26 U.S.C. § 460: Special rules for long-term contracts

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)). 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 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). first, 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, 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 then using the adjusted overpayment rate (as defined in paragraph (7)), compounded daily, on the overpayment or underpayment determined under subparagraph (B). 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). $1,000,000, or 1 percent of the average annual gross receipts of the taxpayer for the 3 taxable years preceding the taxable year in which the contract was completed, and which is completed within 2 years of the contract commencement date. the look-back method of paragraph (2) shall be applied at the entity level, any increase in the income under the contract for any taxable year by reason of the allocation under paragraph (2)(A) shall be treated as giving rise to an underpayment determined by applying the highest rate for such year to such increase, and any decrease in such income for any taxable year by reason of such allocation shall be treated as giving rise to an overpayment determined by applying the highest rate for such year to such decrease, and any interest required to be paid by the taxpayer under paragraph (2) shall be paid by such entity (and any interest entitled to be received by the taxpayer under paragraph (2) shall be paid to such entity). This paragraph shall not apply to any closely held pass-thru entity. This paragraph shall not apply to any contract unless substantially all of the income from such contract is from sources in the United States. the highest rate of tax specified in section 11, or 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. partnership, S corporation, or trust. 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. 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. The 10-percent method is the percentage of completion method, modified so that any item which would otherwise be taken into account in computing taxable income with respect to a contract for any taxable year before the 10-percent year is taken into account in the 10-percent year. The term “10-percent year” means the 1st taxable year as of the close of which at least 10 percent of the estimated total contract costs have been incurred. 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. This paragraph shall not apply to any taxpayer which uses a simplified procedure for allocation of costs under paragraph (3)(A). The 10-percent method shall be taken into account for purposes of applying the look-back method of paragraph (2) to any taxpayer making an election under this paragraph. the cumulative taxable income (or loss) under the contract as of the close of such taxable year, is within 10 percent of the cumulative look-back taxable income (or loss) under the contract as of the close of the most recent taxable year to which paragraph (1)(B) applied (or would have applied but for subparagraph (B)). the cumulative taxable income (or loss) under the contract as of the close of each prior contract year, is within 10 percent of the cumulative look-back income (or loss) under the contract as of the close of such prior contract year. The term “contract year” means any taxable year for which income is taken into account under the contract. The look-back income (or loss) is the amount which would be the taxable income (or loss) under the contract if the allocation method set forth in paragraph (2)(A) were used in determining taxable income. The amounts taken into account after the completion of the contract shall be determined without regard to any discounting under the 2nd sentence of paragraph (2). 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. 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. beginning on the day after the return due date for any taxable year of the taxpayer, and ending on the return due date for the following taxable year. 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. 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. Except as provided in subparagraphs (B) and (C), in the case of a long-term contract, interest costs shall be allocated to the contract in the same manner as interest costs are allocated to property produced by the taxpayer under section 263A(f). the contract commencement date, or in the case of a taxpayer who uses an accrual method with respect to long-term contracts, the date by which at least 5 percent of the total estimated costs (including design and planning costs) under the contract have been incurred, and ending on the contract completion date. 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. independent research and development expenses, expenses for unsuccessful bids and proposals, and marketing, selling, and advertising expenses. any expenses which are directly attributable to a long-term contract in existence when such expenses are incurred, or any expenses under an agreement to perform research or development. 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. For purposes of this paragraph, the term “qualified property” means property described in section 168(k)(2) which has a recovery period of 7 years or less. to which the United States (or any agency or instrumentality thereof) is a party, or which is a subcontract under a contract described in subparagraph (A). For purposes of paragraph (1), the rules of section 168(h)(2)(D) (relating to certain taxable entities not treated as instrumentalities) shall apply. any residential construction contract, or 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 who meets the gross receipts test of section 448(c) for the taxable year in which such contract is entered into. For purposes of paragraph (1)(B)(ii), in the case of any taxpayer which is not a corporation or a partnership, the gross receipts test of section 448(c) shall be applied in the same manner as if each trade or business of such taxpayer were a corporation or partnership. Any change in method of accounting made pursuant to paragraph (1)(B)(ii) shall be treated as initiated by the taxpayer and made with the consent of the Secretary. Such change shall be effected on a cut-off basis for all similarly classified contracts entered into on or after the year of change. 