General Contractor Tax Under Section 263A: Uniform Capitalization, Long-Term Contracts, and the Construction Industry Tax Playbook
What Section 263A actually requires for a general contractor
IRC §263A is the uniform capitalization rule. It says certain costs that would otherwise be deductible as period expenses have to be added to the basis of property you produce. For a general contractor, ‘property you produce’ is a building, a road, a swimming pool, a finished basement, anything tangible that gets handed to a customer when the job ends.
Direct costs are obvious — lumber, drywall, concrete, the framing crew’s wages, the foreman’s wages on a particular job. Everybody knows those go into job cost. 263A is about the second bucket: indirect costs. The IRS wants those allocated to the job too, instead of deducted as overhead.
Treas. Reg. §1.263A-1(e)(3) lists indirect costs that have to be capitalized when allocable to production: utilities at a jobsite, equipment maintenance, repairs on construction equipment, rent on a tool yard, depreciation on a backhoe used across multiple jobs, taxes on real property used in production, insurance, employee benefits for production-side workers, indirect labor (the bookkeeper who codes job-cost invoices, the dispatcher who routes crews), purchasing costs, handling and storage of materials, and a slice of officer compensation tied to production oversight.
What stays as a deductible period expense? Selling expenses, advertising, marketing, general business meals, owner compensation tied to non-production activities like bidding new work or running the office, interest (with its own §263A(f) rules), and most income tax expense.
The mechanic. At year-end you compute total indirect production costs, allocate them across all jobs in progress using a reasonable method (typically a labor-hours or direct-cost ratio), and add the allocated piece to each job’s WIP balance. The WIP balance sits on the balance sheet. When the job closes the next year, the capitalized indirects flow into COGS and finally reduce taxable income.
The cash-flow effect. A contractor with $2M of revenue and $400K of indirect overhead, three open jobs at year-end representing 40% of annual labor — 263A says $160,000 of that overhead gets capitalized into WIP. Federal tax at 24% marginal: a $38,400 timing hit in year one. That money comes back when those jobs close, but it’s not gone, just deferred.
Why the IRS cares. Contractors used to deduct everything as paid. The construction industry was a giant timing gimmick. Congress tightened the rules in 1986 (TRA ’86) and Treasury has been refining the regs since.
Who isn’t subject? Two categories. Small contractors who meet the §471(c) gross-receipts test (covered below). And taxpayers whose production activity is fully on the long-term contract method under §460 — though §460 has its own production-cost capitalization rules that look a lot like 263A.
Rev. Proc. 2024-40 set the 2026 small-business threshold at $31M average gross receipts (three-year average). If your shop is under $31M and you meet the rest of the test, you’re exempt from 263A and from the §471 inventory rules.
The small-contractor exception — $31M average gross receipts
The big break for most general contractors is the small-business taxpayer exemption. Tax Cuts and Jobs Act §13102 created the $25M threshold in 2018 and indexed it for inflation. Rev. Proc. 2024-40 set the 2026 figure at $31M.
The test. Your average annual gross receipts for the three prior tax years has to be $31M or less. If you’re a calendar-year filer reporting 2026, you look at 2023, 2024, and 2025 receipts. Add them. Divide by three. Under $31M and you qualify.
What counts as gross receipts? Total sales from operations, before COGS. For a GC that’s all customer billings — progress billings, change orders, retainage when earned, the works. Don’t net out anything other than returns and allowances. IRC §448(c) aggregation rules apply if you control multiple entities under common ownership: receipts of all controlled entities are added together.
Three-year lookback example. Riverside Construction LLC has gross receipts of $26M in 2023, $29M in 2024, $35M in 2025. Average is ($26 + $29 + $35) / 3 = $30M. Under the $31M threshold. Qualifies for 2026.
Aggregation trap. The owner of Riverside Construction also owns Riverside Excavation LLC, which had $8M, $9M, $10M of gross receipts. Same controlled group under §52(a). Aggregate receipts are $34M, $38M, $45M = $39M average. Over the threshold. Both entities are subject to 263A.
Why this catches people. GCs frequently spin off subsidiary entities for equipment ownership, for joint ventures, for liability protection. If common control exists, all of it aggregates.
Benefits of being a small contractor.
First, exemption from 263A. You don’t have to capitalize indirect costs to WIP. Lumber, labor, and subs still go into job cost the normal way, but the office bookkeeper’s salary, the truck depreciation, the jobsite trailer rent — all current deductions.
Second, you can use cash-method accounting instead of accrual under §448(c). Cash method means revenue when collected, expense when paid. Massive timing benefit for a business with growing receivables.
Third, you can elect §471(c) — treat inventory using your books-and-records method. For a GC, this often means no formal job-cost system is required for tax purposes if your books treat materials as expense when purchased.
Fourth, exemption from §163(j) interest-deduction limitation. Below $31M, you deduct interest expense without the 30%-of-EBITDA cap.
Election mechanics. The exemption is automatic if you qualify — no form to file in the first year you cross under the threshold. To change your accounting method when you become a small business taxpayer (or when you stop being one), file Form 3115 Application for Change in Accounting Method. Designated automatic-change numbers cover the common situations and don’t require IRS approval.
What if you cross above $31M? You’re subject to 263A starting the first year your three-year average exceeds the threshold. Form 3115 to change methods. Section 481(a) adjustment captures the income or loss from the method change and spreads it over four years if positive (income), one year if negative (loss).
