Every job starts simple until it doesn’t.
You win the bid.
You schedule the crew.
You order materials.
Then comes the call:
- “Can you move that wall?”
- “We changed the countertops.”
- “Let’s upgrade the master bath.”
Welcome to change orders, the contractor’s daily surprise.
And right behind them comes retainage, your client’s way of saying, “We’ll pay you the rest… later.”
If you’re a small contractor using cash basis accounting, you need to know how both affect your taxes and cash flow.
Let’s break it down.
Cash Basis = Simple (Mostly)
Most small contractors file taxes on a cash basis which means:
✅ You only report income when you’re paid
✅ You only deduct expenses when you pay them
This keeps things straightforward. But if you’re not careful, change orders and retainage can still sneak up on your bottom line.
Change Orders: Great for Business, Tricky for Cash Flow
Change orders = more work, more money.
But when do you pay taxes on that money?
Under cash basis accounting:
- You don’t report income until the payment hits your bank
- You can’t deduct costs until you’ve paid the supplier or sub
So even if the job’s done, if you haven’t been paid — it’s not taxable income yet.
But here’s the catch:
❌ Many contractors forget to invoice change orders immediately
❌ You might pay for labor and materials upfront — and not get reimbursed for weeks
❌ That delay can split income and expenses into different tax years
And that leads to the real pain: spending money before you earn it, and paying taxes after the cash is long gone.
Retainage: The Client’s Holding Pattern
Retainage (a.k.a. retention) is when the client withholds 5% to 10% of your total payment until final inspections or project completion.
You’ve earned it.
You just don’t have it.
The good news: Under cash basis, retainage isn’t taxable until you get paid.
So if you finish a job in December but collect the retainage in February — the income goes on next year’s tax return.
But be careful…
If several retainage payments land in the same year, you could see a sudden spike in taxable income and a bigger tax bill than expected.
The Real Threat Isn’t the IRS — It’s Cash Flow
You might be profitable on paper.
But in real life?
- You’ve paid your crew
- You’ve bought the materials
- You’re still waiting to get paid
And that delay chokes your cash flow.
You’re not losing money from bad jobs — you’re losing it from bad timing.
5 Simple Rules to Stay Ahead
At Blu Hat Bookkeeping, we help small contractors avoid cash flow traps using these five rules:
1️⃣ Invoice Change Orders Immediately
As soon as a change is approved, invoice it. Don’t wait until the end of the job.
2️⃣ Collect Deposits for Big Changes
If a change order is major (materials, subs, added labor) — ask for a deposit upfront.
3️⃣ Track Retainage Separately
Keep retainage in its own category in your books. That way, you know what’s owed vs. what’s paid.
4️⃣ Forecast the Tax Hit
Know when retainage payments are due and plan for the tax impact. Don’t get blindsided.
5️⃣ Build a Cash Buffer
Set aside some of every payment to cover payroll, materials, and taxes — even when retainage or change orders are delayed.
Bookkeeping That Builds with You
You started your business to build, not to spend your evenings buried in spreadsheets.
That’s where Blu Hat Bookkeeping comes in.
We help small contractors:
- Track change orders and retainage the right way
- Stay compliant with IRS rules
- Plan for tax season with no surprises
- Maximize every legal write-off
- Protect their cash flow all year long
You swing the hammer.
We swing the spreadsheets.
Don’t Let Change Orders & Retainage Eat Your Profit
These are normal parts of the job.
Handled well — they’re bonus money.
Handled poorly — they’re a financial headache.
👉 Schedule a free consultation with Blu Hat Bookkeeping
👉 We’ll review your books and help you fix the cracks before tax season
Final Thought:
You don’t go broke because of bad jobs.
You go broke because of bad cash flow.
Let’s make sure that never happens to you.
