In the construction industry, choosing how to recognize revenue is a strategic decision that goes far beyond bookkeeping. It influences everything from your cash flow and profitability to your ability to stay compliant with IRS guidelines. Two of the most common methods for revenue recognition in the construction world are the Completed Contract Method (CCM) and the Percentage of Completion Method (PCM). While each has its place, understanding the tax implications of both is essential for any construction business aiming for sustainable growth.
Understanding the Completed Contract Method
The Completed Contract Method, commonly known as CCM, allows a business to recognize revenue and expenses only when a contract has been fully completed. That means no taxable income is reported until the job is finished and delivered. This method is typically used by smaller contractors or businesses working on short-term projects, as it provides the advantage of deferring taxable income.
From a tax perspective, CCM is particularly beneficial when a contract spans multiple fiscal years. For example, if a project starts in November and finishes the following February, the revenue and associated expenses are not recorded in the books until the project is completed. This deferral often results in short-term tax savings by pushing the income into the next tax year, potentially allowing contractors to manage their tax liabilities more efficiently.
However, there are drawbacks. Delaying income recognition can distort a company’s financial performance in the interim. Stakeholders may see fluctuating profitability and inconsistent earnings. For companies seeking external financing or looking to maintain a stable financial image, this inconsistency may become problematic.
Understanding the Percentage of Completion Method
In contrast, the Percentage of Completion Method requires revenue and expenses to be recognized as work progresses on a project. Under PCM, a portion of the contract’s revenue is reported each year based on the project’s percentage of completion. This approach provides a more consistent and accurate picture of financial performance over time.
The IRS generally requires contractors with average annual gross receipts exceeding a certain threshold—$27 million as of 2022, with annual adjustments for inflation—to use PCM for long-term contracts. This is outlined under Internal Revenue Code Section 460. The rationale is that for large-scale, long-term projects, it’s more appropriate to match income and expenses to the work being performed, rather than waiting until a project is fully complete.
While PCM leads to earlier income recognition and thus earlier tax liabilities, it also supports better forecasting and financial planning. It provides a more accurate reflection of the company’s operations and aligns more closely with Generally Accepted Accounting Principles (GAAP). For construction businesses seeking investor confidence or long-term stability, PCM is often the preferred method.
IRS Requirements and Eligibility
The IRS imposes specific guidelines regarding which method a construction business can use. If your company exceeds the IRS threshold for gross receipts, you are generally required to use the Percentage of Completion Method for long-term contracts. However, certain types of contracts are exempt. Home construction contracts, for example, are often allowed to use the Completed Contract Method. Additionally, small contractors (those under the gross receipts threshold) may also qualify to use CCM.
Short-term contracts that begin and end within the same tax year are usually permitted to use the Completed Contract Method regardless of company size. These exceptions can be highly beneficial, but they require careful evaluation and documentation to ensure compliance. Mistakenly using the wrong method or failing to properly apply for IRS approval when switching methods can result in penalties, back taxes, and audits.
Comparing the Two Methods in Practice
To illustrate how these methods work in the real world, consider two examples. A residential renovation company that primarily handles smaller projects, each lasting only two or three months, would likely benefit from using the Completed Contract Method. Since all work is completed within the same fiscal year, revenue deferral can help smooth out income and reduce tax liabilities without complicating financial reporting.
On the other hand, a commercial construction firm managing large-scale developments or government contracts often falls under the IRS requirement to use the Percentage of Completion Method. These projects can span several years, and PCM allows for more accurate financial reporting during that time. Although taxes may be due before the project is completed, the benefit of predictable income and financial consistency outweighs the drawback of faster tax payments.
Strategic Factors to Consider
Several key factors should be considered when choosing between CCM and PCM. Project duration is a major determinant. If most of your contracts are completed in less than one year, CCM could be a favorable option. For long-term engagements, especially those lasting multiple years, PCM is often required and can offer more realistic financial projections.
Cash flow needs are another important consideration. The Completed Contract Method allows companies to defer tax liabilities, which can preserve capital for immediate operational needs. However, it may also result in large, lump-sum tax bills in the year a project is completed. This can create a sudden financial burden if not planned for adequately.
Compliance risks should also be weighed. Improper application of either method can draw unwanted attention from tax authorities. Working with a CPA experienced in construction accounting ensures that your reporting is accurate, timely, and audit-ready. It also allows for proactive tax planning based on the projects and contracts in your pipeline.
How MKS&H Helps Construction Companies Succeed
At MKS&H, we understand that revenue recognition is a strategic business choice. Our construction-focused CPAs work closely with clients to evaluate the size and scope of their contracts, assess IRS eligibility criteria, and determine which method aligns best with their financial goals.
We provide hands-on assistance with tax filings, financial forecasting, and compliance audits. Our experts can help you segment your contracts to apply different recognition methods where appropriate, allowing you to optimize your tax position. We also offer job costing and project management insights to support businesses using the Percentage of Completion Method, ensuring every aspect of your financial reporting is accurate and transparent.
When IRS regulations change or your company grows beyond the threshold for CCM, MKS&H is there to guide you through the transition. From preparing IRS Form 3115 to managing the accounting adjustments required, we offer full-service support to help your construction business remain in compliance and positioned for success.
Actionable Tips for Business Owners
To make the most of your accounting method, it’s important to take a proactive approach. Review your contracts annually and consult with your CPA to determine whether your revenue recognition strategy remains optimal. Keep detailed job cost records, especially if you are using or transitioning to PCM. Invest in project management and accounting tools that support accurate percentage tracking and financial forecasting.
Planning ahead for tax liabilities—whether they are deferred under CCM or paid incrementally under PCM—can prevent cash flow disruptions and allow you to budget effectively. Clear communication with your CPA ensures that any method changes are done properly and documented according to IRS standards.
Make MKS&H Be Your Partner Today!
Whether you’re a small contractor looking to reduce your tax burden or a large construction firm seeking consistency in financial reporting, choosing the right method is essential. MKS&H brings decades of experience working with construction companies just like yours. We offer customized tax planning, compliance support, and accounting strategies designed to fit the unique needs of your industry.
If you’re ready to improve your accounting practices and align your tax strategy with your business goals, contact us today. Our dedicated professionals are always on standby to offer a personalized consultation and show you how the right revenue recognition method can make a measurable difference in your bottom line.
About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by putting complex financial data into a truly meaningful context. But deeper than dollars and data, our focus is on developing an understanding of you, your culture, and your business goals. This approach enables our clients to achieve their greatest potential.
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