As you approach year-end, now is an ideal time to explore whether your current accounting methods are still the most beneficial from a tax savings perspective. For construction companies, the question of which accounting method to use for tax purposes isn’t as straightforward as it is for other types of businesses. Below is an overview of key accounting methods construction businesses should keep in mind as they conduct year-end tax planning. 

Basic options

The IRS requires businesses to choose and consistently apply a tax accounting method that clearly reflects their income. The cash and accrual methods are the two commonly recognized approaches.

Cash method 

Under the cash method, a taxpayer:

• Recognizes gross income (whether cash, property or services) in the tax year in which those items are actually or constructively received, and
• Deducts expenditures in the tax year in which they’re actually paid.

The primary advantages of the cash method are its simplicity and better timing of cash flow with income tax payments.

Historically, most companies couldn’t use the cash method if they maintained inventory; they had to use the accrual method. However, thanks to the Tax Cuts and Jobs Act, in 2024, taxpayers with $30 million or less in average annual gross receipts for the preceding three tax years are exempt from the required accounting for inventory and mandated use of the accrual method. So, many more businesses, including construction companies, can now use the easier-to-manage cash method.

Accrual method

Under the accrual method, income is applied to the taxable year only when all the events have occurred that establish the right to receive the income, and the amount of the income can be accurately determined. Some entities, including C corporations and partnerships with a C corporation partner, must use the accrual method. (Your CPA can help determine whether your construction business falls under this requirement.)

A major benefit of the accrual method is that it provides a more accurate matching of revenue and expenses, as both are recorded when incurred, not necessarily when paid. This method can also allow additional tax planning opportunities through year-end accruals.

Long-term contracts

Here’s where things get complicated. The IRS requires construction businesses (and others) to handle tax accounting differently for “long-term” contracts — that is, those not completed in the same tax year as started, regardless of the time needed to complete the job. Two of the most widely used approaches to long-term contracts include the percentage-of-completion and completed-contract methods. 

Percentage-of-completion method 

Here you report income according to the percentage of the contract that’s completed during the year. This percentage is most often calculated by comparing costs allocated to the contract and incurred during the year with the estimated total contract costs.

One benefit of this method is a more accurate allocation of income and expenses. However, the IRS requires you to do a separate calculation for tax purposes (often called the “look back method”) that may result in interest charges.

Completed-contract method

Under this method, income isn’t reported until you complete a contract, even though you may receive payments in years before completion. Thus, the completed-contract method is advantageous because you can defer taxes. 

The downside is that you can’t include the cost of supplies or materials you allocated to the contract yet never used as an allocable contract expense. These supplies must remain on the books as an asset until they’re used in a project. They may be deducted at the time the project is completed.

Weigh your options

Whether you can or should use the completed-contract method depends on the size of your company as measured by gross receipts. In 2024, businesses with average gross receipts over $30 million for the previous three years must use the percentage-of-completion method.

If you have average gross receipts for the previous three years under $30 million this year, you’re required to use the completed-contract method only for contracts expected to take longer than two years to complete. However, you may choose to use it for contracts you’ll complete in less than two years.

Note: Alternative minimum tax rules may also require use of the percentage-of-completion method. Also, certain exceptions may apply to homebuilders.

Accounting complexities

Accounting complexities are all part of the distinctive nature of the construction industry. Our dedicated construction CPAs bring a deep understanding to these tax nuances to identify which tax accounting methods work best for your construction business. To obtain assistance with year-end tax planning for your business, contact us today.