What are common IRS audit triggers for construction companies?
Construction companies face higher audit scrutiny than many other industries. The combination of large cash transactions, subcontractor payments, and equipment purchases creates multiple areas where the IRS looks for discrepancies.
Worker misclassification is probably the biggest trigger. The IRS knows construction companies rely heavily on subcontractors, and they look for situations where workers should be classified as employees. If you have subs who work exclusively for you, use your tools, and follow your schedule, the IRS may reclassify them as employees. That means back payroll taxes, penalties, and interest.
1099 compliance issues go hand in hand with subcontractor payments. If you pay a sub more than $600 in a year and don’t file a 1099-NEC, that’s a red flag. The IRS can cross-reference what subs report as income against what you reported paying them. Mismatches trigger letters and sometimes full audits.
Cash payments are common in smaller construction jobs, and the IRS knows it. Large deposits that don’t match invoiced work or unexplained cash flow patterns draw attention. If you’re taking cash payments, they still need to be recorded and reported as income.
Vehicle and equipment deductions get scrutiny because they’re often overstated. Claiming 100% business use on a truck that’s clearly used for personal trips raises questions. Section 179 deductions on equipment need proper documentation showing the asset is actually used for business purposes.
Disproportionate expenses relative to income trigger automated IRS algorithms. If your reported expenses are unusually high compared to similar construction businesses or your gross receipts seem low for your operation’s size, expect questions.
Income timing issues specific to construction can cause problems too. Long-term contracts have specific accounting method requirements. Reporting income using completed contract method when you should be using percentage of completion creates discrepancies the IRS may catch.
The best protection is consistent small business bookkeeping that documents everything. Track every subcontractor payment, file 1099s on time, record vehicle mileage properly, and make sure your income recognition method matches IRS requirements. Clean books give you a defensible position if the IRS comes asking.
If you do receive an audit notice, having organized records and professional representation makes a significant difference. Enrolled Agents can represent you directly before the IRS and often resolve issues faster than handling it yourself.
The Treasure Valley's Tax and Accounting Team
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More Questions
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Keep contracts, change orders, invoices, material receipts, labor records, subcontractor agreements, permits, and inspection reports. These records support tax deductions, protect you in disputes, and help you understand job profitability.
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Record change orders as soon as they're approved, tracking both the additional revenue and the associated costs separately from the original contract. This lets you see whether change orders are actually profitable.
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Credit card tips track automatically through your POS system. Cash tips require employees to report daily. Both need to flow into payroll so you withhold taxes correctly and stay compliant.
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Use classes in QuickBooks or separate income accounts to track each revenue stream. The key is capturing both revenue and direct costs by segment so you can see true profitability.
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Food waste is deductible, but not as a separate line item. It's captured through your cost of goods sold calculation. When you throw out spoiled inventory, that cost is already reducing your taxable income.
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