For construction firms, percentage of completion accounting is often the default way to report revenue, but it is not the only option, and it is not always the best one for tax. The method you select affects when you recognize profit, how much tax you defer, and how your financial statements look to a surety or lender. This article compares the percentage-of-completion method (PCM) with the completed-contract method (CCM), explains the federal rules under IRC Section 460, and helps you think through the book and tax decision for a contracting business.
Quick answer: Percentage of completion accounting recognizes revenue and profit gradually as a long-term contract progresses, usually measured by costs incurred to date against total estimated costs. The completed-contract method defers all revenue and profit until the job is substantially finished. For federal income tax, IRC Section 460 requires most large contractors to use PCM, but a small contractor that meets the gross receipts test and expects to finish a contract within two years, along with qualifying home construction contracts, can use CCM or another permitted method. For book purposes under ASC 606, most construction contracts are recognized over time, which produces results similar to PCM.
How the Two Methods Work
The percentage-of-completion method ties revenue to the work performed during a period. The most common measure is the cost-to-cost approach: you divide costs incurred to date by the total estimated contract cost to get a completion percentage, then apply that percentage to the contract price to determine revenue earned. If a $2 million contract has incurred $500,000 of an estimated $1.6 million in costs, the job is roughly 31% complete, and you would recognize about $625,000 of revenue.
PCM smooths income across the life of a project and matches revenue with the costs that generate it. This is why it is preferred by sureties and banks: it shows steady performance rather than lumpy results, and it surfaces problems early through over- and under-billing schedules. The downside is that it relies on estimates, and an inaccurate total-cost estimate distorts the profit reported each period.
A related practical concern is the discipline PCM imposes on job-cost systems. To compute progress accurately, a contractor needs reliable cost coding, timely commitment tracking, and a process for updating estimates at completion as conditions change. Firms that invest in this infrastructure tend to bid more accurately and catch margin erosion before a project closes, so the accounting method doubles as a project-management feedback loop.
The completed-contract method takes the opposite approach. You accumulate all contract costs and billings on the balance sheet and recognize nothing on the income statement until the job is substantially complete. CCM is simpler and defers tax, since no taxable profit appears until completion. The tradeoff is volatile reported income and financial statements that can understate a company’s activity in any given year, which can frustrate lenders and bonding agents.
Determining when a contract is “substantially complete” matters under CCM, because that event triggers recognition of the entire accumulated profit. Common triggers include final acceptance by the customer or completion of all but minor punch-list items. A contractor that runs several large jobs to completion in the same year can see a sharp spike in taxable income, which is one reason CCM rewards careful timing of project starts and closeouts.
The IRC Section 460 Rules for Tax
For federal income tax, the starting point is the definition of a long-term contract. Under IRC Section 460, a long-term contract is any contract for the building, installation, construction, or manufacture of property that is not completed within the tax year in which it is entered into. A job that starts and finishes inside one tax year is not a long-term contract, so Section 460 does not govern it.
The general rule is strict: income from a long-term contract must be reported using the percentage-of-completion method. Congress designed this to prevent contractors from indefinitely deferring tax by stringing out completion. PCM under the tax rules uses the cost-to-cost method to measure progress and generally requires a look-back computation that trues up interest on the difference between estimated and actual profit once the contract closes.
Section 460 then carves out exceptions. The most important for contractors is the small contractor exception. A contract qualifies for relief from mandatory PCM if, at the time the contract is entered into, the contractor expects to complete it within the two-year period beginning on the commencement date, and the contractor meets the gross receipts test of Section 448(c) for the tax year the contract begins. A contractor that fits both conditions can use the completed-contract method or another permitted method instead of PCM.
The gross receipts test looks at the average annual gross receipts for the three prior tax years. The base figure of $25 million is adjusted for inflation. According to the IRS, the inflation-adjusted threshold is $30 million for tax years beginning in 2024 and $31 million for tax years beginning in 2025. A contractor whose three-year average stays at or below the applicable figure can qualify for the small contractor exception, assuming the two-year completion expectation is also met.
A second exception applies to home construction contracts. A home construction contract is one in which 80% or more of the estimated total contract costs are reasonably expected to be attributable to dwelling units in buildings containing four or fewer dwelling units, plus related on-site improvements. These contracts are exempt from the PCM requirement regardless of the contractor’s size or the expected duration, which is significant for residential builders and certain multifamily developers. The IRS describes the long-term contract framework and these exceptions in its practice unit on land developers and subcontractors.
These contracts should be distinguished from those that must apply the look-back. Exempt contracts, including qualifying small contractor and home construction contracts, can use CCM, the exempt-contract percentage-of-completion method, or another permissible method, and they are not subject to the look-back interest computation. Contracts that remain under the general PCM rule are.
