Explaining PCM For Large Contractors

While small contractors have much more flexibility to choose an accounting method that works for them, large contractors are required to use a predetermined method for their construction contracts. Under IRC §460, large contractors generally must use the percentage-of-completion method, often called PCM, to report taxable income from long-term contracts. If your business’s average annual gross receipts exceed $32 million for the 2026 tax year, you are considered a large contractor under IRS regulations.

Under PCM, a contractor generally reports income as the job progresses, based on costs incurred compared to total estimated contract costs. This is commonly referred to as the cost-to-cost method. Under Reg. § 1.460-4(b), percentage of completion is generally based on estimated costs rather than on the physical stage of the project.

In other words, if 40% of a contract’s total expected costs have been incurred in a year, roughly 40% of the contract profit will be recognized for tax purposes. For example, assume a contractor has a $10 million contract and expects total costs of $8 million. If the contractor incurs $3.2 million of those costs by year-end, the job is considered 40% complete for PCM purposes. The contractor would generally recognize 40% of the contract revenue and related gross profit in that tax year, even if billings or collections differ from that amount.

Another Layer: The Look-Back Calculation

PCM can also involve a look-back calculation after the job is completed. The purpose of the look-back method is to compare the income that was reported using estimated contract revenues and costs with the income that would have been reported if actual results had been known from the beginning.

Under Reg. § 1.460-6, the look-back method generally determines whether the taxpayer must pay, or is entitled to receive, interest on a hypothetical tax underpayment or overpayment for the contract. This does not mean the prior-year returns are amended. Instead, the calculation is intended to account for the time value of money when estimates used in prior years differ from actual results.

There are exceptions. For example, the look-back method generally does not apply to certain small contractor construction contracts for regular taxable income, and there are also de minimis exceptions for certain contracts. However, the rules can be nuanced, and some contracts may still require PCM or look-back calculations for alternative minimum tax purposes unless an exemption applies.

If you have any questions, please reach out to your Meadows Urquhart accountant!