CCA 200507013: Custom manufacturing may require percentage of completion accounting

Plain-English summary

A manufacturer asked to use the completed contract method for part of its work, and the IRS had denied that accounting method change. In a follow-up memorandum, Chief Counsel observed that some customer-specific components could instead be produced under long-term manufacturing contracts. If the contracts meet the regulatory definition, section 460 requires the percentage of completion method rather than the manufacturer's overall accrual method. Counsel referred the matter to the field office for any appropriate action; the memorandum does not make a final finding that the contracts qualify.

Ruling snapshot

• Question: Could some customized manufacturing contracts be subject to percentage of completion accounting?
• Outcome: Advice: the field office should consider section 460 if the contracts meet the long-term manufacturing definition.
• Key authorities: IRC § 460; Treas. Reg. § 1.460-2(a).

Full text (IRS public release)

Office of Chief Counsel

Memorandum
Internal Revenue Service

Number: 200507013
Release Date: 2/18/05
CC:ITA:B04:ADHolliday
POSTN-158760-04

UILC: 460.05-00

date: November 10, 2004
to: Bruce Dickinson, PSP
Territory Manager, SB/SE
Compliance Area 5
Jacksonville, FL

from: Robert M. Brown
Associate Chief Counsel
(Income Tax & Accounting)

subject: ----------------------------------

LEGEND

X = --------------------------------------------------------------------------------------------
---------------------

Commodities = --------------------
Property = --------

FACTS

X manufactures and installs Commodities. X manufactures certain acoustical, seating, ceiling and other materials that are to be incorporated into the finished product. X purchases raw materials, e.g., lumber, fabric, and similar items and produces elements of its finished products that are installed in a customer’s Property as a Commodity.

X requested permission to change its accounting method of recognizing income and expenses for what it termed the construction portion of its hybrid contracts from an accrual method to the completed contract method, for the taxable year beginning ---------

POSTN-158760-04
2

----------------------. This office denied the taxpayer request for permission to make the requested change in accounting method.

However, the taxpayer indicates that its overall method of accounting is the accrual method and such method is being used to report income and expenses from what appear to be manufacturing activities.

LAW AND ANALYSIS

Section 460(a) of the Internal Revenue Code provides, in part, that in the case of any long-term contract, the taxable income from such contract shall be determined under the percentage of completion method (as described in § 460(b)).

Section 1.460-2(a) of the Income Tax Regulations provides that § 460 generally requires a taxpayer to determine income from a long-term manufacturing contract using the percentage-of-completion method (PCM). A contract not completed in the contracting year is a long-term manufacturing contract if it involves the manufacture of personal property that is (1) a unique item of a type that is not normally carried in the finished goods inventory of the taxpayer; or (2) an item that normally requires more than 12 calendar months to complete. See also § 460(f).

It appears that one of the products that X manufactures are components for Commodities that are specifically designed to the specifications of a particular customer. Thus, it appears that X may enter into long-term manufacturing contracts under § 1.460-2. If so, X would be required to report these contracts under the PCM rather an overall accrual method of accounting.

We refer this matter to you for any action you believe is appropriate.

This writing may contain privileged information. Any unauthorized disclosure of this writing may undermine our ability to protect the privileged information. If disclosure is determined to be necessary, please contact this office for our views.

Please call (202) 622-4920 if you have any further questions.

Attachments
Copy of ruling letter
Copy of administrative file