contract but not including any cost of selling or any return on capital.
13. Direct and indirect costs incurred by any service, administrative, or support function to the extent such costs are allocable to a long-term contract pursuant to Treas. Reg. section 1.451-3(d)(9).
14. Officers compensation paid for services performed on long-term contracts but not including any cost of selling.
15. Insurance costs, such as insurance on machinery and equipment used in the construction of the subject matter of a long-term contract.
16. Stock bonus, pension, profit-sharing or annuity plan contributions or other plans deferring the receipt of compensation, whether or not the plan qualifies under IRC section 401(a), and other employee benefit expenses paid or accrued on behalf of labor, to the extent such contributions or expenses are otherwise allowable as deductions.
17. Research and experimental expenses as described in IRC section 174 and the regulations directly attributable to a long-term contract in existence at the time the expenses are incurred, or any expenses incurred under an agreement to perform
research or experimentation.
18. Rework labor, scrap and spoilage to the extent incurred in the performance of a long-term contract.
19. Bidding expenses incurred in the solicitation of a long-term contract awarded to the taxpayer. Bidding expenses do not include any research and experimental expenses described in IRC section 174. The taxpayer shall defer all bidding
expenses paid or incurred in the solicitation of a long-term contract until the contract is awarded. If the contract is awarded to the taxpayer, the bidding
costs become part of the indirect costs assigned to the contract. If the contract is not awarded to the taxpayer, bidding costs become deductible in the taxable year the contract is awarded, or the taxable year the taxpayer is notified in writing that no contract will be awarded and the contract will not be re-bid, or in the taxable year that the taxpayer abandons its bid or proposal, whichever occurs first. Interest expense incurred in connection with long-term contracts generally must be allocated to long-term contracts in the same manner as in IRC section 263A(f) dealing with interest cost being allocated to property not produced under a long-term contract (IRC section 460(c)(3)).
Pension expense that represents past service costs is subject to the cost allocation rules under IRC section 460(c) and the uniform capitalization rules of IRC section 263A, for cost incurred after December 31, 1987, with respect to contracts entered into after February 28, 1986, (The Revenue Act of 1987).
Treas. Reg. section 1.451-3(d)(9) requires the allocation of administrative, service, or support costs to extended period long-term contracts, if a function or department of the taxpayer incurs costs that directly benefit or are incurred by reason of the extended period long-term contract activities of the taxpayer, the costs of such function or department are allocable to such extended period long-term contracts.
Extract
Treas. Reg. section 1.451-3(d)(9)
(vi) Illustration of types of activities with respect to
which these costs ordinarily are required to be allocated. Costs incurred by the
following types of functions or departments ordinarily are required to be allocated to extended period long-term contracts:
(A) The administration and coordination of manufacturing or construction projects (wherever performed in the business organization of the taxpayer);
(B) Personnel operations, including the cost of recruiting, hiring, relocating, assigning, and maintaining personnel records of employees whose labor cost is allocable to extended period long-term contracts;
(C) Purchasing operations, including purchasing materials and equipment, scheduling and coordinating delivery and return of materials and equipment to or from factories or jobsites, and expediting and follow-up;
(D) Materials handling and warehousing operations;
(E) Accounting and data services operations related to contract activities, including cost accounting, accounts payable, disbursements, billing, accounts receivable, and payroll;
(F) Data processing; (G) Security services; and
(H) Legal departments that provide legal services to contracts.
The regulations also provide illustrations of types of activities with respect to which costs ordinarily are not required to be allocated.
Treas. Reg. section 1.451-3(d)(6)(iii) -- provides that costs that are not required to be allocated to long-term contracts include:
1. Marketing, selling, and advertising expenses.
2. Bidding expenses incurred in the solicitation of contracts not awarded to the taxpayer.
3. Interest expense incurred that is not allocated to long-term contracts under IRC section 263A(f) rules dealing with production period interest.
4. General and administrative expenses (but not including any cost described above as administrative costs and direct and indirect costs incurred by any service,
administrative, or support function) and compensation paid to officers attributable to the performance of services that do not directly benefit or are not incurred for reason of any long-term contracts.
5. Research and experimental expenses as described in IRC section 174 and the regulations neither directly attributable to a long-term contract in existence at the time the expenses are incurred, nor any expenses incurred under an agreement to perform research or experimentation.
7. Depreciation, amortization, and cost recovery allowances on equipment and facilities that have been placed in service but are temporarily idle. An asset is not considered to be temporarily idle on nonworking days. An asset used in
construction is considered to be idle when it is not in route to or not located at a jobsite.
8. Income taxes attributable to income received from long-term contracts.
9. Contributions paid with respect to contracts entered into before March 1, 1986, under a pension or annuity plan under IRC sections 404 and 404A to the extent such contributions represent past service costs.
10. Costs attributable to strikes.
Extract
Treas. Reg. section 1.451-3(d)(9)(vii)
* * * Costs incurred by the following types of functions or
departments ordinarily are not required to be allocated to extended period long-term contracts:
(A) Functions or departments responsible for overall management of the taxpayer, or for setting overall policy for all of the taxpayer's activities or trades or businesses (such as, the board of directors (including their immediate staff), and the chief executive, financial, accounting and legal officers (including their immediate staffs) of the taxpayer, provided that no substantial part of the costs of such departments or functions directly benefit extended period long-term contracts);
(B) General business planning;
(C) Financial accounting (including the accounting services required to prepare consolidated reports, but not including any accounting for particular contracts);
(D) General financial planning (including general budgeting) and financial management (including bank relations and cash management);
(E) General economic analysis and forecasting; (F) Internal audit;
(G) Shareholder, public and industrial relations; (H) Tax department; and
(I) Other departments or functions that are not responsible for day-to-day operations but are instead responsible for setting policy and establishing procedures to be used by all of the taxpayer's activities or trades or businesses.
Independent Research and Development Costs
The Act of 1986 added IRC section 460(c)(4) which states that independent research and development (IR&D) cost are specifically excepted from the long-term contract costs allocation rules. IR&D costs are expenses incurred in the performance of research or development which are not directly attributable to a long-term contract in existence when incurred or any expense incurred under an agreement to perform research or development. Any costs that qualify as independent research and
development expenses under the Federal Acquisition Regulations System, 48 C.F.R. section 31.205-18 (1985) will be excepted from the long-term contract costs allocation rules.
Special Rules for Cost-Plus and Federal Long-Term Contracts
The '86 Act added special costing rules that apply only to cost-plus and federal long-term contracts. In addition to the costing rules under IRC section 460(c)(1) as noted above, the taxpayer must also allocate to the contract any cost that is identified by the taxpayer (or a related person) pursuant to the terms of the contract or pursuant to federal, state, or local laws and regulations (Notice 89-15, Q & A 39).
Example 3
General and administrative expenses identified pursuant to a cost-plus contract, or pursuant to a contract with a Federal agency in which costs are certified under Federal statute or regulations, must be capitalized, regardless of whether such costs may be treated as period costs under existing regulations.
COST TO COST EXAMPLE - WITH CHANGE ORDERS