Tax Deferral Strategies for Contractors: Timing Moves by Accounting Method
Every year end, contractors hear the same advice: defer income and accelerate expenses. It sounds universal, but the moves that actually work depend on your tax accounting method. The best tax deferral strategies for contractors on the cash method can be useless, or even harmful, for a contractor on the accrual or percentage of completion method. And every dollar of deferral has a second effect that matters to bonded contractors: it can lower the equity and working capital your surety sees.
This article walks through the timing levers available under each method and how to weigh them against your bonding goals. For a broader list of year-end decisions, see our article on contractor year-end tax planning decisions.
Contractors can use different methods for different purposes. Your overall method of accounting might be cash or accrual, and long-term contracts may be reported under a separate method such as percentage of completion or completed contract. Smaller contractors that meet a gross receipts test, which is indexed for inflation each year, have more flexibility in choosing methods. Before planning any timing move, confirm with your tax preparer exactly which methods appear on your return. For a refresher, read our article on cash vs accrual accounting for contractors.
Timing Levers on the Cash Method
Cash method contractors report income when received and deduct expenses when paid, which makes timing relatively direct.
Pay deductible expenses before year end. Vendor bills, supplies, and services paid by December 31 are generally deductible this year.
Time billings thoughtfully. Sending a December pay application later may push the receipt into January. Be careful: income you have the right to receive and could collect may still be taxable under constructive receipt rules.
Consider prepaid expenses carefully. Certain prepayments for benefits that do not extend too far into the future may be deductible, but the rules are specific. Check with your tax advisor before prepaying.
Watch the cash. Paying bills early and slowing collections both reduce cash at year end.
Timing Levers on the Accrual Method
Accrual method contractors report income when earned and deduct expenses when the liability is fixed and economic performance has occurred. Simply paying a bill early usually does not change the tax result.
Accrue year-end bonuses for employees. Bonuses fixed by year end and paid within a short window after year end may be deductible this year. Bonuses to owners of pass-through entities and related parties follow different rules and are often deductible only when paid.
Review accrued liabilities. Make sure legitimate year-end liabilities, such as subcontractor costs for work performed, are recorded.
Write off truly uncollectible receivables. Bad debts that are worthless may be deductible when properly documented.
Review retainage treatment. How retainage receivable and payable are handled for tax can vary, so ask your preparer how yours is reported.
Timing Levers on Long-Term Contract Methods
Percentage of completion
Under the percentage of completion method, income is driven by cost incurred relative to estimated total cost. Updating estimates to complete accurately matters. Overstated estimates of total cost reduce percent complete, but estimates must be reasonable and supportable, and a look-back calculation may apply when the contract is finished.
Completed contract
Contractors who qualify for the small contractor exception may be able to use the completed contract method for eligible contracts, deferring income until a job is complete. This can be a significant deferral for long jobs, but eligibility depends on gross receipts and expected contract duration, and a method change may require IRS filings. Our upcoming article on percentage of completion vs completed contract covers this in more detail.
The Tradeoff: Deferral vs Bonding Equity
Most tax deferral works by lowering reported income now. If your financial statements are prepared on the same basis as your tax return, deferral lowers the net worth and working capital a surety uses to size your program. Even when your CPA statements use GAAP, actions such as paying bills early or delaying billing change the year-end balance sheet.
Before choosing a timing move, ask three questions:
How much tax does this actually save this year, and how much of it is just moved to next year?
What does it do to year-end cash, working capital, and net worth on my CPA statements?
Am I planning to ask for a larger bond program in the next twelve months?
Sometimes the right answer is to pay a little more tax and present a stronger balance sheet. That is a business decision, not just a tax one.
Frequently Asked Questions
How can contractors defer taxes at year end?
It depends on the accounting method. Cash method contractors often pay expenses early and time billings, while accrual and long-term contract method contractors focus on accruals, estimates, and method elections. Review options with a tax professional.
Does deferring income hurt my bonding capacity?
It can. Deferral often lowers reported income and equity, and some timing moves reduce year-end cash. Coordinate tax planning with your bonding goals.
Can I change my accounting method to defer taxes?
Some method changes are available, especially for smaller contractors, but they often require IRS filings and have long-term effects. Talk with a tax professional before making a change.
Plan Year-End Timing With Your Bonding Goals in View
SuretyCFO provides tax planning and CFO services for bonded commercial contractors. We model how each timing move affects your taxes, cash, and year-end balance sheet so you can choose the moves that fit your plans for growth.
This article is for general information only and is not tax or legal advice. Talk with a qualified tax professional about your specific situation.
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