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Tax Intelligence › Client Playbooks › Construction Contractor IRC §162 • §168(k) • §179 • §460 Client Playbook — Trades & Construction Updated April 2026

Tax Planning Playbook for Construction Contractors and Trades Businesses: Equipment Depreciation, Vehicle Deductions, Subcontractor Compliance, Percentage-of-Completion Method, and Every Strategy That Reduces a Contractor’s Tax Bill in 2026

Construction contractors — general contractors, subcontractors, electricians, plumbers, HVAC technicians, roofers, and other trades professionals — operate businesses with significant capital equipment, multiple vehicles, large subcontractor workforces, and complex revenue recognition issues. A general contractor with $1,000,000 in annual revenue can reduce their taxable income by $150,000–$300,000 with proper equipment depreciation, vehicle deductions, retirement plan contributions, and entity structure. The One Big Beautiful Bill (OBBB) restored 100% bonus depreciation for 2026, making this the best year in recent memory to accelerate equipment deductions. This playbook covers every strategy for construction and trades businesses — written for the practitioner who wants to deliver comprehensive results.

100%
Bonus depreciation rate for 2026 (restored by OBBB) — a contractor who buys $500,000 in equipment in 2026 can deduct the entire $500,000 in Year 1 under IRC §168(k)
$2,560,000
2026 Section 179 expensing limit — allows immediate deduction of qualifying equipment and vehicles, subject to the taxable income limitation
$600
1099-NEC filing threshold — contractors who pay any subcontractor $600 or more in a year must file a 1099-NEC; failure to file results in penalties of $310 per form (2026)
$72,000
2026 SEP-IRA maximum contribution for a self-employed contractor — 25% of net SE income up to $72,000; the fastest retirement plan to set up for a sole proprietor or single-member LLC
✓ 2026 Bonus Depreciation Confirmed: 100% (OBBB, IRC §168(k)) ✓ 2026 Section 179 Limit Confirmed: $2,560,000 (Rev. Proc. 2025-32) ✓ 1099-NEC Penalty Confirmed: $310/form (2026, IRC §6721) ✓ 2026 Mileage Rate Confirmed: 70 cents/mile (IRS Rev. Proc. 2025-38) ✓ PCM Threshold Confirmed: $30M average annual gross receipts (IRC §460)
Business DeductionsIRC §162
Bonus DepreciationIRC §168(k)
Section 179IRC §179
Long-Term ContractsIRC §460
1099-NEC FilingIRC §6041A • Treas. Reg. §1.6041A-1
QBI DeductionIRC §199A

Equipment Depreciation: The Most Powerful Tool for Contractors in 2026

The One Big Beautiful Bill (OBBB) restored 100% bonus depreciation for property placed in service after January 19, 2025, and before January 1, 2030. This is the most significant tax change for capital-intensive businesses like construction contractors in years. Under IRC §168(k), qualifying property (machinery, equipment, vehicles over 6,000 lbs. GVWR, computers, and certain improvements) placed in service in 2026 can be deducted 100% in the year of purchase — no depreciation schedule, no waiting.

What qualifies for 100% bonus depreciation in 2026:

  • Heavy equipment: excavators, backhoes, bulldozers, cranes, forklifts, skid steers
  • Trucks and vehicles with GVWR over 6,000 lbs. (pickup trucks, work vans, dump trucks)
  • Trailers and attachments
  • Tools and equipment (power tools, hand tools, safety equipment)
  • Computers, tablets, and software
  • Qualified improvement property (QIP) — interior improvements to nonresidential buildings

What does NOT qualify for bonus depreciation:

  • Land (never depreciable)
  • Buildings (39-year MACRS; eligible for cost segregation to accelerate)
  • Passenger automobiles subject to the luxury auto limits (IRC §280F) — limited to $12,200 first-year deduction for vehicles under 6,000 lbs. GVWR

A contractor who purchases $800,000 in qualifying equipment in 2026 can deduct the entire $800,000 in 2026, generating a $296,000 federal income tax savings at the 37% marginal rate. This is a cash flow acceleration strategy — the contractor would have paid the same total tax over the equipment’s useful life under MACRS depreciation, but bonus depreciation moves the deduction to Year 1.

