My construction company has unpaid retainage. When does it enter taxable income?
Retainage is common in construction, but withholding a percentage of a progress billing does not by itself tell a contractor when the amount belongs on the tax return. The answer depends on contract terms and the accounting method actually used for that contract.
The owner's question
A profitable contractor has substantial open jobs and a meaningful retainage balance at year end. The owner needs a contract-by-contract answer before signing the return or negotiating a business sale.
Retainage is common in construction, but withholding a percentage of a progress billing does not by itself tell a contractor when the amount belongs on the tax return. The answer depends on contract terms and the accounting method actually used for that contract.
Classify the contracts before totaling the retainage
List each open job, contract start and completion dates, progress billings, retainage earned, retainage received, and disputed amounts. Separate long-term construction contracts from short service or installation jobs. One contractor may have multiple contract types, and a bookkeeping receivable is not a substitute for method analysis.
The IRS Construction Industry Audit Technique Guide discusses retainage treatment under cash, accrual, completed-contract, and percentage-of-completion methods. The permitted method and any exception must be established before changing income recognition for a specific job.
Reconcile tax records to job costing
Compare job-cost reports, billing applications, bank deposits, and year-end work-in-progress schedules. Retainage on the customer side should not be confused with amounts the contractor withholds from subcontractors. Work out whether a disputed change order is a separate issue from ordinary retainage under the signed contract.
If prior returns used a different accounting method, ask whether a prospective method change, a correction, or no change is appropriate. A unilateral year-end journal entry may create an unexplained gap between financial statements and the filed return.
Review before a sale, lender package, or return filing
AE can prepare a contract-level reconciliation, identify the method used on prior returns, and coordinate any tax-method work with the preparer. A buyer or lender will also want to know whether reported earnings include cash that remains subject to punch-list work or collection risk.
Bring major contracts, applications for payment, retention ledgers, job-cost reports, prior returns, and any method-change history. The deliverable should identify each material job and a supportable tax-year treatment.
Primary tax sources
Related AE Tax guidance
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