Taxes 101 for Contractors & Construction Companies

Key Takeaways: 

• Choose the right entity type — S‑corps often offer the best tax benefits for contractors by avoiding double taxation and reducing self‑employment tax exposure. 
• Match your accounting method to your revenue size — Smaller contractors may use cash or completed‑contract methods, while larger ones must use accrual or percentage‑of‑completion. 
• Use bonus depreciation strategically — Many types of equipment qualify, but contractors should plan carefully to avoid storage and vehicle‑eligibility pitfalls. 
• Don’t overlook R&D credits — Experimentation, modeling, and solving engineering challenges can qualify contractors for valuable credits traditionally associated with tech. 
• Watch SALT exposure across states — Simply installing or selling in a state can create nexus, and in some cases filing in more states can even create “nowhere sales” benefits. 
• Proactive planning reduces risk — Construction tax rules are complex, and early guidance helps contractors avoid compliance issues and uncover savings opportunities. 

Taxes 101 for Contractors & Construction Companies 

Long project timelines, multistate operations, and unique revenue recognition rules — taxes in the construction industry are more complex than many people think. This basic guide to construction taxation will help you avoid risks and noncompliance and maximize available tax savings. 

Construction Company Entity Selection 

The legal form you choose for your company will have substantial tax implications. The three common entity classifications that you can choose from are:  

• C-corporation 
• S-corporation 
• Partnership/sole proprietorship 

In the construction industry, S-corporations are typically the most beneficial entity classification. S-corporations have a single level of taxation, and income is not subject to self-employment taxes (although you need to take a reasonable salary).  

C-corporations are generally only selected if the company has foreign investors or could benefit from the 1202 Gains Exclusion because of plans to sell the company in the future. A C-corp is not a favored entity classification for construction companies because income is taxed twice — once when it is earned and again when it is distributed to shareholders.

Partnerships are usually only selected when income will be distributed or allocated in a method contrary to ownership percentages (which is disallowed in S-corps). The downside of partnerships is that all income is subject to self-employment tax. Although it is oversimplifying to say, a sole proprietorship is essentially a partnership with only one partner.  

This is a high-level review of the issues to consider when selecting an entity. It is best to discuss this topic with a qualified advisor; our team can assist with entity selection in the construction sector.  

Accounting Methods 

After you select your entity structure, you will need to select your accounting method from the following:  

• Cash method – Revenue is recorded when cash is received, and expenses are recorded when paid. This is usually the best method if you are allowed to use it. It is limited to companies whose average gross receipts total less than $31 million (indexed for inflation) over the past three years.  
• Accrual method – Revenue is recorded when earned (when work is performed/items are delivered), and expenses are recorded when they are incurred (items are received or work is completed). This method is required if your average gross receipts for the past three years exceed $31 million (indexed for inflation).  
• Completed contract method - If you are a homebuilder or your average gross receipts total less than $31 million (indexed for inflation) over the past three years, you also have the option of using the completed contract method. Contract revenue and expenses are capitalized until the completion of the contract, when they are then taken into income.  
• Percentage-of-completion method - If you have long-term contracts and your three-year average revenue exceeds $31million (indexed for inflation), you will need to use the percentage-of-completion method to record the revenue and expenses associated with that contract. In the percentage-of-completion method, you recognize income and expenses ratably as you complete the project. The usual method of calculation is using the cost-to-cost method. Here’s a more detailed look at revenue recognition methods.   

Understanding Depreciation Options for Construction Companies 

You are allowed to reduce your taxable income for the cost of purchasing equipment used in your business.  

Bonus depreciation is an accelerated tax deduction that allows you to deduct the cost of a qualifying expense immediately. This is opposed to spreading depreciation over a longer period, thereby having to wait to see that money. 

Lots of equipment is eligible for bonus depreciation, but be warned: 

• Certain limits exist on passenger vehicles, so be sure the vehicle you purchase meets eligibility criteria, or you won’t see that bonus depreciation.  
• Just because you can purchase equipment and receive that bonus doesn’t mean you should. Consider how much it’ll cost to store that equipment. Is it worth it? Careful planning is warranted.  

Section 179 is similar to bonus depreciation. Both let contractors write off equipment and expedite depreciation. Section 179, however, has a maximum overall deduction; it is reduced if you put too many assets in service and section 179 cannot create a loss. Bonus depreciation is almost always the correct answer. Our contractor clients rely on both depending on the situation, and we can advise you which is best for you at any given time. 

Research & Development Credits for Contractors 

In the interest of further maximizing your savings, keep abreast of R&D credits you’re eligible to claim. You can generally get a credit for activities that: 

• Improve products/processes 
• Eliminate uncertainty 
• Are technological in nature 
• Require an experimentation process 

Many contractors assume these credits are reserved for the tech industry, but that’s not the case. If your team is experimenting, modeling, testing, or solving engineering uncertainties — that’s R&D. Let us help you claim the credit you are due. 

State & Local Tax (SALT) Concerns Contractors Should Watch 

SALT is always top-of-mind for our tax professionals serving construction clients because of the opportunities and exposure it can present. We can address income, franchise, excise, sales, use, and other state tax issues. Keep in mind that simply selling products or performing an installation can create a nexus that requires filing tax returns in a state. That's because nexus can be triggered not only by a brick-and-mortar business presence, but also by economic means.  

Sometimes filing in additional states can turn into a tax benefit. For example, in some instances, we should consider creating a nexus to generate what are called “nowhere sales.” Nowhere sales mean that those sales are not taxed in any state. You can only do this if you file in more than one state and you sell to a state that allows for nowhere sales.  

Let us investigate nexus along with any of these other tax items for construction companies. As a team, we enjoy providing service in areas that others may not be addressing.