Subcontractor Compliance: 1099-NEC Filing Requirements

Construction contractors who use subcontractors face significant 1099-NEC filing obligations. Under IRC §6041A and Treas. Reg. §1.6041A-1, any business that pays $600 or more to an individual or unincorporated entity (sole proprietor, partnership, LLC taxed as a sole proprietor or partnership) for services in the course of a trade or business must file a 1099-NEC. The penalty for failure to file is $310 per form for 2026 (IRC §6721), with a maximum annual penalty of $3,783,000 for large businesses. For intentional disregard, the penalty is $630 per form with no maximum.

Key compliance points for contractors:

  • Collect Form W-9 from every subcontractor before the first payment — do not wait until year-end
  • Payments to corporations (including S-Corps) are generally exempt from 1099-NEC reporting, but payments for legal services to a corporation are still reportable
  • Payments to LLCs: if the LLC is taxed as a sole proprietor or partnership, the payment is reportable; if taxed as a C-Corp or S-Corp, it is generally exempt (but collect a W-9 to confirm the tax classification)
  • 1099-NEC forms must be furnished to recipients by January 31 and filed with the IRS by January 31
  • Backup withholding (24%) applies if the subcontractor fails to provide a valid TIN or if the IRS notifies the payer that the TIN is incorrect

Frequently Asked Questions

My contractor client bought a $120,000 pickup truck for the business. How much can they deduct in 2026?›

The answer depends on the truck’s gross vehicle weight rating (GVWR). If the truck has a GVWR over 6,000 lbs. (which most full-size pickup trucks do — a Ford F-250, Chevy Silverado 2500, Ram 2500, or similar), it qualifies for 100% bonus depreciation under IRC §168(k) and is not subject to the luxury auto limits under IRC §280F. If the business use is 100%, the contractor can deduct the full $120,000 in 2026. If the business use is 80%, the deductible amount is $96,000 (80% of $120,000), and the remaining $24,000 is not deductible. The contractor must maintain a mileage log documenting business vs. personal use to support the business-use percentage. If the truck has a GVWR of 6,000 lbs. or less (e.g., a smaller pickup or car), it is subject to the IRC §280F luxury auto limits, which cap the first-year deduction at $12,200 for 2026 (plus any additional first-year depreciation allowed under §168(k) for passenger automobiles, which is an additional $8,000 for 2026 = $20,200 total first-year limit). For a $120,000 passenger automobile, the remaining $99,800 would be depreciated over the remaining useful life under MACRS. Practitioners should verify the GVWR of any vehicle before advising on the depreciation deduction — the difference between a truck over and under 6,000 lbs. GVWR can be $100,000+ in first-year deductions.

My contractor client uses the cash method of accounting. Should they switch to the percentage-of-completion method for long-term contracts?›

The percentage-of-completion method (PCM) is required for long-term contracts under IRC §460 for contractors with average annual gross receipts exceeding $30 million (2026 threshold, adjusted for inflation). Contractors below this threshold can use the completed-contract method (CCM) or the cash method for long-term contracts. Under PCM, income is recognized as the contract progresses (based on costs incurred to date divided by estimated total costs). Under CCM, income is recognized when the contract is completed. Under the cash method, income is recognized when received and expenses are deducted when paid. For a contractor below the $30 million threshold, the cash method or CCM is generally more favorable from a tax deferral perspective because it allows the contractor to defer income recognition until the contract is completed or cash is received. However, the cash method has limitations: it cannot be used by C-Corps with gross receipts over $30 million, and it can create large income spikes in years when multiple contracts are completed. Practitioners should model the contractor’s projected income under each method and choose the one that minimizes the present value of tax liability over the relevant time horizon. The choice of accounting method is made on the tax return for the first year the method is used and generally requires IRS consent to change (Form 3115).

