In the construction industry, you’re constantly managing projects, juggling contractors, and watching your bottom line. But there’s another critical aspect that can’t be overlooked, staying on the IRS’s good side. Construction businesses face unique tax challenges and are unfortunately, more likely to get flagged for audits. That’s why it’s essential to understand the IRS red flags for construction businesses and take steps to avoid them.

At Tavola Group, we specialize in year-round tax planning for businesses just like yours. We know where the pitfalls are and how to help you steer clear of them. In this blog, we’re breaking down some of the top IRS red flags for construction businesses, so you can stay compliant and reduce risk.

 

High Cash Payments and Lack of Documentation

The IRS pays extra attention to industries that tend to deal in large amounts of cash and construction happens to be one of them. Whether it’s payments from clients, subcontractors, or suppliers handling large amounts of money without proper documentation can raise immediate red flags.

If you’re accepting cash payments, make sure you’re documenting everything thoroughly. That includes issuing receipts, logging payments in your accounting system, and reconciling your records regularly. Failure to do so not only opens you up to audits but it could lead to serious tax penalties.

 

Misclassification of Workers: Employee vs. Independent Contractor

One of the most common and costly mistakes construction businesses make is misclassifying workers. Classifying someone as an independent contractor when they should legally be considered an employee can trigger an IRS audit.

We see this all the time. Maybe you’re trying to save on payroll taxes, or maybe you just didn’t know the classification rules. But the IRS takes worker misclassification seriously because it affects tax revenue and employee protections. If the IRS decides your contractors should’ve been employees, you could be on the hook for back taxes, interest, and penalties.

Always review the IRS guidelines and consult a tax advisor before deciding how to classify your workers.

 

Unusually High Deductions or Losses

We get it construction expenses can add up quickly. But if your business reports unusually high deductions or continuous losses year after year, the IRS may start to take a closer look.

Common deductions include:

• Excessive vehicle or equipment expenses
• High travel and entertainment costs
• Large home office deductions
• High meals expenses without proper substantiation

It’s not that you can’t claim these deductions, it’s that you need to make sure they’re legitimate, documented, and reasonable for your business. A proactive tax plan can help ensure your write-offs are above board and audit-proof.

 

Underreported Income

This is one of the biggest red flags of all. If the income you report doesn’t match what the IRS expects based on your 1099s or industry averages, you could be inviting an audit.

Construction businesses often deal with multiple payers, job sites, and contract types, which makes it easy to overlook or underreport income. But remember the IRS receives copies of every 1099 you get, and they use sophisticated algorithms to cross-check your numbers.

Make sure your bookkeeping is tight, all income is reported accurately, and you reconcile your 1099s before filing. 

 

Inconsistent Payroll Records

Payroll is a huge area of risk for construction businesses, especially if you have both full-time employees and independent contractors. If your payroll records are incomplete, inconsistent, or don’t align with your tax filings, the IRS may flag your business.

We’ve seen cases where contractors pay workers off the books or forget to issue W-2s or 1099s on time. Not only is this a compliance issue, but it also puts you at risk for fines and penalties.

To avoid this red flag, maintain consistent payroll records, use reputable payroll software, and file your tax documents on time. 

 

Failure to File 1099s for Subcontractors

Construction companies often rely heavily on subcontractors. But here’s the catch, if you paid any contractor over $600 during the year, you’re required to file a Form 1099-NEC with the IRS.

Missing, late, or incorrect 1099s can trigger audits, especially if the income isn’t reported elsewhere. And with the IRS increasing enforcement around contractor payments, this is a red flag you’ll want to avoid.

Don’t wait until January to gather this information. Track contractor payments throughout the year, collect W-9s up front, and file your 1099s accurately and on time.

 

Not Reconciling Bank Statements

You’d be surprised how many construction businesses skip this step, but not reconciling your bank and credit card statements can cause major problems. If the IRS sees mismatches between your deposits and reported income, it may look like you’re underreporting revenue.

We always recommend reconciling your accounts monthly and using accounting software that can flag discrepancies early. If your books don’t add up, the IRS will want to know why and that’s a conversation you’d rather avoid.

 

Business and Personal Finances

This is a big one, especially for small construction firms and sole proprietors. If you’re using your business account to pay for personal expenses (or vice versa), it’s a huge audit trigger.

The IRS wants to see clear separation between business and personal finances. That means having a dedicated business bank account, using business credit cards, and never mixing funds. It also means keeping clean records of all business expenses, with receipts and notes.

 

Large Fluctuations in Income or Expenses

Construction is a seasonal business, so some fluctuation is expected. But if your reported income or expenses swing wildly from year to year without a clear explanation, the IRS might start asking questions.

Maybe you had a big job one year and a slow season the next. That’s perfectly normal, but you need to be prepared to explain those fluctuations, and you need documentation to back it up.

One of the best ways to protect yourself is through proactive tax planning. When you work with a firm like Tavola Group, we help you track trends, prepare explanations, and build a strong case for your financials.

 

Inadequate Recordkeeping

At the end of the day, almost all IRS red flags boil down to poor recordkeeping. If you can’t support your deductions, income, or contractor payments with documentation, the IRS may disallow your claims and charge penalties.

We can’t stress this enough, good bookkeeping is your first line of defense against audits. Whether you do it yourself or outsource it, make sure your records are accurate, complete, and easy to retrieve. We help our clients put systems in place that make this simple and sustainable.

 

How We Help Construction Businesses Avoid IRS Trouble

At Tavola Group, we partner with construction companies nationwide to develop proactive tax strategies that reduce risk and boost profitability. We know the unique tax challenges your industry faces because we’ve helped clients navigate them firsthand.

Whether you’re dealing with worker classification issues, inconsistent income tracking, or the complexities of 1099 reporting, we’re here to simplify the process. Our approach goes beyond filing, we focus on strategic planning, minimizing red flags, and keeping your business audit-ready year-round.

If you’re concerned about potential IRS red flags or simply want to make sure your construction business is on the right track, now is the perfect time to book a free tax planning consultation. We’ll review your current tax setup, uncover any areas of risk, and offer expert insights to help you stay compliant while minimizing your tax liability.