📋 Tax Strategies for Contractors
Construction companies have unique tax opportunities and challenges. Work with a construction-savvy CPA to minimize your burden.
Tax planning happens year-round, not in April. Make decisions throughout the year with taxes in mind.
Business Structure
Entity Types
Sole Proprietorship:
- Simple but no liability protection
- All income on personal return
- Self-employment tax on all profit
LLC:
- Liability protection
- Flexible tax treatment
- Can elect S-corp taxation
S Corporation:
- Liability protection
- Pass-through taxation
- Can reduce self-employment tax
- Requires reasonable salary
C Corporation:
- Double taxation (corp + dividend)
- Rarely makes sense for contractors
- Some benefits for very large companies
S-Corp Election
Benefit: Reduce self-employment tax
- Pay yourself reasonable salary (subject to payroll tax)
- Take additional profit as distributions (no SE tax)
How it works: Self-employment tax (15.3%) applies to your salary but not to distributions. The IRS requires you to pay yourself a "reasonable" salary—typically 30–50% of profit for owner-operators. If you pay too little, you risk reclassification and back taxes.
S-Corp vs. Sole Proprietorship: Estimated Annual Tax Savings
| Profit Level | Sole Prop SE Tax | S-Corp (Salary + Distribution) | Approx. Savings |
|---|---|---|---|
| $200,000 | ~$28,000 | ~$15,000 (e.g., $100K salary + $100K dist.) | ~$13,000 |
| $400,000 | ~$37,000 | ~$21,000 (e.g., $150K salary + $250K dist.) | ~$16,000 |
| $600,000 | ~$41,000 | ~$26,000 (e.g., $200K salary + $400K dist.) | ~$15,000 |
The IRS scrutinizes S-corps that pay too little in salary. A roofing contractor taking $60K salary and $340K in distributions on $400K profit will draw attention. Benchmark against what you'd pay someone else to do your job.
When S-corp makes sense: Typically when net profit exceeds $80,000–$100,000. Below that, the cost of payroll (administrative burden, payroll taxes, filings) may outweigh savings.
Accounting Methods
Cash vs. Accrual
Cash basis:
- Income when received
- Expense when paid
- Simpler
- Limited to smaller contractors
Accrual basis:
- Income when earned
- Expense when incurred
- Required over $27M average revenue
- More complex
Completed Contract vs. Percentage of Completion
Completed contract:
- Defer income until job complete
- Good for cash flow timing
- Limited availability
Percentage of completion:
- Report income as work progresses
- Required for larger/longer contracts
- Matches income with costs
Accounting Method Decision Matrix
| Contractor Type | Annual Revenue | Typical Best Method | Why |
|---|---|---|---|
| Solo handyman / small repair | Under $100K | Cash | Simplest; minimal bookkeeping |
| Small residential (1–5 crew) | $100K–$500K | Cash | Flexibility on timing; defer tax when possible |
| Growing residential / light commercial | $500K–$2M | Cash or Accrual | Depends on job length and retainage; discuss with CPA |
| Commercial / heavy civil | $2M–$27M | Accrual often required | Longer contracts; lenders expect accrual |
| Large general contractor | Over $27M | Accrual required | IRS mandate |
Changing accounting methods requires IRS approval (Form 3115). Plan ahead—don't wait until tax season to decide you want to switch.
Contractor-Specific Tax Deductions Checklist
Don't leave money on the table. Track these throughout the year so you have records at tax time.
