A holdback amount on each invoice (i.e. 10% of the progress billing) is a typical billing method in the construction industry. The customer does not pay this amount until they have approved the work as 100% completed and without deficiencies. If there are any holdbacks on the receivable or payable, and the lien period has not expired, those receivables can be excluded from income. If the receivables are excluded from income, the related payables must also be excluded from the expense.

If the contract is for less than two years, the contractor has the option of using the “completion method” of accounting for income for tax purposes. When using the “completion method” the holdback is not a concern because revenue is not recognized for tax purposes prior to the contract’s completion. The holdbacks would not be taxable until they are released upon the project’s completion.

For accounting purposes, the holdbacks may be recognized as income. The payables must also be treated similarly. As well, if choosing this method they would not recognize the profits from the job until it is completed and any anticipated losses from the job would not be recognized until completion. However, if the contractor is using the percentage of “completion method” then profits and losses are recognized as the job progresses. If you use the “percentage of completion method” you could deduct it when calculating taxable income for the year, as the proceeds are not yet due.