Percentage of Completion vs. Completed Contract: Which Method and When

A contract that starts in November and finishes in March forces a deceptively simple question: which year's tax return does that profit belong on? For contractors, the answer comes down to two accounting methods — percentage of completion and completed contract — and the difference between them can shift six figures of taxable income from one year into another. Here's how each works, who's allowed to use which, and how to think about the choice.

The Two Methods in Plain English

Percentage of completion recognizes revenue as the work gets done. If a job is 40% complete at year-end, you report roughly 40% of its revenue and profit this year, whether or not the job is finished or fully billed. Completed contract waits: no revenue and no profit hit the tax return until the year the job wraps up. Same job, same dollars — the only thing that changes is *when* the income shows up. And in tax, timing is money.

A Worked Example

Say you sign a $2M contract you expect to cost $1.6M — a projected $400K gross profit. At year-end you've incurred $800K of cost, so the job is 50% complete ($800K ÷ $1.6M). The figures are illustrative, but the mechanics are exact:

• Percentage of completion: you recognize 50% of the contract — $1M of revenue against $800K of cost — and pay tax on $200K of gross profit this year, with the rest recognized as the job finishes.
• Completed contract: you recognize nothing this year. The full $2M of revenue, $1.6M of cost, and $400K of profit land in the year of completion.

Multiply that across every job still open in December and you can see why the method question is one of the biggest tax-timing levers a contractor has.

Who's Required to Use Percentage of Completion

For tax purposes, IRC §460 makes percentage of completion the default — and for larger contractors, mandatory — on long-term contracts, meaning any contract not completed in the year it's signed. There are two big carve-outs:

• Home construction contracts — where 80% or more of costs relate to buildings with four or fewer dwelling units — are exempt from required percentage of completion regardless of company size.
• The small contractor exemption covers other construction contracts expected to finish within two years of starting, as long as your average annual gross receipts fall under the threshold in IRC §448(c) — originally $25M, indexed for inflation each year (confirm the current-year figure).

Contractors who qualify for an exemption can generally use their normal accounting method for those jobs — completed contract, cash, or accrual — which is where the planning opportunity lives. Most firms in the $1M–$10M range we work with qualify comfortably. The trap is growing past the threshold without noticing, because once you cross it, new long-term contracts have to switch to percentage of completion.

The Fine Print on Each Side

Percentage of completion has a true-up mechanism: because it runs on estimates, the IRS applies a look-back calculation when a contract closes, charging or refunding interest if the profit you reported along the way turns out to have been front-loaded or deferred by bad estimates. That's filed on Form 8697, and it's one more reason your cost estimates need to be real. Even mandatory percentage-of-completion users have a lever or two — §460 permits electing to defer a contract until it's at least 10% complete, for example.

Completed contract has its own catches. The deferral is temporary — the profit all arrives at once, sometimes stacking several jobs into one high-income year at higher marginal rates. And for some owners, the alternative minimum tax claws part of the benefit back, because AMT rules generally require percentage of completion on long-term contracts even when the regular tax doesn't. Deferral is a tool, not free money; it needs to be projected, not assumed.

Your Books and Your Tax Return Don't Have to Match

This surprises a lot of owners: the method on your tax return doesn't have to be the method in your financial statements. Sureties and banks want accrual, percentage-of-completion statements built on a monthly WIP schedule, because that's the honest picture of an open job's health. Plenty of well-run contractors keep exactly those books — and still use completed contract or cash on the tax return to defer income legally. Running both correctly is standard practice in construction accounting; the two just have to be reconciled, not identical.

How to Think About the Choice

• If you're under the threshold and want deferral, completed contract (or cash) on the return can push open-job profit into next year — powerful in a growth year, but watch the AMT and the pile-up effect.
• If your income is lumpy, percentage of completion smooths it, which can actually lower total tax by keeping you out of top brackets in spike years.
• If bonding matters, keep percentage-of-completion books regardless of your tax method — your surety doesn't read your tax return, it reads your WIP.
• If you're approaching the gross-receipts threshold, plan the transition before it's forced on you; the year you cross is a planning event, not a footnote.

The method decision sits inside the bigger picture we cover in our construction tax planning guide and construction accounting guide — accounting method, entity structure, and equipment timing work best when they're coordinated as one tax strategy instead of decided one at a time.

If you've never had the method conversation — or your revenue is closing in on the threshold and nobody has flagged it — that's exactly the kind of decision our advisory work exists for. Let's talk before year-end locks the answer in.