Vehicle & Travel
- Vehicle expenses — Standard mileage OR actual (gas, oil, repairs, insurance, registration, depreciation)
- Truck/trailer used for work — Deductible; document business use %
- Tools and equipment in vehicle — If used exclusively for business
- Tolls and parking — For job sites, supplier runs, client meetings
- Lodging — When traveling overnight for jobs (not your normal commute)
- Meals — 50% deductible for business travel; 100% for certain per diem situations
Tools & Equipment
- Hand tools — Hammers, power tools, levels, specialty equipment
- Work boots and safety footwear — If required for job (not everyday shoes)
- Safety gear — Hard hats, gloves, harnesses, respirators
- Small tools under $2,500 — Can often expense immediately (de minimis safe harbor)
Professional & Education
- Continuing education — License renewal courses, safety certifications
- Trade association dues — AGC, ABC, specialty associations
- Union dues — If applicable
- Professional licenses — Contractor license, subcontractor licenses
- Subscriptions — Trade magazines, estimating software, plan services
Business Operations
- Cell phone — Business portion (or 100% if second phone for work only)
- Internet — Percentage used for estimating, billing, bidding
- Home office — If you have dedicated space (simplified: $5/sq ft up to 300 sq ft)
- Office supplies — Paper, ink, filing, printing job docs
- Software — Accounting, estimating, project management, CRM
Insurance & Professional Services
- Liability insurance — General liability, umbrella
- Workers' comp — Premiums
- Vehicle insurance — Business-use portion
- Bond premiums — If required for contracting
- CPA and legal fees — Tax prep, business advice, contract review
- Bookkeeping — If outsourced
Marketing & Client Development
- Advertising — Website, yard signs, directories, truck wraps
- Business cards and brochures
- Referral fees — Paid to others for sending work
- Sponsorships — Local sports, charity events (if business-related)
Other Often-Missed
- Bank fees — Account fees, merchant fees
- Interest — On business loans, credit lines, equipment financing
- Bad debts — Uncollectible receivables (accrual basis)
- Subcontractor payments — 1099 payments, materials you buy for subs
If you can't prove it, you can't deduct it. Keep receipts, mileage logs, and a clear connection to business use. "Because I use it for work" isn't enough—show it.
Estimated Tax Payments
If you're self-employed or have significant pass-through income, the IRS expects you to pay taxes quarterly—not in one lump sum in April.
Quarterly Payment Schedule
| Quarter | Covers Income From | Due Date |
|---|---|---|
| Q1 | Jan 1 – Mar 31 | April 15 |
| Q2 | Apr 1 – May 31 | June 15 |
| Q3 | Jun 1 – Aug 31 | September 15 |
| Q4 | Sep 1 – Dec 31 | January 15 (next year) |
How to Calculate
- Prior year method: Pay 100% of prior year's tax in four equal installments (110% if prior year AGI exceeded $150K).
- Annualized method: Estimate current year income and pay based on what you've earned each quarter. Better if income is uneven (e.g., busy summer, slow winter).
- 90% of current year: Pay at least 90% of what you'll owe for the current year.
The penalty applies if you've paid less than 90% of your actual tax liability through withholding and estimated payments. Making four equal payments based on last year's return is the safest way to avoid it—even if you have a big year.
Penalties for Underpayment
- Underpayment penalty: Charged on the amount you underpaid, calculated quarterly
- Interest: Accrues from the due date of each quarter
- Typical impact: Could add 3–5% to your total tax bill if you skip or short estimated payments
Who must pay estimated taxes: Sole proprietors, partners, S-corp shareholders, and anyone with significant income not subject to withholding (rental income, side gigs, etc.).
Deductions to Maximize
Vehicle Expenses
Options:
- Standard mileage rate (track miles)
- Actual expenses (track everything)
- Choose method that benefits you most
Documentation: Mileage log with date, destination, purpose, miles
Equipment
Equipment is one of the biggest tax opportunities for contractors. Two main tools: Section 179 and bonus depreciation.
Section 179 vs. Bonus Depreciation: Comparison
| Factor | Section 179 | Bonus Depreciation |
|---|---|---|
| Current limit (2025) | ~$1.2M max deduction | 60% first-year (phasing down from 100%) |
| Phase-out | Deduction phases out when purchases exceed ~$3M | No phase-out; applies to all qualifying property |
| Income limit | Cannot create a loss; limited to taxable income | Can create/show a loss (NOL) |
| Used equipment | Yes, if new to you | Yes (post-2017) |
| Best for | Profitable year; want to cap deduction | Large purchase year; want maximum upfront deduction |
| Sunset | Permanent (limits adjust annually) | Phasing out: 60% (2025), 40% (2026), 20% (2027), 0% (2028+) |
Best use cases:
- Section 179: Good year, bought $500K in equipment, want to zero out income but not go negative.
- Bonus depreciation: Bought $2M in equipment; Section 179 phases out. Take 60% bonus to maximize first-year deduction.
- Both together: Often you can combine—Section 179 first, then bonus on the remainder.
Equipment purchases are timing decisions. Buying in December vs. January shifts a full year of depreciation. Run the numbers with your CPA before the purchase.
