Percentage of Completion Method Tax Rules vs Completed Contract
The percentage of completion method tax rules decide when a commercial contractor pays tax on contract profit. Under Section 460, the answer can be "a little every year as the job progresses" or "all at once when the job is finished." On a multi-year project, that timing difference can move a large amount of taxable income from one year to another.
This post covers the Section 460 basics, who must use percentage of completion, who can use completed contract, and what each method means for cash flow and bonding.
What Counts as a Long-Term Contract
For tax purposes, a long-term contract is generally a contract to build, install, or construct property that is not completed in the tax year it was entered into. That covers most commercial work that crosses December 31: a school renovation, a warehouse shell, a hospital MEP package, or a parking structure.
If you sign a contract in November and finish in March, it is a long-term contract for tax purposes, even though the job lasts only five months. The question is whether it crosses a tax year, not how long it runs.
Percentage of Completion Method Tax Basics
Under the percentage of completion method (PCM), you recognize contract revenue each year based on how far along the job is. For tax purposes, progress is measured cost to cost: costs incurred to date divided by total estimated contract costs.
Who must use PCM
Contractors that do not meet the Section 448(c) gross receipts test generally must use PCM for long-term contracts. For 2026, the test is average annual gross receipts of $32,000,000 or less over the prior 3 tax years, with related businesses combined under the aggregation rules.
If your average is above that line, PCM is the default for your long-term construction contracts.
Example: PCM on a $10 million job
A general contractor signs a $10,000,000 contract with estimated total costs of $8,000,000, so expected gross profit is $2,000,000.
Year 1: costs incurred are $2,000,000. Progress is $2,000,000 divided by $8,000,000, or 25%. Revenue recognized is 25% of $10,000,000, which is $2,500,000. Gross profit for the year is $500,000.
Year 2: cumulative costs reach $8,000,000 and the job is done. Cumulative revenue is $10,000,000, so year 2 revenue is $7,500,000 and gross profit is $1,500,000.
Total gross profit is $2,000,000 either way. PCM decides how much lands in each year.
Retainage under PCM
Under PCM, revenue follows cost-to-cost progress, so retainage does not change the timing. Holding back 10% of each pay app does not delay recognizing that revenue for tax purposes.
Look-Back Interest
Because PCM uses estimates, the IRS wants to know if your estimates were off. After a PCM contract is completed, you generally must run the look-back calculation on Form 8697. It compares the income you reported using estimates with what you would have reported using actual final numbers.
If you underestimated profit in earlier years, you owe interest to the IRS. If you overestimated, the IRS owes interest to you. Certain small contracts are excepted, and a simplified marginal impact method is available in some cases. This is a separate filing that many contractors overlook.
The Completed Contract Method
Under the completed contract method (CCM), you recognize all revenue and costs from a contract in the year the contract is completed. Nothing is taxed while the job is in progress.
Using the same $10,000,000 example, CCM would put the entire $2,000,000 of gross profit into year 2. Year 1 would show no gross profit from that job.
Who can use CCM
CCM is generally available only for exempt contracts. For commercial contractors, the main exemption is the small contractor exception: the contractor meets the gross receipts test, and the contract is expected to be completed within 3 years. OBBBA expanded this from 2 years, effective for contracts entered into in tax years beginning after July 4, 2025.
Exempt contracts are not limited to CCM. They can also use accrual, cash, or other permissible methods, depending on the contractor's overall method. OBBBA also expanded a separate exemption for residential construction contracts, but that applies to residential work rather than the commercial projects this post covers.
PCM vs CCM at a Glance
| | Percentage of completion | Completed contract | |---|---|---| | When profit is taxed | As the job progresses | When the job is completed | | Who must or can use it | Required above the gross receipts test | Exempt contracts only | | Look-back interest | Generally yes (Form 8697) | No | | Effect of estimate changes | Spread across years | Only final numbers matter | | Cash flow fit | Tax paid earlier | Tax deferred to completion |
Choosing and Changing Methods
If you are eligible for exempt contract methods, the choice is a real planning decision. CCM can defer tax on profitable jobs, but it can also bunch income into a single year when several big projects close at once.
Changing a long-term contract method generally requires Form 3115, and many changes are automatic. Method decisions matter most when your gross receipts are moving across the $32,000,000 line in either direction. Plan for that before it happens, not after the return is due.
How This Connects to Your Bonding
Your surety relies on reviewed or audited financial statements prepared under GAAP (ASC 606), which typically measure progress on contracts over time. Those statements show your WIP schedule, overbillings, and underbillings.
The tax method does not have to match. An exempt contractor can use CCM for tax while its financial statements continue to show revenue as work is performed. That is normal, but it means two sets of numbers that your tax advisor and your financial statement preparer need to reconcile. The goal is to defer tax where it makes sense without creating confusion or weakness in the statements your surety uses.
Frequently Asked Questions
Do all contractors have to use the percentage of completion method for taxes?
No. Contractors above the gross receipts test ($32,000,000 for 2026) generally must use PCM for long-term contracts. Contractors under the test may use other methods for contracts expected to be completed within 3 years (2 years for contracts entered into in earlier tax years).
Is the completed contract method still allowed?
Yes, for exempt contracts. For commercial contractors, that usually means meeting the gross receipts test and expecting the contract to finish within 3 years.
What is Form 8697 used for?
Form 8697 reports look-back interest on contracts accounted for under PCM. It compares estimated profit with actual profit after completion and calculates interest owed to or by the IRS.
Talk to a Contractor Tax Specialist
Payless Taxes works with bonded commercial contractors from $5M to $50M in revenue nationwide. We review your contract methods with both your tax return and your surety financials in mind. Book a 30-minute call to see whether your current method still fits.
This article is general information, not tax or legal advice. Tax rules change and depend on your specific facts. Talk with a qualified tax professional before acting.
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