Long-term contracts under §460 — when this overrides 263A
IRC §460 governs long-term contracts. A long-term contract is one that doesn’t get completed within the taxable year it’s entered into AND involves the manufacture, building, installation, or construction of property. Roofers doing a one-week reroof — not a long-term contract. A GC building a custom home that starts in October and finishes the following March — long-term contract.
Two methods exist for long-term contracts. Percentage-of-completion method (PCM) — generally required for all long-term contracts except home construction. Completed-contract method (CCM) — available only for home construction contracts and for small contractors meeting the §460(e) exception.
Percentage-of-completion math. Each year, you recognize a portion of the contract revenue and contract cost equal to the percentage of total costs incurred to date divided by total estimated costs.
Example. Lighthouse Builders signs a $1,000,000 commercial buildout contract. Estimated total cost: $750,000. Year 1 costs incurred: $200,000. Year 1 percentage complete: $200,000 / $750,000 = 26.67%. Year 1 revenue recognition: $1,000,000 × 26.67% = $266,700. Year 1 cost recognition: $200,000. Year 1 gross profit: $66,700.
Year 2 costs: another $450,000. Cumulative costs: $650,000. Cumulative percentage: $650,000 / $750,000 = 86.67%. Cumulative revenue: $866,700. Year 2 revenue recognition: $866,700 – $266,700 = $600,000. Year 2 cost: $450,000. Year 2 profit: $150,000.
Year 3 (completion). Final costs $100,000 (actual total $750K matches estimate). Final billing $133,300. Year 3 profit: $33,300. Total profit across three years: $250,000.
Look-back interest under §460(b)(2). If your actual costs differ materially from estimates, the IRS hindsight-calculates what the gross profit recognition should have been and charges or refunds interest on the difference. Compute via Form 8697. The simplified marginal-impact method (most contractors elect it) caps the analysis at the contract level rather than line-by-line.
Look-back is the part contractors hate. You finished a job two years ago, but if reality didn’t match the estimates you reported, the IRS comes back and charges retroactive interest. The interest rate is the §6621 underpayment rate (currently 8% annual through 2026). For a contractor whose actual gross profit on a large job came in $100,000 higher than reported, look-back interest can add $10K-$15K of tax cost spread over multiple years.
Completed contract method. CCM defers all revenue and cost recognition until the year the contract is substantially complete (95% or more of costs incurred, customer in possession, or contract acceptance — whichever happens first per Treas. Reg. §1.460-1(c)). For a GC running long jobs, CCM can defer income recognition by 1-3 years.
Who can use CCM? §460(e)(1) small-contractor exception: contracts expected to be completed within two years AND contractor average gross receipts under $31M (2026, same threshold as the §263A exemption). Plus home-construction contracts (residential buildings with four or fewer dwelling units), regardless of contractor size.
Mixing methods. A GC who does both spec houses and commercial work might use CCM for home construction contracts and PCM for commercial work simultaneously. Each contract is evaluated separately.
The 263A overlap with §460. §460 has its own production-cost allocation rules in §460(c) that look a lot like 263A. For PCM contracts, allocable contract costs include direct material, direct labor, AND indirect costs (similar list to 263A). For CCM contracts under the small-contractor exception, only direct costs need to be capitalized — indirect costs can be expensed currently if the contractor is small.
Allocating indirect costs — labor-based, direct-cost-based, and step-allocation methods
Once you decide indirects need to be allocated to jobs (because you’re over $31M or just want a cleaner picture), how do you actually do it? Treas. Reg. §1.263A-1(f) and §1.263A-2 give you several methods.
Simplified production method (SPM). The catchall for taxpayers not in inventory-heavy production. Allocate additional 263A costs to ending inventory and WIP using a ratio: (additional 263A costs) / (total §471 costs incurred during the year) × (§471 costs in ending inventory/WIP).
Example. Northern Construction has $400,000 of indirect costs subject to 263A capitalization. Total §471 costs (direct materials, direct labor, subs, and pre-263A indirects already in job cost) for the year are $4,000,000. Year-end WIP balance using §471 costs: $1,000,000. SPM allocation: ($400K / $4M) × $1M = $100,000 of additional 263A costs added to ending WIP.
Simplified resale method (SRM). For pure resellers. Most GCs don’t qualify.
Modified simplified production method (MSPM). Refinement of SPM that separates pre-production and production costs. More accurate but more record-keeping.
Specific identification. Allocate each indirect cost to the specific job it relates to. Most accurate, most labor-intensive. Useful for contractors with a small number of large jobs (e.g., a custom home builder with three jobs at any time).
Facts-and-circumstances method. Any reasonable allocation under Treas. Reg. §1.263A-1(f)(4). Contractors with sophisticated job-cost systems often use a labor-hours method (allocate indirect costs based on labor hours per job) or a direct-cost-ratio method (allocate based on direct cost incurred per job).
Labor-hours allocation example. Three open jobs at year-end. Project A had 800 hours of direct labor. Project B had 1,200 hours. Project C had 500 hours. Total open-job labor hours: 2,500. Project A gets 32% of indirect cost allocation (800/2500). Project B gets 48%. Project C gets 20%.
Burden rate method. Compute a ‘burden rate’ as a percentage of direct labor cost. If your indirect costs subject to 263A are 25% of direct labor for the year, apply a 25% burden rate to direct labor in WIP. So a job with $50,000 of direct labor in WIP gets $12,500 of indirect cost added.