The two-year completion expectation deserves emphasis because it is judged when the contract begins, not in hindsight. A contractor that reasonably expects to finish within two years can use an exempt method even if unforeseen delays push actual completion past that window. Documenting the basis for that expectation at the contract’s start protects the position if the timeline later slips.
Book Accounting Under ASC 606
The tax method is only half the picture. For financial reporting under U.S. GAAP, the relevant standard is ASC 606, which replaced the older ASC 605-35 construction-contract guidance. ASC 606 applies a single five-step revenue model to all industries, and it does not use the labels “percentage of completion” or “completed contract.”
Instead, ASC 606 asks whether a performance obligation is satisfied over time or at a point in time. Most construction contracts meet the criteria for recognition over time, because the customer controls the asset as it is built or the contractor has an enforceable right to payment for work completed to date. When revenue is recognized over time, the contractor measures progress using an input or output method. The cost-to-cost input method, the same mechanics as traditional PCM, remains common and acceptable.
ASC 606 also changes how certain items feed the progress calculation. Uninstalled materials, significant inefficiencies, and wasted materials can distort a pure cost-to-cost measure, so the standard may require adjustments to keep the percentage from overstating performance. Variable consideration, such as unpriced change orders and incentive payments, must be estimated and constrained, which can move recognized revenue away from a simple cost ratio.
The practical result is that a contractor can land in different places for book and tax. A small contractor might recognize revenue over time under ASC 606 for its financial statements, satisfying its surety and bank, while using the completed-contract method for tax to defer income. That divergence is legitimate, but it creates book-tax differences that must be tracked, and it usually requires a deferred tax liability for the income reported on the books ahead of the return. Firms that issue reviewed or audited financials should plan for how examiners will reconcile these differences during audit and assurance engagements.
Choosing a Method for Your Construction Business
The right combination depends on size, contract mix, cash flow goals, and reporting obligations. A contractor above the gross receipts threshold has little choice on tax: PCM is mandatory for non-exempt long-term contracts, and aligning the book method to over-time recognition keeps the two systems close and reduces deferred-tax complexity. For these firms, the planning focus shifts to accurate cost estimating and managing the look-back computation.
Smaller contractors and residential builders have more room to plan. If deferring tax is a priority and the work qualifies as exempt under Section 460, CCM can push taxable income into later years, which helps cash flow in a growth phase. The cost is income volatility and financial statements that may not satisfy a bonding company, so many small contractors deliberately keep PCM-style recognition for the books while electing CCM for tax.
Contract mix can complicate the picture further, because a single contractor may hold some contracts that qualify as exempt and others that do not. The Section 460 analysis is performed contract by contract, so a firm can apply PCM to non-exempt jobs while using an exempt method for qualifying small or home construction contracts in the same year. Tracking each contract’s classification keeps the return defensible and supports the look-back computation where it applies.
Method changes are not casual. Switching your tax method of accounting for long-term contracts generally requires filing Form 3115 and following the IRS procedures for an accounting method change, including any Section 481(a) adjustment. Because the gross receipts threshold is indexed for inflation, a growing contractor can cross the line from year to year, so the analysis should be revisited annually rather than set once and forgotten. Firms that serve the construction industry routinely model these scenarios before locking in a method.
The bottom line: treat the book method and the tax method as two separate decisions that should be coordinated, not assumed to match. Get the Section 460 eligibility analysis right first, then choose the book treatment that best serves your lenders and sureties while minimizing the friction of tracking book-tax differences.
Frequently Asked Questions
Is the percentage-of-completion method required for tax?
For most long-term construction contracts, yes. IRC Section 460 requires PCM for any contract not completed in the tax year it begins, unless an exception applies. The main exceptions are the small contractor exception, which requires meeting the Section 448(c) gross receipts test and expecting completion within two years, and the home construction contract exception for buildings with four or fewer dwelling units.
What is the gross receipts threshold for the small contractor exception?
The base figure is $25 million in average annual gross receipts over the three prior tax years, adjusted for inflation. The IRS inflation-adjusted amount is $30 million for tax years beginning in 2024 and $31 million for tax years beginning in 2025. A contractor at or below the applicable figure may qualify, provided the two-year completion expectation is also met.
Can I use different methods for book and tax?
Yes. ASC 606 governs financial statements and generally requires over-time recognition for construction contracts, while Section 460 governs the tax return. A qualifying small contractor can recognize revenue over time for the books and use the completed-contract method for tax. The difference creates a book-tax timing difference and typically a deferred tax liability that must be tracked.
Does the completed-contract method defer tax?
It can. CCM recognizes no taxable income until a contract is substantially complete, so profit on multi-year jobs is deferred to the year of completion. This benefits cash flow but produces uneven taxable income and can complicate financial reporting, which is why it is usually limited to smaller contractors and exempt contracts under Section 460.
