Identify the tax unit before calculating the year
A single signed construction or manufacturing agreement does not necessarily establish a single contract for section 460 tax accounting. The severing and aggregating provisions in section 1.460-1(e) can require different contract boundaries to clearly reflect income. This decision precedes the completion calculation. Otherwise, an operating forecast can combine finished profitable work with unfinished obligations and defer income without support.
Start with the customer's actual bargain rather than the number of job codes, invoices, or signatures. Collect proposals and negotiation records showing whether each component was priced independently and would have been commercially acceptable on its own. Separate delivery or acceptance matters, but it does not alone require severance. A project-management preference to combine jobs in one dashboard is not a tax conclusion.
Test whether each part stands on its own
Assume an eligible contractor uses a valid completed-contract method. One agreement covers two independently priced construction units. Unit A has a $900,000 price and $760,000 of allocable costs, while Unit B has a $1.2 million price and $980,000 of estimated allocable costs. The agreement provides separate delivery and acceptance. Contemporaneous negotiations demonstrate that each unit provides a reasonable standalone profit and that a reasonable businessperson would have accepted either bargain separately.
Assume the facts require severance, Unit A reaches tax completion in 2026, and Unit B remains incomplete until 2027. Unit A's simplified 2026 contract income is $140,000. At a stipulated 21 percent federal rate with no other limitation or offset, the current tax reserve is $29,400. Leaving both units under one unfinished tax contract would omit that income on the stated assumptions.
Unit B's projected $220,000 margin remains a later-year forecast under the assumed completed-contract treatment, subject to actual price, cost, and completion facts. The combined expected margin is still $360,000. Severance changes the recognition schedule; it does not create extra economic profit. Keep allocated costs and customer collections linked to each unit so the business can fund the tax on Unit A even while Unit B consumes working capital.
Review linked bargains and the PCM consent restriction
Aggregation works in the other direction. Separate agreements can form one tax contract when their pricing is interdependent and a reasonable businessperson would not enter one without the other. For example, a deliberately loss-making first production run might be part of a jointly negotiated profitable package. The mere hope of winning future business does not establish that interdependence. Preserve the actual negotiation and pricing evidence rather than inferring a package from the customer's identity.
The regulation places an important restriction on taxpayer severance of a contract that would be subject to the percentage-of-completion method: prior written IRS consent is required. Do not apply the completed-contract example mechanically to a mandatory-PCM contract. An internal memorandum describing independent units does not replace that consent requirement, even when separate job accounting would appear commercially sensible.
Options and change orders also need review. An added unit with separate delivery or acceptance can implicate the mandatory severance provision, subject to the PCM restriction. A price adjustment for the original unit does not automatically create a new contract. Record what the amendment changes, when the parties became bound, and whether it adds a separately deliverable unit rather than merely revising the original compensation.
Make the conclusion visible in the reporting file
Document the facts known by the end of the contracting year, including pricing formulas, independent profitability, delivery provisions, and the commercial reason for the arrangement. Obtain an allocation schedule for shared design, mobilization, and overhead costs. Explain changes to that schedule when scope changes. A tax contract should have a reproducible price and cost history even when the business continues using a different internal project structure.
When the taxpayer severs or aggregates under the regulation during the taxable year, the original federal return needs the prescribed notification statement, including the regulatory legend, taxpayer name, and identifying number. Retain the statement and filed return with the contract-boundary analysis. Track any required written consent separately so staff do not confuse disclosure with approval.
Apply the established boundaries when determining contract classification, completion, and income rather than revisiting them opportunistically each December. Related-party work, non-long-term service components, and method-change questions can require additional analysis. The useful owner decision is to establish supported tax units early enough that billing plans, project margins, and tax reserves reflect the same commercial obligations.
Sources & further reading
Consult the original guidance and its effective dates. These references support the educational discussion; their application depends on the specific facts.