The 1% de minimis rule. Treas. Reg. §1.263A-1(e)(3)(iii) lets you skip allocation for indirect costs that are less than 1% of total §471 costs (subject to certain limits). Marginal cost categories can be expensed.
Mixed service costs. Office overhead is a ‘mixed service cost’ — partially benefits production, partially not. Treas. Reg. §1.263A-1(h) gives a simplified service-cost method: allocate mixed service costs between production and non-production using a labor-cost ratio.
Audit defense. Whatever method you pick, document it. Write a memo describing the methodology, the rationale, the data sources, and the percentage results. Apply it consistently year after year. Methods can change but only with Form 3115.
Subcontractor 1099-NEC reporting — what trips up GCs
If you pay any subcontractor $600 or more in a calendar year for services (not goods), you owe them a 1099-NEC by January 31 of the following year. IRC §6041 and §6041A are the reporting authority. Treas. Reg. §1.6041-1 has the mechanics.
Who gets a 1099-NEC. Sole proprietors. Single-member LLCs (treated as disregarded entities). Partnerships. Multi-member LLCs taxed as partnerships. Subcontractors who are individuals.
Who doesn’t. C corporations and S corporations are generally exempt from 1099-NEC reporting (with exceptions for legal fees and medical/health payments). So a sub that comes back as ‘Acme Drywall Inc.’ on its W-9 — no 1099-NEC required. But a sub that comes back as ‘Acme Drywall LLC’ might still need one (LLC taxation status matters).
Get the W-9 first. The IRS form for collecting taxpayer ID is W-9. Get it from every new subcontractor before you cut the first check. If they refuse, you’re required by §3406(a) to backup-withhold 24% from payments to them. That’s a heavy stick. Most subs hand over the W-9 quickly.
Penalty for missing 1099-NEC. IRC §6721 imposes per-form penalties for failing to file information returns. 2026 amounts: $60 per form if filed within 30 days of due date, $130 if filed by August 1, $330 if filed after August 1. Intentional disregard penalties are higher — minimum $660 per form with no maximum cap.
Penalty for missing payee statement (the copy you send the sub). IRC §6722 doubles the exposure. So a 1099-NEC missed by both the IRS filing and the payee delivery is $660 per form ($330 + $330) in 2026.
What if you can’t get a W-9? Backup withhold 24% from payments. Remit the withholding monthly or quarterly via Form 945. Issue Form 1099-NEC at year-end showing the gross payment and backup withholding amount.
Why GCs get caught. The classic audit issue: subs that are paid in cash, paid by personal check from owner’s account, paid via Venmo/Zelle (which doesn’t issue 1099-Ks until 2024-2026 phase-in). The IRS has been adding payment-platform reporting since 2022, narrowing the cash-economy gap.
Form 1099-K phase-in. Form 1099-K from third-party payment platforms now triggers at $2,500 in 2025 and $600 in 2026 (after multiple delays). Subs who get paid via Venmo Business or Zelle for business will be reported regardless of whether the GC issues a 1099-NEC.
Treatment of materials embedded in subcontractor invoices. If a subcontractor’s invoice lumps services and materials together, the entire payment is reported on 1099-NEC. There’s no requirement to break out the labor and materials.
Cash payments to day labor. Day laborers paid in cash who aren’t on payroll are independent contractors. Same $600 rule. If you can’t get a W-9 from someone you hired for two days, you have a documentation problem before you have a reporting problem.
Worker classification audit risk. The bigger issue with cash-paid day labor isn’t the 1099-NEC — it’s worker classification. The IRS and DOL are aggressive about reclassifying ‘independent contractors’ as employees, especially in construction. Lose that fight and you owe back FICA, FUTA, withholding, plus penalties for failure to withhold.
Vehicles, equipment, and §179 expensing — the contractor deduction list
Construction equipment is the contractor’s largest depreciable asset category. Trucks, trailers, backhoes, excavators, loaders, tools, generators. Most are written off aggressively under §179 and bonus depreciation.
IRC §179 election. 2026 limit (per Rev. Proc. 2024-40): $1,290,000 of §179 expense allowed, with the phase-out beginning at $3,210,000 of total §179-eligible purchases. Phase-out is dollar-for-dollar: a contractor that puts $3,500,000 of equipment in service has the §179 limit reduced by $290,000 to $1,000,000.
Bonus depreciation. §168(k). Phasing down post-TCJA: 60% in 2025, 40% in 2026, 20% in 2027, 0% in 2028 (unless Congress extends — bills have been introduced).
Order of operations. §179 first, then bonus depreciation on remaining basis, then MACRS on what’s left. For a $200,000 excavator in 2026: §179 = $200,000 (if under the cap and the business has taxable income to absorb it). Full deduction year one.
Heavy SUV trap. §179 expense on SUVs with GVWR over 6,000 lbs is limited to $30,500 in 2026 (up from $30,000 in 2025). The full §179 amount is only available for vehicles classified as ‘trucks’ that meet the §179 vehicle exception (bed length over 6 feet, designed for cargo, etc.). A Ford F-250 work truck = full §179. A Suburban or Tahoe = $30,500 cap.
