Are You Paying Tax on Retainage You Haven't Collected? Check Your Method Before Electing CCM.

If you've read our retainage tracking playbook, you know retainage is structural cash drag, money you've earned but the GC is sitting on. A possible second cost is a tax timing problem. Under some tax methods, retainage can be taxable before the cash arrives; under others, it generally is not. What matters is your tax method of accounting, not the revenue label in your bookkeeping system.

For commercial contractors whose current method does accelerate income on retainage or open contracts, a method change can defer tax. The deferral is tied to the balances outstanding at year-end. It persists while those balances stay at a similar level, it shrinks if they shrink, and the deferred tax comes due as contracts complete. It is not new profit.

Here is how to tell whether you have the timing problem, how the small construction contract exemption works, and what to take to your tax adviser.

How the timing trap works

For the examples here, assume monthly commercial progress invoices with 5-10% retainage. Your contract sets the actual percentage and release conditions.

Fictional progress bill: a $100K progress invoice with 10% retainage means $90K is payable now and $10K is held as retainage receivable. How that $10K is taxed depends on which method you are on.

Which method are you on?

Under PCM, revenue recognized can be higher or lower than amounts billed, so the $10K retainage on one invoice does not by itself tell you what was taxed. Retainage released after completion generally adds no new revenue at release under PCM, because the contract revenue was already recognized as costs were incurred.

Now test the balances already included in taxable income. These balance-level figures are upper-bound timing illustrations, not a first-year benefit from a new-contract-only cut-off change. Fictional planning assumption, not a measured industry figure: a $10M commercial contractor carries $500K of retainage at year-end, all of it already included in taxable income under its current method, and pays a 27% combined effective rate on the marginal income.

• $500K × 27% = $135K of tax paid ahead of the retainage cash in that fictional case
• If the same contractor carried $800K, the figure would be $800K × 27% = $216K
• If the contractor is on the cash method, the retainage portion of this exposure is generally close to zero, because uncollected retainage is usually not yet income

The tax doesn't disappear under any method. The question is whether your method pulls it ahead of the cash, and by how much at your actual balances.

The Completed Contract Method (CCM)

Under IRC Section 460, contractors with exempt construction contracts (see the small contractor exemption below) can use the Completed Contract Method for tax purposes. CCM defers contract revenue and allocable contract costs until the contract is complete under the tax definition of completion. Under Treasury Regulation 1.460-1(c)(3), completion generally occurs at the earlier of customer use for its intended purpose with at least 95% of allocable contract costs incurred, or final completion and acceptance. Testing, secondary items and disputed amounts have specific rules. It is a tax definition, not automatically the GC's substantial-completion letter.

Under CCM, mechanically:

• During construction: contract revenue and allocable contract costs are generally deferred for tax purposes
• At completion: contract revenue and contract costs are recognized in that tax year
• Result: income on the whole contract, including retainage, is deferred until completion. Retainage the GC releases months after completion is still generally taxed in the completion year, so CCM does not by itself match retainage tax to the release date.

Fictional example: a 12-month project with $500K of contract value, $400K of estimated cost and $50K of retainage. It starts July 1, finishes June 30 of the next year, and incurs $200K of cost in year one.

• Percentage-of-completion: $200K ÷ $400K = 50% complete at the end of year one. So $250K of revenue and $200K of cost, or $50K of gross profit, land in year one. The remaining $50K of gross profit lands in year two.
• Completed Contract Method: the full $100K of gross profit lands in year two, the year of completion. The year-one deferral is $50K of gross profit, about $13.5K of tax at a fictional 27% rate.
• Retainage: under both methods, the $50K of retainage released after the June 30 completion adds no taxable income at release, because it was included in contract revenue by completion.

This is a timing deferral, not a permanent tax savings. The deferred amount is roughly the gross profit on exempt contracts still open at each year-end. It persists while that open-contract balance stays at a similar level and reverses if open work shrinks. Do not equate it with retainage × tax rate, and do not count it as recurring annual profit.

The small construction contractor exemption

Here's the catch: not all contractors can elect CCM. Section 460 generally requires the percentage-of-completion method for "long-term contracts" (contracts not completed in the same tax year they begin).

The exception that matters: construction contracts expected to be completed within two years, entered into by a contractor that meets the Section 448(c) gross receipts test and is not a tax shelter barred from the cash method, are exempt from the required percentage-of-completion method. That opens the door to CCM or another permitted exempt-contract method.

This is the same Section 448(c) gross receipts test that governs cash-method eligibility (covered in our phantom income tax post). The threshold is inflation-indexed every year. For tax years beginning in 2026 it is $32M, measured as average annual gross receipts over the prior three tax years, with aggregation rules for related entities (Rev. Proc. 2025-32, IRB 2025-45). For other years, use the revenue procedure for that year rather than this page. Gross receipts are a tax test, not your GAAP revenue line.

Translation: if your three-year average gross receipts do not exceed the threshold for the year and a contract is expected to finish within two years, ask your adviser whether it qualifies as exempt. Whether that covers your work depends on your own aggregation, receipts history and contract durations. The statutory exemption is in IRC 460(e)(1)(B). Residential construction has separate rules after the July 4, 2025 law change; this guide focuses on other construction contracts. A small construction contract exempt for regular tax can still require PCM for alternative minimum tax, as the Form 8697 instructions explain.

