Construction is a high-audit-risk industry — not because contractors are dishonest, but because the IRS has identified specific patterns where misreporting is common. Knowing those patterns lets you file a return that doesn’t fit the profile.
Construction is a high-audit-risk industry for reasons the IRS has documented. Knowing what specifically gets flagged lets you file a return that’s both aggressive (taking every legitimate deduction) and audit-resistant (with documentation).
The IRS publishes Audit Technique Guides (ATGs) for various industries. For construction, the ATG is publicly available on irs.gov. Themes that come up repeatedly: unreported cash income, personal expenses run through the business, inadequate subcontractor documentation, worker misclassification, inflated deductions, improper recognition of long-term contract income.
Auditors look for: lifestyle that doesn’t match reported income, bank deposits exceeding reported gross receipts, unusual customer mix (lots of cash, no checks). How to file defensibly: Report every dollar. Cash customers get receipts, get logged in sales records, get deposited in business bank account.
The IRS pays attention to large 1099 payments because they correlate with misclassification. They also notice missing 1099 filings — large subcontractor expenses with no corresponding 1099s issued. How to file defensibly: issue 1099-NEC for every unincorporated subcontractor paid over $600. Collect W-9s before payment. Pay by check/electronic transfer.
Auditors look for: claimed business-use percentages over 90% on a single-vehicle household, round-number mileage figures (always exactly 18,000 every year), no contemporaneous mileage log, vehicle deductions large relative to gross receipts, commuting miles claimed as business. Keep a contemporaneous mileage log. Don’t claim round numbers.
Auditors look for: meal deductions inconsistent with business activities, travel that looks personal (vacation destinations, family-trip timing), home office claims that don’t fit “exclusive and regular use” requirement, vehicle expenses on multiple vehicles when only one or two seem justified. Only deduct meals with clear business purpose. Document home office: exclusive-use room or area.
When a contract spans more than one tax year, the IRS has specific rules. Contractors under $30M (2024 threshold) can use completed-contract method for home construction; percentage-of-completion for other contracts. Auditors look for revenue recognition that doesn’t match industry norms.
The IRS audits worker classification aggressively in construction. If your “subcontractors” are really employees, the bill at audit time can dwarf your annual tax.
For 2022, the IRS audited about 0.45% of individual returns. Schedule C filers had higher rates — roughly 1.4%. Construction returns run slightly higher than Schedule C average, but still under 2% for most income ranges.
Report every dollar of income. Match bank deposits to gross receipts. Issue 1099-NECs on time. Keep contemporaneous mileage logs. Keep receipts (photo them with QBO mobile). Document worker classifications (W-9s for subs, W-4s for employees). Don’t claim 100% business use on shared-use assets. Don’t run personal expenses through the business. Reconcile books monthly. Match books to bank statements at year-end.
First 30 days matter. Don’t panic, don’t ignore, don’t call the IRS yourself before talking to a credentialed tax professional. An EA or CPA can read the notice and respond appropriately. Most “audits” are actually correspondence audits — letters asking for substantiation of specific items. Send it; the audit ends. The thing not to do: ignore the letter.
Foad is a federally licensed Enrolled Agent who writes about tax and bookkeeping for small businesses.