As a construction contractor, choosing the right accounting method can significantly impact your cash flow, tax liability, and financial reporting. The rules vary based on contract size, duration, and recent legislative changes. If your average annual gross receipts exceed $31 million, you're generally required to use the Percentage of Completion Method (PCM). Smaller contractors may be eligible to use an exempt contract method for their long-term contracts, but understanding the nuances of each method is key to aligning your accounting practices with your business goals.
To help you navigate your options and take full advantage of the changes to residential contracts under the One Big Beautiful Bill Act (OBBBA), this guide outlines five key accounting methods available to contractors, how each one works, and what to consider when choosing the best fit for your business. Understanding these methods can help you optimize tax outcomes and strengthen financial performance.
1. Percentage of Completion Method
Who it applies to:
- Contractors with average annual gross receipts over $31 million
- Businesses engaged in long-term contracts
How it works:
- Income and expenses are recognized as the project progresses, using the following calculations:
- Percentage Complete = Actual Costs to Date ÷ Total Estimated Contract Cost
- Recognized Income = Estimated Gross Profit × Percentage Complete
Advantages:
- Aligns income with project progress for a more accurate reflection of taxable income
- Smooths income recognition over time, avoiding large swings as long as your estimates are accurate
Challenges:
- Requires detailed cost tracking
- Can accelerate income recognition before receipt of payment
Planning Opportunities:
- 10% Deferral Method: Delays income recognition until 10% of costs are incurred, improving cash flow early in a contract
- Percentage of Completion-Capitalized Cost Method (PCCM):
- Historically, a partial exemption existed for residential construction contracts where qualifying taxpayers could use PCCM
- PCCM allowed 70% of income to be recognized under PCM and 30% under an exempt method such as the Completed Contract Method (CCM) or cash
- Eligibility was based on projects involving buildings with more than four dwelling units, such as apartments
- See OBBBA’s expanded definition of residential contracts later in this guide
2. Completed Contract Method
Who it applies to:
- Previously limited to home construction contracts and small contractors under the gross receipts threshold
- Contracts expected to be completed within two years
- Land developers and subcontractors under IRC Section 460(e)
- Expanded under the OBBBA to include a broader range of residential construction contracts after July 4, 2025
How it works:
- Income and expenses are deferred until the contract is completed
Advantages:
- Maximizes tax deferral by postponing income recognition
- Offers flexibility in timing of income and expense
- Improves short-term cash flow – especially beneficial for growing contractors
Challenges:
- Not allowed for larger contractors
- May cause income spikes when multiple projects finish in the same year
- Less alignment with actual project progress
- May cause alternative minimum tax (AMT) exposure for pass-through entity owners
3. Cash Method
Who it applies to:
- Small contractors under the gross receipts threshold
How it works:
- Income is recognized when received; expenses are recognized when paid
Advantages:
- Typically defers taxable income compared to PCM, improving cash flow
Challenges:
- May distort financial results due to mismatched timing
4. Accrual Method
Who it applies to:
- Small contractors under the gross receipts threshold
How it works:
- Revenue is recognized when earned (billed), and expenses when incurred
Advantages:
- Matches income and expenses more accurately
- Allows retainage deferral in some cases
Challenges:
- Overbilling inflates reported income
- Accelerates tax liability
- Accrual Less Retainage
Who it applies to:
- Small contractors under the gross receipts threshold
How it works:
- Revenue is recognized when earned, excluding retainage (withheld amounts) until received
- Costs are recognized when incurred, excluding retainage payable until paid
Advantages:
- Defers taxable income from unpaid retainage
- Reflects economic reality more accurately
Challenges:
- Requires precise tracking of retainage terms
- May complicate revenue recognition
- Not applicable to all contract types
5. Strategic Opportunity for Contractors
If you work in residential construction, recent changes under the OBBBA present a valuable opportunity to improve cash flow and simplify tax reporting. Starting with contracts entered into in tax years beginning after July 4, 2025, qualifying contractors may use an exempt contract method, such as CCM or cash basis, instead of PCM or PCCM. This can significantly defer taxable income.
What’s new under the OBBBA?
- Home construction contract replaced with a broader residential contract exception
- The definition of residential contracts now includes multifamily projects, senior living, student housing, and more
- Small contractor exception expanded to contracts of three years or less
Steps to take advantage of this change:
- Evaluate whether your contracts qualify under the new exemption
- File Form 3115 to formally change your accounting method
- Apply the change on a cut-off basis (only to new contracts after the effective date)
- Note that no § 481(a) adjustment is required or permitted
For more information on how the OBBBA impacts contractors, read our related article.
We Can Help
Our Construction team specializes in selecting and implementing accounting methods and tax strategies tailored for contractors. We help businesses identify opportunities, navigate IRS rules and filing requirements, and align accounting practice with broader financial goals.
Let’s explore how your accounting method can support smarter tax planning and stronger financial performance. Contact us today.
The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.
