Small Contractor Exception Now Covers 3-Year Contracts
The small contractor exception just got bigger. Under the One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, contractors that meet the gross receipts test can now treat contracts expected to be completed within 3 years as exempt from the percentage of completion method. The old limit was 2 years.
For commercial contractors bidding hospitals, schools, distribution centers, and large tenant fit-outs, that extra year can bring a lot more work under exempt tax methods.
What the Small Contractor Exception Does
Section 460 generally requires long-term construction contracts to be accounted for under the percentage of completion method (PCM). That means paying tax on profit as the job progresses, followed by a look-back interest calculation on Form 8697 after completion.
The small contractor exception carves out certain contracts. An exempt contract can use the completed contract method, accrual, cash, or another permissible method instead of PCM. Exempt contracts also avoid the PCM look-back calculation.
Who Qualifies
Two conditions must both be met.
1. The contractor meets the gross receipts test
For 2026, that means average annual gross receipts of $32,000,000 or less over the prior 3 tax years. Related businesses under common control are generally combined, so an operating company and a sister equipment company may be tested together.
2. The contract is expected to be completed within 3 years
The test looks at what you reasonably expect when you enter into the contract. A project schedule, bid documents, and the owner's timeline all support that expectation. A job expected to take 30 months qualifies. A job expected to take 40 months does not.
The Effective Date
The 3-year rule applies to contracts entered into in tax years beginning after July 4, 2025. Here is what that means in practice:
Calendar-year contractor: the first tax year beginning after July 4, 2025 is the year starting January 1, 2026. Contracts signed on or after January 1, 2026 can use the 3-year rule.
Fiscal-year contractor whose year starts October 1: the tax year beginning October 1, 2025 starts after July 4, 2025, so contracts entered into on or after October 1, 2025 can use the 3-year rule.
Older contracts: contracts entered into in earlier tax years stay under the prior 2-year rule. The new rule does not reach back to existing contracts.
Keep the signed contract dates organized. They determine which rule applies to each job.
Example: One Project, Two Results
A $25,000,000 mechanical contractor meets the gross receipts test. It wins an $18,000,000 HVAC and plumbing package on a hospital expansion, with an expected duration of 30 months and an expected gross profit of $2,700,000.
Under the old 2-year rule: 30 months is over 2 years, so the contract is not exempt. The contractor would use PCM. If 40% of estimated costs are incurred in year 1, about 40% of the expected profit, or $1,080,000, is taxed that year ($2,700,000 times 40%).
Under the new 3-year rule: 30 months is within 3 years, so the contract is exempt. If the contractor uses the completed contract method, none of the $2,700,000 is taxed until the contract is completed.
The total profit is the same. What changes is timing, and on a multi-year job, timing affects cash flow for years.
Planning Points for Commercial Contractors
Document the expected duration at signing
Since the test is based on expectations at the start, save the baseline schedule, the owner's milestone dates, and your own estimate of duration with the contract file. If the job later runs long because of owner delays, your original expectation still matters.
Think about phased and multi-building work
Large owners often award work in phases or across several buildings. Whether that is one contract or several affects the duration test. A 48-month campus program awarded as one contract would not qualify, while separate phase contracts each expected to finish within 3 years might, subject to the tax rules on severing and aggregating related contracts. How contracts are structured and signed is a business decision first, but it is worth understanding the tax effect before you sign.
Review your method elections
A wider exemption is only useful if your accounting method takes advantage of it. If your company has been using PCM for all contracts, ask whether completed contract or another method fits your exempt jobs better. Changes generally require Form 3115, and many are automatic.
Do not assume deferral is always best
Deferring profit until completion can bunch income into a single year when several big jobs close together. Sometimes spreading income is better. Your tax advisor can model both paths using your backlog.
Watch the gross receipts trend
The exception depends on meeting the gross receipts test. If your company is growing toward $32,000,000 on a 3-year average, the exempt status of future contracts may change. Forecast the test before bidding your next large multi-year project.
A note on residential work
OBBBA also expanded a separate exemption to cover residential construction contracts. That rule applies to residential projects. For commercial contractors, the small contractor exception described here is the one that matters.
How This Connects to Your Bonding
Your surety relies on reviewed or audited financial statements prepared under GAAP, which generally recognize revenue as work is performed. That does not change because your tax method changes.
So if you move an exempt contract to completed contract for tax, your WIP schedule and financial statements still show progress, overbillings, and underbillings the usual way. That is acceptable and common. The key is keeping your tax and book numbers reconciled, and keeping enough cash available for the tax that will come due at completion.
Frequently Asked Questions
What is the small contractor exception?
It is an exemption from the percentage of completion requirement under Section 460. It applies when the contractor meets the gross receipts test ($32,000,000 for 2026) and the contract is expected to be completed within 3 years.
Does the 3-year rule apply to contracts I signed in 2025?
For a calendar-year contractor, no. The 3-year rule applies to contracts entered into in tax years beginning after July 4, 2025, which for calendar-year companies starts January 1, 2026.
If a job runs longer than 3 years, do I lose the exemption?
The test is based on what was reasonably expected when you entered into the contract. Documenting the expected schedule at signing is the best support if a job runs long.
Talk to a Contractor Tax Specialist
Payless Taxes works with bonded commercial contractors from $5M to $50M in revenue nationwide. We review your backlog, contract dates, and methods to see where the expanded exception can help. Book a 30-minute call to talk through your next multi-year bid.
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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