABC) and the Construction Financial Management Association (CFMA) first worked together in 2005 to try to convince the IRS to reduce its focus on subcontractors. The IRS accepted the issue into its Industry Issue Resolution (IIR) program, and industry stakeholders met with the IRS during the next 18 months.
As a result of the IIR program, the IRS finally issued proposed regulations in mid-2008 that resolved ABC’s concerns for subcontractors, including whether certain contracts qualified as home construction contracts and therefore the use of the CCM was permissible. They also addressed whether the IRS would revert policy and follow definitions of common improvements that had been accepted since the late 1980s. The IRS even included in the proposed regulations certain provisions beneficial to the industry that stakeholders had not even pursued as part of the IIR program.
This appeared to be a big win for ABC and the industry.
Latest Directive Countermands Proposed Regulations On Sept. 15, the IRS issued a second directive superseding the 2007 directive telling IRS auditors to ignore the proposed regulations, which have yet to be finalized. This new directive specifically identifies two subcontractor scenarios as being permissible once the proposed regulations are finalized.
However, the proposed regulations state the new rules would not take effect until one year after the regulations are finalized. If the regulations are not finalized until 2010, then the new rules would not be effective until 2011.
ABC testified that contractors should be permitted to rely on the proposed regulations prior to finalization and that the changes at issue are merely the clarification of a definition. The IRS, on the other hand, states the changes at issue are an expansion of the CCM—not just a clarification—and therefore the delay is necessary.
The IRS intended to issue additional ancillary rules that would affect the use of the CCM.
Delay in Finalizing Regulations Ultimately, the delay in finalizing the regulations was due to higher priority issues, including national economic concerns and the need for the U.S. Department of Treasury to work out the details of stimulus programs. The directive states that any limitation on what agents should be reviewing during audits of contractors does not apply to the areas addressed by the proposed regulations. The end result: While proposed regulations await finalization, IRS auditors are told to pursue subcontractors according to the circumstances that the proposed regulations reflect as permissible. This is Big Brother at his worst.