Ask most business owners about their method and you get one of two answers: cash or accrual. For a contractor running jobs that cross a year end, that is not the question that decides anything.
The question that decides your tax bill is how you recognise revenue on a contract that is not finished yet. Get that wrong and you can pay tax on profit you have not collected, on a job that has not closed, in a year when the cash is tied up in retainage.
Why a Contract Is Different From an Invoice
For most businesses, revenue happens at a moment. You deliver, you invoice, you recognise. Cash basis records it when the money lands, accrual when the invoice is raised, and the difference between the two is usually a few weeks.
A construction contract is not a moment. It is eighteen months of cost and progress and change orders, and somewhere in the middle a tax year ends. Something has to decide how much of that contract belongs to this year. That decision is your method, and on long-term contracts the tax code has firm views about it.
Percentage of Completion
Percentage of completion recognises revenue as you perform the work. The standard measure is cost-to-cost:
Cost-to-cost, in two steps
Costs incurred to date divided by total estimated costs gives percent complete.
Percent complete multiplied by the contract value gives revenue earned to date. Compare that against what you have billed, and the difference is your over or under billing.
Two things follow from that formula, and both matter more than the tax outcome.
First, the method is only as good as your estimate of total cost. If the estimate is stale, the percent complete is wrong, and so is the revenue. This is why job costing that reconciles to the field is not an administrative nicety on a contractor running percentage of completion. It is the input.
Second, this calculation is exactly what produces a work-in-progress schedule. A surety asking for a WIP schedule and the tax code asking for percentage of completion are asking for the same underlying arithmetic. Contractors often discover they need it twice, for two different readers, in the same quarter.
Completed Contract, and Who Can Actually Use It
Completed contract defers everything until the job is done. No revenue, no cost recognition, no tax, until closeout. For a contractor with jobs finishing in a later year, the deferral is real money.
It is also restricted. IRC 460 generally requires percentage of completion on long-term contracts, and completed contract survives through exceptions rather than as a free choice. The two that matter most are home construction contracts and a small contractor exception based on average annual gross receipts.
Do not rely on a threshold you remember. The gross receipts figure for the small contractor exception is indexed and has moved more than once in recent years. Whether you are under it this year is a question to confirm against the current figure, with your actual averaged receipts, not a number carried forward from the last time somebody looked.
There is a second trap in the exception, which is that growing through it is silent. A contractor who qualified comfortably three years ago and has had two good years may no longer qualify, and nothing announces that. It is discovered at filing, in the year it is already too late to plan around.
Look-Back Interest, the Part Nobody Warns You About
Percentage of completion runs on estimates, and estimates move. When the job finally closes, the actual outcome is compared against what you reported along the way. If the difference means tax was paid later than it should have been, interest is owed on it, calculated on Form 8697.
It runs both ways, so it can produce a refund as easily as a bill. It is not a penalty and it does not mean anything went wrong. But it is a line item contractors meet for the first time with no warning, usually in the year a large job closed, and it is easier to absorb when somebody told you it was coming.
Two Sets of Books Is Normal Here
A lot of contractors assume they have to pick one. In practice, a commercial contractor usually needs both views, because two different audiences want two different things.
- The tax return uses whichever method you are properly on, and may be cash for the parts of the business that are not long-term contracts.
- A surety, a lender and a GC prequalification packet expect accrual financials and a current work-in-progress schedule. A cash basis statement tells an underwriter almost nothing about a business whose value is sitting in open contracts.
Maintaining accrual books alongside the cash basis the return needs sounds like duplicated work and mostly is not. It is one set of job cost data presented two ways. What makes it painful is a chart of accounts built to produce a tax form rather than to report on jobs, which is a fixable structural problem rather than a permanent tax.
Changing Method Is a Filing, Not a Decision
If the method you are on is not the one you should be on, you do not simply start doing it differently next January. A change in method of accounting is made formally on Form 3115, and it carries a section 481(a) adjustment whose entire job is to stop income being counted twice or dropped in the year of the change.
Some changes are automatic and some require consent. It is very doable. What it is not is something to discover in March, because by then the year it would have applied to is closed.
Worth checking this year
- Which method your last return actually used, as opposed to which one you think you are on.
- Whether your averaged gross receipts still sit under the small contractor exception.
- Whether your contract mix has changed enough that the method chosen years ago no longer fits.
- Whether indirect costs are being handled correctly under IRC 263A.
- Whether a large job closing this year brings look-back with it.
This is the single largest tax lever in commercial construction and it is not a filing-season activity. We cover how it runs alongside the rest of the engagement on the construction tax page, and the reporting it produces on WIP and bonding capacity.
Nothing here is advice on your specific facts. Method eligibility turns on your receipts, your contract types and your entity, and the thresholds move. Confirm the current year figures before acting on any of it.
Frequently Asked Questions
What is the percentage of completion method?
Percentage of completion recognises revenue on a long-term contract as the work is performed rather than when the job finishes. The usual measure is cost-to-cost: costs incurred to date divided by total estimated costs gives percent complete, and that percentage applied to the contract value gives revenue earned to date. It is the method the tax code generally requires for long-term contracts, and it is also the method that produces a work-in-progress schedule a surety can read, which is why contractors often end up needing it for two separate reasons at once.
What is the completed contract method and can I use it?
Completed contract defers all revenue and cost recognition until the job is finished, which can defer tax significantly. Availability is limited. IRC 460 generally requires percentage of completion for long-term contracts, with exceptions including home construction contracts and a small contractor exception based on average annual gross receipts. That gross receipts threshold is indexed and changes, so confirm the current year figure rather than relying on a number you remember. Whether you qualify depends on your receipts, your contract mix and contract duration, and it is worth confirming rather than assuming.
Can I keep cash basis books and still bill on percentage of completion?
In practice many contractors need two views at once. Cash basis may be what the tax return uses, while accrual and a work-in-progress schedule are what a surety, a general contractor's prequalification packet and a lender expect to see. Maintaining accrual books alongside the cash basis your return needs is normal for a commercial contractor and is not duplicated effort so much as two different audiences reading the same underlying job data.
What is look-back interest?
When a long-term contract is reported under percentage of completion using estimates, the estimates are compared to actual results once the job closes. If the estimates shifted enough that tax was paid later than it should have been, interest is owed on the difference, computed on Form 8697. It runs in both directions, so it can produce a refund as well as a payment. It is a routine consequence of the method rather than a penalty, but it surprises contractors who have never seen it.
How do I change my accounting method?
You do not simply start doing it differently. A change in method of accounting is made formally on Form 3115, and it carries a section 481(a) adjustment that prevents income being counted twice or dropped in the year of the change. Some changes are automatic and some require consent. The important point is timing: this is a decision to make deliberately with a full year in view, not something to discover during filing season.
The Method Is a Decision, Not an Inheritance
Most contractors are on whatever method was set up when the business was small, and most have never revisited it. On long-term contracts the method decides when you pay tax on a job you have not finished, whether you owe look-back interest later, and how your financials read to a surety. It is worth deciding deliberately, with your actual contract mix in front of you.
About the Author
Tom Woolley, MBA
Tom Woolley is a fractional CFO who spent six years running job costing and logistics in construction before founding Today CFO. He works with commercial subcontractors and small general contractors on the reporting a GC and a surety actually read.
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