More Tax Planning FAQs

What equipment depreciation strategies are available for construction contractors?
Construction equipment qualifies for §179 expensing up to $1,220,000 in 2026 and 100% bonus depreciation (restored by OBBBA for property placed in service after Jan 19, 2025). Heavy equipment (excavators, cranes, bulldozers) with a GVWR over 6,000 lbs is not subject to luxury auto limits. A contractor purchasing $300,000 in equipment can deduct $120,000+ in the first year. Equipment must be placed in service during the tax year to qualify.
How does the percentage-of-completion method affect a contractor’s taxes?
Under the percentage-of-completion method (PCM), income is recognized as a percentage of the contract price equal to the percentage of work completed. Contractors with average annual gross receipts over $30 million must use PCM for long-term contracts. Contractors below this threshold can use the completed-contract method, deferring income until the contract is complete. The choice of accounting method significantly affects the timing of tax liability.
Can a construction contractor deduct vehicle expenses?
Construction contractors can deduct vehicle expenses using either the standard mileage rate (70 cents/mile in 2026) or actual expenses. Heavy trucks and SUVs with a GVWR over 6,000 lbs qualify for §179 expensing and bonus depreciation without the luxury auto limits. A $80,000 pickup truck used 100% for business can be fully expensed in the first year under §179.
What is the tax treatment of subcontractor payments?
Payments to subcontractors are deductible as a business expense. Contractors must issue Form 1099-NEC to subcontractors paid $600 or more during the year. Failure to issue 1099s can result in the contractor being denied the deduction. Contractors should obtain Form W-9 from all subcontractors before making payments to ensure accurate 1099 reporting.
How does the home office deduction apply to a construction contractor?
A construction contractor who uses a dedicated home office space exclusively and regularly for administrative work (estimating, billing, scheduling) qualifies for the home office deduction under §280A. The deduction is calculated as a percentage of home expenses equal to the office’s share of total home square footage. The home office must be the contractor’s principal place of business.
What retirement plan options are available for construction business owners?
Construction business owners can establish a Solo 401(k) (up to $70,000 in 2026), a SEP-IRA (25% of W-2 wages up to $70,000), a SIMPLE IRA, or a Defined Benefit Plan. For owners with employees, a SIMPLE IRA or 401(k) plan must cover eligible employees. The employer match is deductible as a business expense.
Can a construction contractor deduct the cost of tools and supplies?
Yes. Tools and supplies used in the construction business are deductible as business expenses. Small tools costing less than $2,500 can be expensed immediately under the de minimis safe harbor. Larger tools must be depreciated or expensed under §179. Safety equipment (hard hats, gloves, safety glasses) required by OSHA is also deductible.
What is the tax treatment of retainage for construction contractors?
Retainage (the portion of contract payments withheld until project completion) is not taxable until received by the contractor (cash basis) or until earned (accrual basis). Contractors using the completed-contract method defer all income, including retainage, until the contract is complete. Contractors using the percentage-of-completion method recognize retainage income as the project progresses.
How does the S-Corp election reduce self-employment tax?
An S-Corp election allows the owner to split income between a reasonable salary (subject to 15.3% FICA on the first $176,100 in 2026) and distributions (not subject to FICA). For a business owner with $200,000 in net profit paying an $80,000 salary, the annual SE tax savings are approximately $15,500–$18,500. The S-Corp must file Form 2553 within 75 days of formation.
What is the Section 199A QBI deduction and how does it apply?
The §199A deduction allows pass-through business owners to deduct up to 23% of qualified business income (QBI) from taxable income (increased from 20% under OBBBA). For taxpayers above $403,500 (MFJ) in 2026, the deduction is limited to the greater of 50% of W-2 wages or 25% of W-2 wages plus 2.5% of qualified property. Specified Service Trades or Businesses (SSTBs) phase out above this threshold.
What retirement plan options are available for self-employed professionals?
Self-employed professionals can establish a Solo 401(k) (up to $70,000 in 2026), a SEP-IRA (25% of net self-employment income up to $70,000), a SIMPLE IRA ($16,500 + $3,500 catch-up), or a Defined Benefit Plan (up to $280,000+ depending on age). The Solo 401(k) is the best option for most self-employed professionals because it allows the highest contributions relative to income.
How should a construction contractor set up payroll for S-Corp shareholder-employees to ensure compliance with FICA tax requirements?
