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Industry tax guide

Government contractors tax and accounting

Tax and accounting that keeps contract costs auditable and credits defensible.

Government Contractors business environment

Government contractors work under cost rules, audits and contract types that shape their accounting as much as the tax code does. Direct labor, indirect pools and unallowable costs all need a clear trail.

That same discipline supports tax savings. Contracts that leave the contractor at risk can produce research credits, and energy-efficient designs for government buildings have supported the 179D deduction.

Compared with a general business

What makes taxes different for government contractors

Cost accounting rules beside tax rules

Federal contracts follow FAR cost principles and sometimes Cost Accounting Standards, which classify costs differently from the tax code.

Indirect rates and audits

Indirect cost rates are submitted and audited, and the records must reconcile to both the books and the tax return.

Funded research

Research paid for under a contract can be excluded from the research credit unless the contractor bears the risk and keeps rights.

Prevailing wage rules on federal contracts

Service Contract Act and Davis-Bacon prevailing wage and fringe requirements affect payroll reporting and benefit plan design.

The rules in detail

Tax rules for government contractors

Funded research and the R&D credit

Research performed under a government contract qualifies for the credit only if payment depends on success and the contractor keeps substantial rights to the results. Fixed-price contracts often pass; cost-plus contracts are usually funded research.

179D allocations from government owners

Designers of energy-efficient government buildings could receive the 179D deduction by allocation. It ends for buildings whose construction begins after June 30, 2026, but projects started by then can still be allocated when placed in service.

Unallowable costs are often still deductible

Costs that the Federal Acquisition Regulation makes unallowable under a contract, such as some entertainment or lobbying, follow their own tax rules. Many remain deductible for tax even though they cannot be billed to the government.

Planning moves

Ways to save tax in government contractors

  1. Separate funded and unfunded research

    Fixed-price and internally funded projects are reviewed for the research credit.

  2. Deduct costs that are unallowable under the contract

    Many costs that cannot be billed to the government remain deductible for tax.

  3. Collect 179D allocations on government buildings

    Designers of buildings that began construction by June 30, 2026 can still receive allocations.

  4. Use the cash method if eligible

    Smaller contractors can defer tax on receivables under the cash method.

  5. Design fringe benefits to meet wage rules

    Bona fide fringe benefit plans can satisfy prevailing wage requirements at a lower tax cost.

  6. Plan multi-state payroll

    Employees on contracts in several states are withheld and reported correctly from the first paycheck.

Working with OICPA

How we help

Service

Sort contracts for the research credit

We review each contract's payment terms and rights before counting its research.

R&D Tax Credit
Service

Payroll across contract sites

Withholding and payroll filings for employees working on contracts in several states.

Payroll Services
Service

Accounting run by our team

A monthly close and contract-level reporting run by our team.

Outsourced Accounting

Bookkeeping and reporting

The accounting behind the tax work

Align project accounting with contract requirements and involve a government-contract specialist where specific compliance standards apply.

The operating challenge

Direct labor, indirect expenses, subcontractor costs, and contract modifications need an audit trail that a general expense list cannot provide.

The records that matter

Contract terms, project budgets, timekeeping records, cost allocation policies, and invoice schedules give the review a practical starting point. We identify missing information before recommending changes.

What you can expect

  • A prioritized review of the industry-specific accounting issues above
  • A tailored reporting and document checklist based on your operating records
  • An agreed action plan connecting financial reporting, tax deadlines, and specialist coordination

Frequently asked questions

Do cost-plus contracts qualify for the R&D credit?

Usually not, because the government pays regardless of success, which makes the research funded. Fixed-price development work is more likely to qualify.

Is the 179D deduction still available to our design team?

For government buildings whose construction began on or before June 30, 2026, yes. The allocation is claimed for the year the building is placed in service.

Are FAR-unallowable costs deductible?

Often. Allowability under a contract and deductibility for tax are separate questions; we review each category.

Related articles

References

  1. 26 U.S. Code § 41: Credit for increasing research activitiesLegal Information Institute, Cornell Law School
  2. 26 U.S. Code § 179D: Energy efficient commercial buildings deductionLegal Information Institute, Cornell Law School
  3. About Form 6765, Credit for Increasing Research ActivitiesInternal Revenue Service

Rules reflect federal tax law as of November 2026.