Contractors are typically required to report their income for financial statement purposes on the Percentage of Completion (POC) method of accounting. However, when filing their annual tax returns, they have the option to use a different method of accounting, often resulting in the deferral of federal and state income taxes. The permissible methods available depend on the size of the contractor, and the type and duration of contracts they perform. Most contractors with average revenue in excess of ten million dollars will be required to use POC for many of their contracts.
That being said, alternative methods are still available for residential contracts (including single family, multi-family, dormitories, prisons, etc.) and jobs that are started and completed in the current year. The most common alternatives to the POC method are the Completed Contract Method (CCM), Accrual with Deferral of Retentions (DOR), and the Cash method.
Completed Contract Method
Under CCM, a contractor can defer the revenue and cost from a contract until the job is complete. In the year the job is completed, the contractor includes the revenue and costs from the entire project in their taxable income.
Deferral of Retentions
The DOR method allows contractors to exclude the retentions receivable from their income until the year when the job has been completed and accepted by the customer.
The Cash method allows the contractor to exclude revenue from their taxable income until the year when payment is received.
Under the POC method, a contractor recognizes income based on the amount of work that has been performed on the contract. Regardless of the amount the contractor has billed, or collected, the contractor has to recognize the income. The goal of the CCM, DOR and Cash methods is to defer income, and the tax due on that income, to later years.
It is important to remember that a contractor could very likely have two or three methods of accounting. Each contract needs to be looked at separately to see what accounting method should be used for that job.