To set up payroll correctly for S-Corp shareholder-employees, the contractor must determine and pay a reasonable salary subject to FICA taxes, per Subchapter S requirements. The salary should reflect market compensation for the services rendered, considering the IRS's focus on reasonable compensation under §3121(d). For 2026, wages up to $184,500 are subject to the 12.4% Social Security tax portion of FICA, plus 2.9% Medicare tax on all wages, with an additional 0.9% Medicare surtax applying above certain thresholds. Proper payroll setup includes timely filing of Forms 941 and 940 to report FICA and FUTA taxes. Failure to comply can result in recharacterization of distributions and penalties.
What steps should a construction contractor take to file employment tax returns properly when operating as an S-Corporation?
A construction contractor operating as an S-Corp must file Form 1120-S annually to report corporate income and Form 941 quarterly to report payroll taxes, including FICA and Medicare. Form 940 is required annually for FUTA taxes. The contractor must accurately report wages paid to shareholder-employees, ensuring compliance with the Social Security wage base limit of $184,500 for 2026 and the applicable Medicare taxes. Timely deposits of payroll taxes are critical to avoid penalties. Additionally, issuing Form W-2 to shareholder-employees reflecting wages and tax withholdings is mandatory.
What documentation should a construction contractor maintain to substantiate a reasonable salary for S-Corp shareholder-employees?
Maintaining thorough documentation is essential to justify a reasonable salary under IRS scrutiny. Contractors should keep records such as industry salary surveys, job descriptions, hours worked, and comparable employee compensation data. Documentation of the shareholder-employee’s role, responsibilities, and time devoted to the business supports the salary determination. This evidence is critical in the event of an IRS audit, where the agency evaluates reasonableness under §3121(d) and related case law. Without proper documentation, the IRS may reclassify distributions as wages, triggering additional payroll tax liabilities and penalties.
What audit triggers should construction contractors be aware of regarding S-Corp shareholder-employee compensation?
Significant disparities between shareholder-employee salaries and distributions often trigger IRS audits, especially when the salary appears unreasonably low to minimize FICA taxes. The IRS scrutinizes salaries that are disproportionately small relative to distributions or industry standards, as allowed under §3121(d). Consistent underpayment of payroll taxes or failure to file Forms 941 and 940 correctly also raises red flags. Contractors should ensure salaries align with market rates and maintain comprehensive payroll records to mitigate audit risks.
If a construction contractor operates both as a sole proprietor and an S-Corp, can they combine income and payroll for FICA tax purposes?
No, income and payroll cannot be combined across business entities for FICA tax purposes because each entity is treated separately under the tax code. Wages paid by the S-Corp to the shareholder-employee are subject to FICA tax and reported on employment tax returns, while sole proprietorship income is subject to self-employment tax under §1401. The Social Security wage base limit of $184,500 applies separately to wages reported from the S-Corp, but self-employment income is aggregated with other self-employment earnings to calculate SE tax. Proper segregation of payroll and income reporting is essential to comply with IRS requirements.
How does the tax treatment of S-Corp shareholder-employee salary compare to distributions in terms of payroll and income tax implications?
S-Corp shareholder-employee salaries are subject to FICA taxes (12.4% Social Security up to $184,500 for 2026 plus 2.9% Medicare tax) and must be reported on Forms W-2 and 941. These wages are deductible by the S-Corp as a business expense, reducing corporate taxable income. Distributions, however, are generally not subject to payroll taxes and are taxed at the shareholder level, avoiding double taxation. However, distributions must not replace reasonable compensation; otherwise, the IRS may reclassify distributions as wages, triggering back payroll taxes and penalties per §3121(d).
What key questions should I ask a construction contractor client to advise on setting a reasonable salary for their S-Corp shareholder-employee role?
Begin by asking about the specific duties and hours worked in the business to understand their operational role. Inquire about industry benchmarks or prior salary history to gauge market compensation rates. Determine if the shareholder-employee performs multiple roles or supervises employees, as this impacts reasonable compensation under §3121(d). Also, review the company’s profitability and cash flow to assess salary feasibility. Finally, verify if the client maintains proper payroll and tax filings to avoid compliance issues.

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Professional Disclaimer

The information on this page is intended for licensed tax professionals (CPAs, EAs, and tax attorneys) and is provided for educational and research purposes only. Tax law is complex and fact-specific — all strategies discussed are subject to limitations, phase-outs, and conditions that may not apply to every client situation. Practitioners should independently verify all information against current IRS guidance, Treasury Regulations, and applicable state law before advising clients. This content does not constitute legal or tax advice.

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