A construction business can remain eligible for cash accounting and still have to report certain contracts under different tax rules. That distinction can have a substantial effect on when income is taxed—and how much cash the business needs to set aside.
This article comes from a real JAG construction-tax planning review. Identifying details and client dollar amounts are omitted. The work described involves method analysis and a modeled tax reconciliation; it is not a claim of a filed return, IRS acceptance, or realized tax savings. The numerical example below is entirely hypothetical.
Start with the business economics
Our aim is to keep taxable income as closely connected to the business’s economics and cash flow as the law permits. Owners need to understand both what the job earned and where the cash will come from to pay the tax.
Those amounts do not always move together. A job can earn profit before the customer pays. Customer cash can arrive before the related work is done. Payroll and supplier payments can fall in a different period again.
Tax rules sometimes require income before the corresponding cash arrives. They also permit certain timing deferrals. The planning work is to identify what is required, use the available choices correctly, and show when deferred amounts return to taxable income.
Cash-method taxable income is not the bank balance. Borrowing ordinarily supplies cash without operating income; repaying loan principal uses cash without an operating deduction. Equipment purchases and other capital expenditures follow their own recovery rules. These differences have to appear in the cash plan. IRS Publication 538
The first question: did the entire business have to switch to accrual?
The business prepared financial statements using percentage-of-completion reporting, often called PCM. Its tax reporting had used an overall cash method. Growth raised a concern: had the business reached the point where it had to abandon cash accounting entirely?
The answer required two separate tests.
The first was the business’s eligibility for an overall cash method. Entity classification, ownership, tax-shelter rules, inventory and other applicable requirements matter. Crossing a gross-receipts threshold does not, by itself, force every partnership to use overall accrual. Treasury Regulation §1.448-2
The second was the method required for long-term construction contracts. For a calendar-year 2025 contractor, the small-contractor test uses a $31 million average of the preceding three years’ gross receipts, with aggregation and other applicable rules. It also requires an expected completion period of no more than two years. Section 460 can require PCM for affected contracts even when overall cash remains permissible. Financial-statement PCM does not settle the tax answer. Rev. Proc. 2024-40, §2.31, Treasury Regulation §1.460-3
Our working conclusion was that the Section 460 threshold alone did not require a switch to overall accrual. Retaining cash for eligible activity while applying the proper special methods to particular contracts remained the planning framework. Final selection still required the separate eligibility, prior-method and return checks.
Why “just file everything on cash” was not the answer
For an affected long-term contract, PCM generally recognizes revenue based on progress, along with the associated tax-allocable costs. Collections alone do not determine that contract’s taxable profit.
We therefore had to identify which contracts actually belonged in that group. The important facts included when each agreement became binding, whether it crossed the tax year, its completion status, the applicable contracting-year receipts test, and any exemption. A first threshold failure does not automatically move every older job into the new year’s treatment. Existing contract methods and history still matter. Treasury Regulation §1.460-1, §1.460-3
In this review, the client went through the contracts and related change orders to confirm the residential classifications. That resolved a factual question. It did not replace the CPA’s separate determination of which tax methods and elections were available.
We built the answer in three connected steps
The starting point was the accrual financial-statement income. From there, the reconciliation needed to:
- Apply the ordinary accrual-to-cash adjustments. Reconcile receivables, payables, contract assets, contract liabilities and other timing accounts.
- Replace the cash result for contracts subject to a special method. Remove those contracts’ cash-method profit and substitute their required tax-method profit. Do not simply add PCM revenue while leaving the same cash receipts or costs counted again.
- Apply the permitted contract deferrals. Reflect qualifying residential treatment and any available 10% election consistently, with income and related costs moving together.
This is why a work-in-progress total alone cannot finish the return. Contract receivables, payables, collections, costs and amounts already recognized have to agree with the tax bridge. We also explain the underlying construction job reporting and cash-flow distinctions.
The residential review could change the timing
For the calendar-year 2025 contracts considered here, qualifying larger residential contracts could use the pre-2026 percentage-of-completion/capitalized-cost method, or PCCM: 70% PCM and 30% under a permissible exempt method. When that 30% portion properly uses completed-contract treatment and the contract remains incomplete, both its income and costs are deferred.