What CCM is NOT good for

CCM has trade-offs that disqualify it for some contractors:

1. Long-duration contracts (24+ months)

For contracts expected to take longer than 2 years, CCM isn't available even under the small contractor exemption. That small-contractor exemption does not cover longer expected durations. Check other exemptions separately rather than assuming every construction contract has the same treatment.

2. Highly profitable jobs in a single tax year

If a $2M contract finishes in December of one tax year, all $2M of revenue lands in that year under CCM. If your other jobs were average, you might get pushed into a higher tax bracket or lose income-based phaseouts that year. Percentage-of-completion spreads this. Model the completion-year spike before switching.

3. Loss contracts

Under CCM, you can't recognize a loss until the contract completes. If you have a loss contract that won't finish for a year, the loss recognition is deferred, bad for tax planning. Percentage-of-completion lets you recognize losses sooner.

4. Bonded work where surety wants accrual financials

Some bonding companies require accrual-method financials for surety qualification. While CCM is a tax method (not a book method), some surety underwriters scrutinize unusual tax method elections. Talk to your surety broker before electing CCM if bonding is critical.

How to elect CCM

Changing an established tax method generally requires Form 3115; adopting a method for your first contract of a type is a different question. For the automatic change from PCM to a permitted exempt construction-contract method under the small-contract exemption, Rev. Proc. 2025-23 section 19.01, as amended in IRB 2026-39, uses designated change number 236. That change uses a cut-off basis: it covers similarly classified contracts entered into on or after the first day of the year of change. A Section 481(a) adjustment is neither permitted nor required for that change. Old contracts continue under their old method. A separate September 2026 residential-contract change uses DCN 275; it is not the number for this small-contract change.

These mechanics were checked against the actual amended section 19.01 in Rev. Proc. 2026-32 on October 8, 2026, rather than inferred from the bulletin summary. The general effective date is for Form 3115 filed after September 4, 2026, with specific transition options tied to duplicate copies properly filed by November 15, 2026. Have your EA or CPA establish eligibility, the applicable year, classification of contracts and current filing requirements before submitting. A method outside this automatic-change scope may follow different consent procedures.

What to bring to that conversation:

• Your current method for exempt contracts, as shown on recent returns (cash, accrual, PCM, or another permitted method)
• The method you are considering (CCM) and which contracts it would cover
• A list of open contracts at year-end with start date, expected completion date, contract value, costs to date and retainage held
• Three years of gross receipts, including any related entities that may be aggregated

For the specifically scoped DCN236 change described above, contracts entered before the year of change are outside that cut-off change and continue under their existing method. New qualifying contracts can create later timing differences. This procedure does not permit or require a Section481(a) adjustment; do not model a four-year spread for it. Confirm the applicable procedure before generalizing this treatment to another change. The earlier $135K and $243K balance illustrations are not first-year projections for DCN236.

The combined play: Cash basis + CCM

For contractors under the gross receipts threshold, the cash method (covered in this post) and an exempt-contract method like CCM are sometimes discussed together. They overlap. They do not stack.

• The cash method generally defers tax on receivables and retainage until the cash is received
• CCM defers contract income until completion
• Uncollected retainage already deferred by the cash method is not deferred a second time by CCM. Adding the AR balance, the retainage balance and the open-contract deferral together double counts

Fictional example: a $10M contractor on accrual with $400K of AR and $500K of retainage at year-end. Suppose both balances are fully in taxable income today. The maximum balance-level deferral is $900K, about $243K of tax at 27%, and only if the method change actually moves both balances out of the current year. Under a cash-method change, costs not yet paid also stop being deductible until paid, which reduces the net deferral. Treat any figure as a balance-level deferral that persists while year-end balances stay at this level, not as working capital added every year.

Ask your adviser how your exempt-contract method and your overall method interact before modeling the two together.

The combined election does require coordinated planning between the EA preparing the elections, the bookkeeper maintaining dual-method books, and a CFO function projecting how the deferred income will recognize in future years. It's not a "set it and forget it" change. Whether the working capital benefit is material depends on your actual method, balances and contract mix, so model it before filing.

What to do this quarter

If you're a commercial contractor whose three-year average gross receipts do not exceed the Section 448(c) threshold for your year ($32M for 2026):

Action 1: Pull your most recent year-end retainage receivable, AR aging and open-contract schedule. Ask your preparer which of those amounts were included in taxable income on the last return, net of related costs already deducted. Multiply only that included amount by your marginal effective rate. That is your current tax-timing exposure. If you are already on the cash method, the retainage portion may be close to zero.

Action 2: Check each contract's expected duration at the time it was entered into, not your average. Contracts expected to finish within 2 years may qualify as exempt if you also meet the gross receipts test. Contracts expected to run longer generally do not. Do not restructure or phase contracts for tax reasons without legal and tax review of the contract terms.

Action 3: Bring the method table above and your open-contract list to your CPA or EA. Ask which method you are on today and whether a change to CCM, the cash method, or neither fits. If your adviser does not handle long-term contract method changes, ask for a referral to someone who does. Weigh the adviser fee against the deferral modeled at your balances, not against a generic estimate.

The tax code gives qualifying contractors method options for exempt construction contracts. Whether you are paying tax ahead of cash depends on the method you are on today. The fix, if one is needed, depends on your contracts and balances.

Use the gap finder to organize your cash and AR numbers or book a free 30-min audit and we'll help assemble the retainage, AR and open-contract schedules your tax adviser needs to evaluate a method change.

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