Passenger vehicle limits. Passenger autos under 6,000 lbs GVWR (most cars and small SUVs) are capped under §280F. First-year limits for 2026 (combined §179, bonus, and MACRS): around $12,400 first year, $20,400 with bonus depreciation. Heavy vehicle rules don’t apply.
Listed property substantiation. IRC §274(d) requires written records for vehicle use: date, business purpose, miles driven, beginning/ending odometer. The auditor will ask. A mileage app (MileIQ, Everlance) covers this. Annual usage report at year-end.
Mixed-use vehicle math. If a pickup is used 80% for business and 20% personal, only 80% of the cost is depreciable, 80% of gas and maintenance is deductible, and §179 is limited to the business-use percentage. Business use must exceed 50% for §179 eligibility at all.
Equipment financing. Equipment purchased on a note is still eligible for §179 and bonus depreciation in the year placed in service. Don’t need to be paid off. Interest on the note is separately deductible as business interest (subject to §163(j) if not a small business).
Section 1245 recapture. Sell a piece of equipment for more than its depreciated basis, the gain up to the original cost is ordinary income (depreciation recapture). Plan equipment trade-ins to time the recapture in a low-income year.
Trade-in mechanics post-TCJA. The old like-kind exchange treatment for equipment is gone since 2018. Trading in a backhoe for a new one is now a sale of the old + purchase of the new for tax purposes. Compute gain on the trade-in separately.
Home office for sole-prop GCs and small S-corp owners
Sole-proprietor general contractors who work from home — and an enormous number of small GCs do — deserve the home office deduction. The rules under IRC §280A(c)(1) require that the home office be (a) used regularly and exclusively for business, and (b) the principal place of business OR a place used to meet customers/clients OR a separate structure used in connection with the trade or business.
Principal place of business test. §280A(c)(1)(A) as amended in 1999: a home office qualifies as principal place of business if it’s used for administrative or management activities AND there’s no other fixed location where the taxpayer conducts substantial admin or management.
For a GC: jobsites are not ‘fixed locations.’ If your bookkeeping, scheduling, estimating, and client meetings happen at the home office, you qualify. The fact that the actual construction is done off-site doesn’t disqualify the home office.
Exclusive use. The room or area used for the office can’t double as a guest bedroom or kid’s playroom. A dedicated home office, an enclosed corner of the garage, a converted shed — all fine. A kitchen table that gets cleared off in the morning — not fine.
Two computation methods.
Simplified method. $5 per square foot, up to 300 square feet. Max deduction $1,500. No depreciation. No depreciation recapture on sale. Easy.
Regular method. Actual costs × business-use percentage. Mortgage interest, real estate tax (limited by SALT cap considerations), utilities, insurance, repairs, depreciation on the office portion of the house. Business use percentage = office square footage / total home square footage.
Example. 200 sq ft office in a 2,000 sq ft house = 10% business use. Annual utility, insurance, maintenance: $8,000. Business portion: $800. Annual depreciation on $400,000 home cost (39-year non-residential commercial life applied to the business portion of $400K × 10% × 1/39 = $1,025). Total regular-method deduction: $1,825.
Income limit. §280A(c)(5): the home office deduction can’t exceed gross income from the business activity less other business expenses. A loss can’t be created or increased by the home office deduction. Excess is carried forward.
S-corp owner home office. The S-corp can’t take the deduction directly because the owner owns the home, not the corporation. Two paths. Accountable plan reimbursement (S-corp reimburses the owner-employee for actual home office costs; reimbursement is deductible to corp and tax-free to owner). Or a written rental agreement (owner rents office space to S-corp; corp deducts rent, owner reports rental income on Schedule E offset by home office expenses).
Depreciation recapture on sale of home with office. Selling the house? The portion of basis attributable to the home office is subject to §1250 recapture. The §121 exclusion (up to $250K/$500K of gain on a primary residence) applies to the residential portion only — the office portion’s gain doesn’t qualify. Some preparers skip the depreciation entirely (simplified method does this) to avoid recapture, accepting a smaller deduction in exchange.
Audit risk. Home office deductions are statistically more audited than other Schedule C items. Mitigation: photos of the office, floor plan with square footage measurements, a copy of the calculation kept in working papers.
Entity choice for a general contractor — Schedule C vs LLC vs S-corp
Most GCs start as sole proprietors filing Schedule C. As revenue grows, the question of entity choice gets louder. Three options dominate.
Schedule C (sole proprietorship). No filing fee. No state registration (other than DBA if operating under a different name). Profits flow to owner’s Form 1040 Schedule C. All net profit is subject to self-employment tax (15.3% on first $184,500 of net earnings in 2026, then 2.9% Medicare above with a 0.9% additional Medicare tax above $200K single / $250K MFJ).
Single-member LLC (SMLLC). Default tax treatment: disregarded entity, taxed as Schedule C. The LLC provides limited liability (mostly — pierce-the-veil and personal-guarantee issues are real in construction). Same SE tax outcome as Schedule C unless the SMLLC elects to be taxed as an S-corp.
Multi-member LLC. Default: partnership. Files Form 1065 and issues K-1s. Partners’ distributive shares are subject to SE tax (with some §1402(a)(13) limited-partner exceptions that are aggressively challenged by IRS).
S-corporation. Either an LLC electing S-corp treatment or a state-law corporation. Files Form 1120-S, issues K-1s. The owner gets W-2 wages (subject to FICA/Medicare) plus distributions (not subject to SE/FICA/Medicare).