Home Office
If you qualify:
- Percentage of home expenses
- Must be regular and exclusive use
- Simplified method available ($5/sq ft, max 300 sq ft = $1,500)
Retirement Plans
Options:
- SEP IRA (up to 25% of compensation)
- Solo 401(k) (higher limits)
- SIMPLE IRA (for employees too)
Benefit: Reduce taxable income while saving for retirement
Year-End Tax Planning Checklist
October
- Meet with CPA — Project year-end numbers; identify opportunities
- Review equipment plans — Will you buy before 12/31? Run Section 179 vs. bonus scenarios
- Check retirement contribution limits — How much can you still contribute?
- Accelerate or defer? — Decide based on whether this year will be strong or weak
November
- Prepay expenses — If good year: pay January insurance, stock up on supplies, prepay professional fees
- Delay income — If good year: push invoicing to early January where possible
- Or do the opposite — If bad year: bill and collect before year-end; delay deductible payments
- Charitable giving — Document donations; consider donor-advised fund for larger gifts
- Order equipment — If Section 179 or bonus depreciation is in play, place orders (placed in service by 12/31)
December
- Finalize equipment purchases — Must be placed in service by 12/31
- Max out retirement — SEP and Solo 401(k) deadlines (can extend to tax filing for SEP)
- Bonus/draw timing — Pay year-end bonuses or take distributions based on plan
- Reconcile books — Clean up WIP, receivables, payables so CPA has accurate numbers
- Q4 estimated payment — Due January 15; don't forget
You can make a SEP IRA contribution up until your tax filing deadline (including extensions). If you extend to October, you have until then to fund it—but you must have had the cash by 12/31 of the prior year in some cases. Ask your CPA.
Audit Red Flags for Contractors
The IRS uses data analytics to flag returns. These increase your audit risk:
| Red Flag | Why It Triggers | How to Avoid |
|---|---|---|
| High vehicle deductions | Personal use disguised as business | Mileage log; separate business vehicle; document % business use |
| Cash income | Underreporting suspected | Deposit all income; avoid "cash only" jobs when possible |
| Large equipment purchases | Section 179 abuse; hobby loss | Match deductions to actual use; reasonable for your revenue |
| Hobby loss rule | Years of losses suggest not a real business | Show profit motive; 3 of 5 years profitable helps |
| 100% business use of vehicle | Rarely true | Document; use actual %; don't claim 100% unless legitimate |
| Round numbers everywhere | Suggests estimates, not records | Use actual numbers; keep receipts |
| Home office | Easy to overstate | Use simplified method; ensure exclusive use |
| Large charitable deductions | Relative to income | Document; get appraisals for non-cash over $5K |
| Contractor with losses | Construction is often profitable | Explain anomalies; document cause (startup, recession, one bad job) |
Being conservative is good for audit risk, but don't leave legitimate deductions on the table. The goal is to pay what you owe—no more, no less. Good records protect you either way.
Construction-Specific Issues
Long-Term Contracts
- Special rules for contracts spanning years
- Percentage of completion often required
- Work with CPA on method selection
Retainage
- Tax treatment depends on accounting method
- May be able to defer until received
Equipment Heavy Businesses
- Depreciation strategies matter
- Section 179 and bonus depreciation
- Track basis for sale calculations
Working with Your CPA
Find the Right One
- Construction experience essential
- Understands your business
- Proactive tax planning
- Available throughout year
Interview Questions for a Construction-Savvy CPA
Before you hire, ask:
- "How many construction clients do you work with?" — You want someone who knows the industry, not a generalist.
- "Are you familiar with percentage-of-completion accounting?" — Essential for commercial contractors.
- "Do you understand Section 179 and bonus depreciation for equipment?" — They should explain it confidently.
- "How do you handle retainage and WIP?" — Construction-specific balance sheet items.
- "Do you do proactive tax planning, or just year-end filing?" — You want quarterly check-ins and strategy.
- "What's your approach to estimated taxes for irregular income?" — Seasonal contractors need annualized method.
- "Can you review our job costing and advise on overhead allocation?" — Shows they think beyond the return.
- "What are common audit triggers you see for contractors?" — They should know the red flags.
A CPA who specializes in construction may charge 20–30% more than a generalist. They'll typically save you far more than that in proper structuring, depreciation timing, and audit avoidance.
What to Provide
- Monthly financial statements
- Job cost reports
- Equipment purchase plans
- Major business changes
Disclaimer
This guide provides general information only. Tax laws change frequently and situations vary. Always consult with a qualified tax professional for advice specific to your situation.