Qualifying home-construction contracts have a separate exemption. A residential label is not enough: the 80% estimated-contract-cost test and the dwelling-unit rules have to be satisfied. Nor does exemption automatically select completed-contract treatment; existing methods, consistency and capitalization still need review. Treasury Regulation §1.460-3
A separate 10% election can defer PCM income and associated costs while a qualifying job is below 10% of estimated allocable costs. At exactly 10%, recognition starts. It cannot defer revenue while deducting the related costs, or be applied only to favorable jobs. Neither the 10% election nor PCCM can use the simplified cost-to-cost method. Treasury Regulation §1.460-4(b)(6), §1.460-5(c) and (e)
Here is one invented example, unrelated to the client’s figures. Assume an incomplete, qualifying 2025 residential contract has $1,000,000 of tax PCM revenue and $700,000 of associated tax costs. Its PCM profit is $300,000. If the available method is 70% PCM/30% completed contract, the current profit becomes $210,000 and $90,000 moves to a later year. The revenue deferral is $300,000, but the related $210,000 cost deduction is also deferred. The net reduction is $90,000—not $300,000.
If the exempt 30% instead uses cash, the comparison is 30% × (PCM profit − cash-method profit) for that contract—not automatically 30% of PCM profit. This can reduce or eliminate the expected deferral.
The invented example illustrates an income timing deferral, not a $90,000 tax saving. For 2025, non-home residential contracts generally use full PCM for alternative minimum tax, retaining an applicable 10% election. The owner’s actual tax benefit can therefore be smaller. Rates, timing and later-year circumstances also matter. Treasury Regulation §1.460-4(f)
Why we also considered overall accrual
Cash accounting does not always produce the lower taxable income. Collecting older receivables or receiving advance payments can push cash-method income above book income. A book label such as “billings in excess” does not establish whether the underlying amount is taxable cash, a refundable deposit or a special-method item.
Overall accrual was therefore an alternative worth comparing. An eligible voluntary cash-to-accrual change may use the automatic Form 3115 procedure. But it also requires a Section 481(a) adjustment to prevent old income or deductions from being lost or counted twice. Opening receivables, payables and other affected balances must be tested, while continuing special contract methods remain separate. It is not enough to use book income and discard the cash adjustments. Rev. Proc. 2025-23, §15.01
A positive Section 481(a) adjustment is generally included over four tax years; a negative adjustment is generally taken in the change year, subject to the applicable exceptions. That transition cost belongs in the comparison alongside current-year income and future cash needs. Rev. Proc. 2015-13, §7.03
Where the conclusion stood—and what carries into next year
The review established a way to retain overall cash where permissible, apply mandatory contract rules where required, and measure available contract deferrals. The returned classifications allowed the residential calculation to move beyond preliminary screening assumptions.
It did not establish that cash always wins, that the lowest possible tax had been finalized, or that the modeled adjustment was already a filed result. Declaring one overall method financially better requires a completed comparison that includes the opening Section 481(a) adjustment, all other tax differences, and the later recognition of deferred profit.
Next year’s work starts with that rollforward. Each deferred amount needs a beginning balance, current-year recognition or reversal, and ending balance so the benefit does not disappear from the records or get claimed twice.
New contracts also need a fresh year-of-entry review. The law expanded the residential exemption for contracts entered in taxable years beginning after July 4, 2025—generally new 2026 contracts for a calendar-year taxpayer. That does not automatically rewrite 2025 contracts. The IRS has issued related method-change procedures in Rev. Proc. 2026-32. Our home-builder tax-method guide explains that year distinction in more detail.
For an owner, the useful outcome is a tax number you can explain, a record of when deferred income will return, and a cash plan that can fund the liability. JAG’s tax-planning work begins with those connected questions. Planning, accounting support and annual return preparation are scoped separately.
Federal tax discussion focused on calendar-year 2025 contracts and the 2026 transition. This planning account does not establish a particular reader’s eligibility or a completed client tax outcome.
Joe Gallegos, CPA/CVA
Partner-in-Charge · JAG CPA & Co.
Author of The Ultimate Guide to Choosing a CPA
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