Why GCs S-corp. The SE tax savings. Take Riverside Builder LLC, net profit $250,000 owner-operator. Schedule C: SE tax = $176,100 × 15.3% + $73,900 × 2.9% = $26,943 + $2,143 = $29,086 (with adjustment for half-deduction).
S-corp with $90,000 reasonable wages plus $160,000 distribution: FICA/Medicare on wages = $90,000 × 15.3% = $13,770. Plus state SUTA. Distribution piece pays no employment tax. SE/payroll tax savings approximately $15,000/year.
Reasonable compensation rule. IRC §3121 and case law (Watson v. Commissioner, David E. Watson PC v. US — 8th Cir. 2012) require S-corp owner-employees to be paid reasonable compensation comparable to what a third-party would charge. Setting wages too low to avoid payroll tax is an IRS hot button. RCReports and similar services produce reasonable-comp studies for GC owners.
QBI 199A. §199A grants a 20% deduction on qualified business income for pass-through entities. GCs are generally not SSTBs (specified service trade or business — construction isn’t on the SSTB list), so the QBI deduction is available regardless of income level (subject to the W-2 wage and UBIA limitations above the income thresholds).
2026 QBI income thresholds. Below $241,950 single / $483,900 MFJ, no W-2 limitation. Above, the deduction is capped at the greater of 50% of W-2 wages or 25% of W-2 wages plus 2.5% of UBIA of qualified property.
For S-corp GCs above the threshold, paying yourself W-2 wages helps the QBI calculation (50% of wages is a deduction floor). The S-corp election may have unintended QBI consequences if not modeled.
When to S-corp. Common rule of thumb: net profit (before owner comp) of $80,000-$100,000 makes S-corp election worthwhile after considering setup costs, payroll service fees, and additional state corporate filings. Below that, the savings are eaten by administration.
State and local nuances — sales tax on materials, contractor licensing
General contractor tax under §263A is the federal piece. State and local tax is its own animal.
Sales tax on materials. Most states treat GCs as the end consumer of materials installed in a building. The contractor pays sales tax to the supplier at point of purchase, doesn’t collect sales tax from the customer, and doesn’t get to issue resale certificates for materials.
Examples. California treats construction contractors as consumers of materials, suppliers charge sales tax to the contractor. Texas similar. New York similar.
Exceptions. Some states (Florida, Arizona, Hawaii) treat contractors as resellers of materials. In those states, the contractor buys materials with a resale certificate (no sales tax to supplier), then charges sales tax to the customer on the materials portion of the contract. Subcontractors complicate this.
Lump-sum vs. time-and-materials. The contract structure can change sales tax treatment in some states. Lump-sum contracts (single contract price covering labor and materials) — contractor pays sales tax on materials. Time-and-materials contracts (separate billings for labor and materials) — in some states, the contractor charges sales tax on materials.
Contractor’s gross receipts taxes. A handful of states (New Mexico, Hawaii) apply a gross receipts tax to construction services. Not income tax. Tax on revenue regardless of profit.
City and county taxes. Some local jurisdictions (Denver, Seattle, Chicago) impose business taxes on GCs separate from state income tax.
Contractor licensing. State contractor licensing boards (CSLB in California, RMOs and RMEs in various states) often require proof of tax compliance. A tax lien on the GC or owner can suspend or revoke a license, halting all work.
Workers’ comp. Required in every state. Premium based on payroll and class code (carpentry, roofing, electrical each have different rates). High-risk class codes have premiums of 20-40% of payroll.
Unemployment insurance (SUTA). State-level employment tax. Rates vary by state and by experience rating. New employers typically pay a beginner rate (2-4% of wages) that adjusts after 3-4 years based on claims experience.
Apprenticeship and union contributions. In union jurisdictions, contractors pay union benefit contributions (health, pension, training). These are deductible business expenses but require careful coding to job cost.
Multi-state contractors. A GC doing work in multiple states will register and file in each state. State income tax apportionment for multi-state work — typically based on cost-of-performance or sales sourcing rules under P.L. 86-272. Multi-state requires a CPA who tracks the contractor’s job locations and apportions so.
Year-end planning playbook for general contractors
Six moves to sit down with your tax preparer before December 31.
Equipment purchases. If you’re projecting a high-income year, place equipment in service by December 31. §179 and bonus depreciation are placed-in-service-based, not paid-based. Even financed equipment qualifies. Buying $200,000 of equipment in late December to absorb tax exposure is a classic GC year-end move.
Don’t overbuy. The ‘tax savings’ on a $200K piece of equipment is only $48K-$74K at typical marginal rates. You spent $200K to save $74K. Only buy what the business will use.
Pay subs. Cash-method contractors can accelerate sub payments into December to claim deductions. Pay all open sub invoices by December 31. Mail checks postmarked by December 31 count as paid (mailbox rule).
Bill customers strategically. The flip side. Cash-method contractors who bill in December collect (and report) revenue in the current year. If income is already high, slow-walk billing into January.
Retirement contributions. SEP-IRA, Solo 401(k), or SIMPLE-IRA. Solo 401(k) 2026 limit: $24,500 employee deferral plus 25% of net SE income employer contribution, up to a $70,000 combined limit. For a GC making $250,000 net, max contribution is roughly $70,000.
S-corp 401(k). S-corp owner-employees can defer up to $23,500 from W-2 wages plus the corporation can contribute 25% of W-2 wages. Lower than Schedule C math because the 25% applies to W-2 wages only, not total profit.
