When you’re running a contracting business—especially one with projects that stretch over multiple tax years—timing your profit recognition matters. One powerful tool at your disposal is the IRC 460(b)(5) “10 % election.” Here’s what it is, why it helps, and how to make sure you’re using it the right way.
IRC 460 puts long-term contracts (contracts not finished within the same tax year) on the percentage-of-completion method for tax purposes. That means you recognize income as you incur costs—even before you bill or finish. But under section 460(b)(5), you can elect not to recognize any profit or income on a contract until the cumulative costs hit at least 10 % of the total estimated contract costs. After that “10 % year,” you slide into the normal percentage-of-completion calculation.
Why bother? If you delay recognizing profit, you can defer taxable income into a future year. That means potentially lower taxes in your current year—and more cash in your pocket now.
Real-life scenario: early-stage projects
Imagine you start a big $1 million job in November. You spend $80 k that year—only 8 % of total costs—to set up the site, order materials, and mobilize crews. If you don’t make the 10 % election, you’d already report 8 % of the contract revenue for tax purposes this year. But with the election, you report zero income until next year, freeing up cash for just-started jobs.
Say next year you’re 40 % complete—now the 10 % threshold has been crossed, so your total revenue to date gets reported on the schedule-of-completion basis from that year forward. This gives you breathing room when you’re starting out, or when cash is tight.
Why it matters for contractors
- Cash management: Paying tax later can help with liquidity, letting you invest in equipment or take on other jobs.
- Smoothing income: If you start many contracts late in the year, this reduces a tax hit from partial completions.
- Still subject to look-back method: You must still check at contract end whether you under- or over-reported income—and pay interest differences under the IRC 460 look-back rules—but making the election gives you time with the cash flow before that adjustment kicks in.
How to actually make or keep the 10 % election
Fortunately, filing this election is simple. You don’t draft a separate form—just use the 10 % method on your original return for the year you first elect it. By reporting zero income on contracts under 10 % complete, you’ve effectively made the election. This applies to all new long-term contracts you enter that year and in future years. You can’t revoke it unless you get IRS permission. So once you go there, stick with it unless you file Form 3115 to change your accounting method.
Key reminders
- Who qualifies? Any contractor using the percentage-of-completion method under IRC 460. If your contracts are small (your average revenue under $26 m and jobs finish in under two years), you may be using completed-contract or other methods—but once you do PCM, the 10 % election is still available.
- When is the 10 % year? It’s the first tax year in which cumulative contract costs exceed 10 % of the total estimated. Then your income recognition shifts.
- Look-back still applies. If your estimates were off, you’ll settle up via Form 8697 and pay or receive interest. But that happens later—and after you’ve already delayed taxes.
Bottom line
The 10 % election is like giving your business a little breathing room—letting you push tax recognition out of the current year when a project is just getting started. It’s simple to make—just use it on your return—and once you’re in, it sticks across all future contracts. Sure, you’ll reconcile your income when projects wrap up, but in the meantime, you’ve got more cash to keep your business moving.
As with any tax strategy, getting your accountant involved is smart—but if you’re wondering why your early-stage jobs feel like they’re eating up profit faster than they should, the 10 % election might be the answer.