In Basic Engineering v. Commissioner, T.C
Memo 2017-26 (Feb. 1, 2017), the Tax Court ruled that an
engineering company was ineligible to use the completed contract
method and was liable for an accuracy-related penalty. The taxpayer
in that case entered into two contracts each of which required the
taxpayer to disassemble, transport, refurbish, assemble and
supervise the commissioning of an oil refinery. The taxpayer
accounted for the contracts using the completed contract
The IRS asserted that the taxpayer must use either the general
rules under the accrual method of accounting for revenue and
expenses or alternatively the percentage of completion method.
The Tax Court concluded that the contracts were long-term
contracts requiring the percentage of completion method under
Section 460 because the contracts were not complete by the end of
the year. The court analyzed various exceptions from applying the
percentage of completion method, but held that the taxpayer did not
meet any of them.
For example, the contracts did not meet the exception under
Section 460(f)(2) for a contract that does not involves the
manufacture of (a) any unique item not normally included in the
finished goods inventory of the taxpayer, or (b) any item which
normally requires more than 12 calendar months to complete.
Additionally, the court considered whether the exception of Section
460(e)(1)(B) applied. That exception requires, in part, that the
taxpayer estimates, at the time a construction contract is entered
into, that it will be completed within the two-year period
beginning on the contract commencement date (the two-year
The court concluded that it was not reasonable for the taxpayer
to estimate that the length of the contracts would allow either
exception to apply (regardless of whether the contracts were
manufacturing contracts subject to Section 460(f)(2) or
construction contracts potentially subject to Section
460(e)(1)(B)). As a result, the taxpayer was required to use the
percentage of completion method of accounting.
Finally, the court also sustained the accuracy related penalties
under Section 6662(b)(2) for a substantial understatement of income
tax, holding that the taxpayer did not act with reasonable cause
and in good faith when using the completing contract method of
accounting. Even though the taxpayer's returns were prepared
and signed by a CPA, the court said there was no evidence of
reliance by the taxpayer on the CPA with regard to advice on the
application of the long-term contract exception under Section
460(e), and, therefore, the taxpayer did not exercise ordinary
business care and prudence, as required under the regulations and
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One of the most publicized and long-awaited business provisions contained in the Omnibus Budget Reconciliation Act of 1993, P.L. 103-66, 107 Stat. 312 (1993) (the "1993 Act") was section 197 of the Internal Revenue Code of 1986 (the "Code"), which governs the tax treatment of acquired intangible assets. However, section 197 cannot be analyzed in isolation. Since it comes into play whenever there is an allocation of consideration to an amortizable section 197 intangible, a basic understanding of
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