Health insurance. Self-employed health insurance deduction under §162(l) for sole props and 2%-or-more S-corp owners. Premiums for owner, spouse, dependents are an above-the-line deduction. Long-term care premiums also deductible subject to age-based caps.
HSA contributions. If the contractor has a high-deductible health plan, HSA contributions are deductible. 2026 limits: $4,400 self / $8,750 family, plus $1,000 catch-up if 55+.
Estimated tax payments. Fourth quarter estimate due January 15. Underpayment penalties under §6654 if cumulative payments are less than the lesser of 90% of current-year tax or 100% of prior-year tax (110% if AGI over $150K). Calc on Form 2210.
Look-back interest review. If you use PCM, review contracts that completed during the year for material variance from estimates. Compute Form 8697 look-back interest. Often surprises clients.
Section 199A planning. If income is near the QBI phase-out threshold ($241,950 single / $483,900 MFJ 2026), consider deferring income or accelerating deductions to stay below the threshold. Above the threshold, W-2 wages from the entity become important — strategy may require S-corp election or salary increases.
Common audit issues and how to defend
The IRS exam division has a Construction Industry Issue Specialization Program. Auditors who specialize in contractors know what to look for.
Issue 1: Cost capitalization. Has the contractor capitalized indirects to WIP correctly? Auditors will ask for the §263A computation, the allocation methodology memo, and the supporting workpaper. If the contractor expensed too much (capitalized too little), the auditor will propose adjustments adding indirects to WIP and disallowing the current deduction.
Defense. Have a written methodology document. Apply consistently. Have job-cost reports showing the allocation. If under $31M, document the small-business exception qualification (three-year gross receipts computation with controlled group attribution).
Issue 2: Worker classification. Are subs really subs, or are they employees? Common findings: a ‘sub’ who works only for you, uses your tools, gets paid hourly, gets directed in how the work is done. The IRS 20-factor test (consolidated into three groups in Rev. Rul. 87-41 and SS-8 procedures) controls.
Defense. Written subcontractor agreements. Subs carry their own insurance and licensing. Sub bills you, you don’t pay an hourly wage. Sub provides own tools or specialty equipment. Sub has multiple customers.
Issue 3: 1099 reporting. Did you issue 1099-NEC to all subs paid $600+ in services?
Defense. W-9 on file for every sub before first payment. Year-end 1099 review. Cross-check Schedule C ‘subcontractor labor’ total against sum of 1099-NECs issued.
Issue 4: Cash transactions. Cash payments to day labor, cash receipts not deposited.
Defense. Deposit all customer payments to business account. Use checks or business credit card for all sub payments. Maintain mileage logs and receipts for cash expenditures.
Issue 5: Personal use of business assets. Truck used personally without proper substantiation. Office in home claimed but not actually used exclusively.
Defense. Mileage app showing 80%+ business use. Photos of dedicated home office. Calendar entries showing client meetings at home office.
Issue 6: Section 460 long-term contract method. Have you used PCM consistently? Are estimates being updated? Are completed contracts being closed out properly?
Defense. Quarterly or year-end review of contract estimates. Documentation of major estimate revisions. Form 8697 look-back computation prepared timely.
Issue 7: Inventory adjustment. If the IRS proposes adjustments to inventory, §481(a) adjustments may carry over into multiple tax years. Negotiation point: spread of the adjustment over four years for positive adjustments.
Defense before audit. Internal tax compliance review every two years with a CPA familiar with construction. Audit-ready files. Methodology documentation. Reasonable comp study for S-corp owners. Contractor-specific accounting software (Foundation Software, Procore Financial, Sage 300 CRE) that produces audit-defensible job cost reports.
Section 174 R&D capitalization — surprise hit for design-build GCs
Most GCs don’t think they have R&D expenditures. Wrong. IRC §174 as amended by TCJA defines specified research or experimental expenditures more broadly than most contractors realize. Design-build firms, GCs developing prefab construction techniques, contractors writing custom estimating software, GCs running BIM modeling departments — all may have §174 expenditures that must be capitalized and amortized over 5 years (15 years for foreign research).
Pre-2022, §174 expenditures could be expensed currently or amortized. TCJA §13206 changed the rules effective for tax years beginning after December 31, 2021. All §174 costs must now be capitalized. Domestic research amortized over 5 years (60 months) starting with the midpoint of the year incurred. Foreign research amortized over 15 years.
What counts as §174 for a GC? Internal-use software development (custom estimating systems, custom project-management platforms, BIM workflow tools). Process improvement R&D (new construction techniques, modular construction development). Material science work (testing new composites or assembly methods). Engineering and architectural design work performed in-house for proprietary products.
What doesn’t count? Routine quality control. Bidding and estimating using off-the-shelf software. General project supervision. Construction work performed under a contract for a customer (this is contract services, not §174 research, generally).
Notice 2023-63 from the IRS provided interim guidance interpreting §174 post-TCJA. Final regs are pending but the broad strokes are clear: capitalize and amortize.
Cash flow hit. A GC with a $200,000 in-house BIM/software team incurs $200K of §174 costs. Year 1 deduction: $200K × 1/5 × ½ (midpoint convention) = $20,000. Years 2-5: $40,000 each. Year 6: $20,000. So $180,000 of the expense is pushed beyond year 1.
