When you think of business risk, how often do you think about tax strategy? If you’re not thinking of these two aspects simultaneously, it’s time to connect them. Construction companies often face unique challenges because of project-based work, revenue-recognition timing, and varied contract types, so a tax strategy can be a powerful tool that helps mitigate risk and strengthen financial resilience.

This article covers common risks in the construction industry, tax specialties to consider, and ways to incorporate those tax strategies into your risk management plan.

Common Business Risks for Contractors

Cash Flow Risks & Tax Method Planning

For contractors, cash is king; tax reporting methods are critical in helping to reduce cash flow risks.

Understanding and regularly considering various tax reporting methods can offer benefits:

• Tax planning: Model tax liability based on project timelines.

• Cash flow management: Select ideal methods as your company changes and grows.

• Risk mitigation: If your company has been using an impermissible method, then consider adjusting to reduce exposure to IRS penalties. If preparing for a sale, then remedy it so it does not become an issue in due diligence.

Certain tax methods can have additional considerations outside net income timing differences, including the alternative minimum tax, state conformity, and your company’s future plans.

Business Risks

Construction companies often come under scrutiny from the IRS and state tax authorities because of operational complexities, types and number of revenue streams, and work across jurisdictions.

Audits

While full-scope audits are uncommon and tend to involve fraud cases, contractors can be subject to random checks. Some common audit triggers include payroll tax noncompliance, incorrect jurisdiction reporting, improper revenue recognition, and improper allocation of income across states.

Red flags for contractors include large changes in revenues year over year, high independent contractor expenses while retaining few W-2 employees, presence in multiple states but only filing in one, and frequent method changes or amended returns.

If an audit does occur, then engaging a knowledgeable tax controversy professional from the first letter of questions or audit announcement is critical. Errors made at the beginning of the audit process are often difficult to repair later.

Employee Retention Credit & Microcaptives

The IRS is spending more time focusing its efforts on specific tax strategies where they believe aggressive approaches may have been used.

The IRS has indicated it believes many Employee Retention Credit (ERC) claims are at high risk for fraud and improper filing.

The significant benefits the ERC offered businesses prompted the emergence of numerous third-party providers; however, some of these providers took aggressive or unsubstantiated positions.¹ Contractors in particular were affected as they faced lingering effects of the COVID-19 pandemic, such as project delays and supply chain disruptions.

As insurance costs have steadily increased for contractors over the past few decades, construction companies have sought cost-saving or tax-planning outlets, such as microcaptives.

Among the various microcaptives available, Internal Revenue Code (IRC) Section 831(b) gained particular attention, becoming a listed transaction of the IRS and a top audit priority.

Many microcaptives have been flagged by the IRS as abusive tax shelters, where companies may put more money into the plan than permitted.² This is typically done via unjustified premium calculations, rare or non-existent claims, or recycling premiums back to related parties.

Given the volatility of material prices and the insurance market in the construction industry, there is a large appeal to decrease costs where possible.