Percentage of completion vs completed contract: which method does your contracting business use?

What is a long-term contract for tax purposes?

A long-term contract is a contract for building, installation, construction or manufacturing that is not completed in the tax year it was entered into. Jobs that begin and end in the same year are outside the rule, so most service calls and short remodels never reach it.

The definition is in IRC section 460(f). The date you sign matters, not the date you start work. A contract signed in November that finishes in February is long-term even if the crew only worked six weeks.

Electricians, plumbers, HVAC, roofers and general contractors all run into this when a job crosses December 31. If most of your work is quick turnaround, you may never have a long-term contract.

Which contractors can use the completed contract method?

Two groups: contractors on home construction contracts, and small contractors whose contract is expected to finish within two years of its start date, provided average gross receipts for the prior three years do not exceed the section 448(c) threshold.

The statute is IRC section 460(e)(1). The threshold was $25 million when the Tax Cuts and Jobs Act set it, and it adjusts for inflation each year. It is $31 million for 2025 (Rev. Proc. 2024-40) and $32 million for tax years beginning in 2026 (Rev. Proc. 2025-32, section 3.30).

Two details trip people up. First, the test looks at three prior years of average gross receipts, not this year's. Second, under section 448(c) related businesses are combined, so an owner with a contracting company and a separate equipment or real estate company needs to run the test on the group.

If you meet the exception, you can report income when the contract is complete. That defers tax on profit from a job that spans years. It also makes a year look better or worse than it really is, which matters when a lender reads your return.

What is a home construction contract?

It is a contract where at least 80 percent of the estimated total contract costs are for building, constructing, reconstructing or rehabilitating dwelling units in a building with four or fewer units, plus improvements to real property directly related to and located on the site.

That definition is in IRC section 460(e)(6)(A). It covers a custom home builder and a remodeler whose jobs are almost entirely residential. It does not cover a contractor who builds a four-unit property one month and an apartment complex the next, because the 80 percent test is applied contract by contract.

A home construction contract is exempt without a gross receipts limit or a two year cap. That is the main reason residential builders often stay on completed contract at any size.

How does percentage of completion work?

You report a share of the contract price each year equal to the share of total estimated cost you have incurred so far. This is the cost-to-cost method in IRC section 460(b)(1).

Here is a hypothetical example with round numbers. It is arithmetic for illustration, not a real job.

The overbilling line is why a work-in-progress, or WIP, schedule exists. It shows which jobs are billed ahead of earnings and which are behind. Underbilled jobs mean you have done work you have not collected for yet.

There is an optional 10 percent rule in section 460(b)(5). You can wait to start reporting a contract until at least 10 percent of estimated costs have been incurred.

Can the tax method differ from the financials your surety sees?

Yes. Tax returns can use completed contract while the financial statements given to a lender or surety use percentage of completion. The difference is a book to tax adjustment, and your CPA has to carry it.

Surety underwriters usually want to see over and under billings and estimated gross profit by job. A tax return that defers profit can make a profitable year look thin on paper. A WIP schedule fixes that without changing your tax method.

That is why our WIP plan, from $2,497 a month, includes a monthly percent-of-completion WIP schedule and over and under billing entries. Prices are on the contractor accounting page.

Can I change methods?

A change in accounting method generally needs IRS consent, requested on Form 3115 under IRC section 446(e). Do not switch just by filing differently one year.

Contractors often cross the gross receipts limit by growing, or lose the exception when a contract is expected to run beyond two years. When that happens, the method for new contracts changes. Plan for it before the year the limit is crossed, not after.

Also check your cash versus accrual method. Section 448(c) is the same test that governs whether many small businesses can use the cash method, so one gross receipts check tells you about both.

Next step

Bring your last two returns and a list of open jobs to a discovery call. We will tell you which method you are on, whether you are near the limit and what a monthly WIP schedule would look like. We work with contractors and trades nationwide. For related reading see our year end payroll and 1099 checklist, or book a free discovery call.