R&D credit §41 interaction. Even with §174 capitalization, the §41 R&D credit remains available for qualifying activities. Credit calculation has its own rules. Practical issue: gathering documentation for §174 capitalization is roughly the same exercise as documenting for §41 credit, so most GCs that do design-build work should pursue both.
Plan around it. If you have significant in-house design or software work, segment it from construction operations for cleaner accounting. Consider whether the activity is genuine R&D vs. routine engineering. Many activities GCs initially categorize as R&D actually fail §174’s experimentation requirement and stay as current deductions.
Cash vs accrual — choosing the right accounting method below $31M
Small-contractor GCs under $31M average gross receipts have a choice: cash or accrual. Most pick cash. Here’s why and when accrual is the better fit.
Cash method. Revenue recognized when collected. Expense recognized when paid. The simplest accounting model. Maximum flexibility for year-end timing — pay subs in December to accelerate deductions, hold off on year-end billings to defer revenue.
Accrual method. Revenue recognized when earned. Expense recognized when incurred. Matches the AICPA GAAP framework. Required for financial statements presented to bonding companies, banks, surety underwriters.
Tax-only cash with GAAP-accrual financial statements is allowed. Most GCs maintain accrual books for internal/external financial reporting and convert to cash for the tax return. The conversion is documented on the M-1 reconciliation between book and tax income.
Cash-method cash flow story for a growing GC. Year-end accounts receivable: $400,000. Year-end accounts payable to subs: $200,000. Accrual recognition: $400K revenue accrued plus $200K expense accrued = $200K of net pre-tax income from these items. Cash recognition: $0 of these items (not yet collected, not yet paid) = $0 income from these items. Cash method defers $200K of income to next year. Tax savings at 24% federal = $48,000 deferred.
Cash-method cash flow story for a contracting GC. Receivables collected but not yet replaced: $300,000. Payables paid: $100,000. Accrual: zero net. Cash: $200,000 of recognition (collections net of disbursements). Cash method accelerates $200K of income into current year. Tax cost $48,000.
The takeaway: cash method works well for growing contractors (defers income). Cash method works against shrinking contractors (accelerates income). Direction of cash flow matters.
Hybrid method options. IRC §446 permits hybrid methods for distinct activities within the same business. A GC might use cash for service revenue and accrual for materials inventory (if inventory is significant). Hybrid methods are common for contractors with both retail and contract revenue streams.
Method change to cash. File Form 3115. Automatic change number 233 (cash from accrual) under Rev. Proc. 2024-23 and successors. Section 481(a) adjustment captures the cumulative effect of the change. For a contractor switching to cash, the §481(a) adjustment is typically a deduction (negative income adjustment) — recognized fully in the year of change if negative.
Method change to accrual. Required if you exceed $31M average. Form 3115 automatic change number 222. Section 481(a) adjustment typically positive (income increase) — spread over four years.
Retainage and the cash-method GC
Retainage (the portion of contract value the customer holds back until completion) creates an interesting cash-method tax issue.
The general rule. Cash-method taxpayers recognize income when actually or constructively received. Retainage is held by the customer pending satisfactory completion. The customer hasn’t paid the contractor. The contractor hasn’t received it. Income recognition is deferred.
Constructive receipt doctrine. Treas. Reg. §1.451-2 says income is constructively received when it’s credited to the taxpayer’s account, set apart, or otherwise made available to the taxpayer without substantial limitation. Retainage held by the customer is not ‘set apart’ in the contractor’s name — it’s the customer’s money until release. So no constructive receipt.
When retainage is released. The contractor collects the retainage upon contract acceptance and final inspection. Receipt = income recognition. For a major project completed in December 2026 with final retainage release in March 2027, the retainage income falls in 2027, not 2026.
Disputed retainage. If the customer disputes the work and refuses to release retainage, the contractor doesn’t recognize income on the dispute resolution — the cash isn’t received. If the dispute resolves with partial release ($50K of $100K retainage), income is $50K. The other $50K never appears.
Accrual contractors. Retainage is earned when the contract is performed, regardless of when collected. So accrual contractors recognize retainage income as the underlying work is performed (PCM contracts) or upon contract completion (CCM). The customer’s withholding of retainage doesn’t defer accrual recognition.
Section 460 PCM treatment. PCM contractors recognize a proportion of contract revenue based on percentage of estimated total cost incurred. The retainage is part of the contract revenue. So retainage flows into PCM revenue recognition as the work is performed.
Bad debt write-off. Cash-method contractors who haven’t recognized retainage as income can’t take a bad debt deduction if the customer ultimately refuses to release — the income was never recognized in the first place. Accrual contractors can take a bad debt deduction under §166 for retainage previously included in income but ultimately uncollectible.
Bonding capacity, financial statements, and the tax method tradeoff
Surety bonds are required for most public construction contracts and many large private contracts. The surety underwrites based on financial statements. The contractor that doesn’t have credible financials doesn’t get the bond.
Sureties want accrual GAAP. Cash-method tax-only financials don’t satisfy a surety. The surety wants to see income and expense matched, WIP schedules, retainage receivable, and a balance sheet that ties to operations.
Compiled, reviewed, or audited statements. Smaller GCs use a CPA compilation ($1,500-$3,000 annually). Mid-size GCs upgrade to a review ($5,000-$10,000). Large GCs with significant bonding capacity need audited statements ($15,000-$30,000+). The cost of the financial statement is part of the cost of doing public work.