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. dwelling units (as defined in section 168(e)(2)(A)(ii)) contained in buildings containing 4 or fewer dwelling units (as so defined), and improvements to real property directly related to such dwelling units and located on the site of such dwelling units. dwelling units (as defined in section 168(e)(2)(A)(ii)), and”. 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. any unique item of a type which is not normally included in the finished goods inventory of the taxpayer, or any item which normally requires more than 12 calendar months to complete (without regard to the period of the contract). 2 or more contracts which are interdependent (by reason of pricing or otherwise) may be treated as 1 contract, and a contract which is properly treated as an aggregation of separate contracts may be so treated. 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. 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. Except as provided in paragraph (2), the amendments made by this section [amending this section] shall apply to contracts completed in taxable years ending after the date of the enactment of this Act [ Aug. 5, 1997 ]. The amendments made by subsection (b) [amending this section] shall apply for purposes of section 167(g) of the Internal Revenue Code of 1986 to property placed in service after September 13, 1995 .” Except as provided in paragraph (2), the amendments made by this section [amending this section] shall apply to contracts entered into on or after July 11, 1989 . The amendments made by this section shall not apply to any contract resulting from the acceptance of a bid made before July 11, 1989 . The preceding sentence shall apply only if the bid could not have been revoked or altered at any time on or after July 11, 1989 . The amendments made by this section shall not apply in the case of a qualified ship contract (as defined in section 10203(b)(2)(B) of the Revenue Act of 1987 [ Pub. L. 100–203 , set out below]).” Except as otherwise provided in this paragraph, the amendments made by subsections (a), (b), and (c) [amending this section and section 56 of this title ] shall apply to contracts entered into on or after June 21, 1988 . The amendments made by subsections (a), (b), and (c) shall not apply to any contract resulting from the acceptance of a bid made before June 21, 1988 . The preceding sentence shall apply only if the bid could not have been revoked or altered at any time on or after June 21, 1988 . The amendments made by subsections (a) and (b) [amending this section and section 56 of this title ] shall not apply in the case of a qualified ship contract (as defined in section 10203(b)(2)(B) of the Revenue Act of 1987 [ Pub. L. 100–203 , set out below]). The amendment made by subsection (d) [amending this section] shall apply as if included in the amendments made by section 804 of the Reform Act [ Pub. L. 99–514 ]; except that such amendment shall not apply to any contract completed in a taxable year ending before the date of the enactment of this Act [ Nov. 10, 1988 ], if the due date (determined with regard to extensions) for the return for such year is before such date of enactment.” Except as provided in paragraph (2), the amendments made by this section [amending this section] shall apply to contracts entered into after October 13, 1987 . The amendments made by this section shall not apply in the case of a qualified ship contract. such ships will not be constructed (directly or indirectly) for the Federal Government, and the taxpayer reasonably expects to complete such contract within 5 years of the contract commencement date (as defined in section 460(g) of the Internal Revenue Code of 1986).” The amendments made by this section [enacting this section] shall apply to any contract entered into after February 28, 1986 . any independent research and development expenses taken into account in determining the total contract price shall not be severable from the contract, and any independent research and development expenses shall not be treated as amounts chargeable to capital account. For purposes of subparagraph (A), the term ‘independent research and development expenses’ has the meaning given to such term by section 460(c)(5) of the Internal Revenue Code of 1986, as added by this section.” In the case of a qualified naval ship contract, the taxable income of such contract during the 5-taxable year period beginning with the taxable year in which the construction commencement date occurs shall be determined under a method identical to the method used in the case of a qualified ship contract (as defined in section 10203(b)(2)(B) of the Revenue Act of 1987 [ Pub. L. 100–203 , set out as an Effective Date of 1987 Amendment note above]). the amount of tax which would have been imposed during such period if this section had not been enacted, over the amount of tax so imposed during such period. The term ‘qualified naval ship contract’ means any contract or portion thereof that is for the construction in the United States of 1 ship or submarine for the Federal Government if the taxpayer reasonably expects the acceptance date will occur no later than 9 years after the construction commencement date. The term ‘acceptance date’ means the date 1 year after the date on which the Federal Government issues a letter of acceptance or other similar document for the ship or submarine. The term ‘construction commencement date’ means the date on which the physical fabrication of any section or component of the ship or submarine begins in the taxpayer’s shipyard. Section 481 of the Internal Revenue Code of 1986 shall not apply with respect to any change in the method of accounting which is required by this section. This section shall apply to contracts for ships or submarines with respect to which the construction commencement date occurs after the date of the enactment of this Act [ Oct. 22, 2004 ].”