WIP schedule for the surety. The WIP schedule (work-in-progress schedule) shows each open contract: total contract value, total estimated cost, costs incurred to date, billings to date, percentage complete by costs, percentage complete by billings, gross profit recognized to date, gross profit remaining, and underbilling/overbilling position.
Underbilling means the contractor has performed more work than billed (cash advance to the customer in effect). Overbilling means the contractor has billed more than performed (cash advance from customer, similar to deferred revenue). Sureties watch both as health indicators.
GAAP requires PCM for all long-term contracts (under ASC 606 revenue recognition). Tax allows CCM for home construction and small-contractor short-duration contracts. So a small residential GC may have GAAP financial statements on PCM and a tax return on CCM. The book-tax difference is reconciled on Form 1120-S Schedule M-1 or Form 1065 Schedule M-1.
Bonding capacity formula. Sureties typically extend a single-project limit and an aggregate limit. Common rule: single-project limit = 10 × working capital. Aggregate limit = 20 × working capital. So a contractor with $500K working capital might be bonded for a single $5M project and a $10M aggregate.
Tax planning to keep bonding capacity. Pulling out cash for owner draws or distributions can hurt working capital. Bonding capacity might dictate retaining cash in the business even when tax-efficient distribution would suggest pulling it out. The bonding-vs-tax tradeoff is real for growing GCs.
Multi-state contractors and apportionment
GCs working across state lines face multi-state income tax apportionment. The federal return is one number, but income gets divvied up to each state based on apportionment formulas.
Apportionment factors. Traditional three-factor formula: property, payroll, and sales. Many states have shifted to single-sales-factor apportionment, where only the sales (revenue) factor matters. Cost-of-performance sourcing vs. market-based sourcing changes how revenue is sourced.
Cost-of-performance sourcing. Revenue is sourced to the state where the income-producing activity occurred (typically where the construction was performed). This works well for construction since the job location is clear.
Market-based sourcing. Revenue sourced to the state where the customer receives the benefit. For construction, this is often the same as cost-of-performance (the building is where it’s built), but for service businesses can produce different results.
Nexus. Physical presence in a state (employees, contractors, equipment, jobsite) creates income tax nexus. Public Law 86-272 protects certain solicitation-only activities but doesn’t apply to construction services. So a GC physically performing work in another state creates nexus and must file in that state.
Withholding for out-of-state employees. Multi-state work requires payroll withholding in each state. Reciprocity agreements between certain states (PA-NJ, MD-DC, KY-IN, etc.) simplify the analysis but most state pairs don’t reciprocate.
Composite returns. Some states allow a composite return filed by the entity covering all non-resident owners. The entity pays tax on behalf of the non-resident owners. Simplifies compliance for partners/shareholders living elsewhere.
Sales tax registration in multiple states. If the GC is treated as the end consumer of materials in each state, sales tax is paid to local suppliers (or use tax remitted on out-of-state purchases). If the GC is treated as a reseller in some states, sales tax collection from customers may be required.
Practical compliance. A GC doing $500K of work in three states beyond home base typically needs: income tax registration in each state, payroll withholding accounts, sales/use tax registration, possibly local business license, workers’ comp in each state, contractor license in each state. Annual compliance costs $2K-$5K per additional state for a small GC. Multi-state CPA help is essential.
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Frequently Asked Questions
If my general contracting LLC averages $28M of gross receipts over three years, am I exempt from Section 263A in 2026?
Yes. Under IRC §448(c) and the 2026 inflation-adjusted figures in Rev. Proc. 2024-40, a taxpayer with average annual gross receipts of $31M or less over the three preceding tax years qualifies as a small business taxpayer. Small business taxpayers are exempt from §263A uniform capitalization under §263A(i), exempt from the §471 inventory rules (allowed to use a books-and-records method instead), eligible to use cash-method accounting under §448(c), and exempt from the §163(j) business interest limitation. The three-year averaging works like this. For tax year 2026, you look at gross receipts for 2023, 2024, and 2025. Add them. Divide by three. Your average is $28M. That’s under $31M. You qualify. Important wrinkles. First, gross receipts means total revenue before subtracting cost of goods sold or any other expense. It’s the top line. Returns and allowances are subtracted. Trade discounts are not. If your construction company also has rental income, finance charges, or other ancillary revenue, those count too. Second, aggregation under §52(a). If you own multiple entities under common control — say your construction LLC plus a separate equipment leasing LLC plus a real estate holding LLC — gross receipts of all entities are aggregated for the test. The §52(a) controlled group definition is broader than people expect: parent-subsidiary chains, brother-sister entities (where five or fewer individuals own 80% or more), and combined groups. Worse, attribution rules under §1563(e) bring in family member ownership. If your wife owns a 50% interest in a separate construction LLC, that entity’s receipts attribute to you. Third, partnerships and S-corps test at the entity level, not the partner/shareholder level. Your construction LLC is the testing taxpayer, not you personally. Fourth, the test is annual. Once you exceed $31M average, you’re subject to §263A starting in the year of crossover. The change requires Form 3115. A negative §481(a) adjustment may apply (if currently expensing indirects that would otherwise be capitalized, those costs get pulled out of the current year and pushed to future periods — a positive income adjustment spread over four years). Practical implications for a $28M GC. You can use cash-method accounting (revenue when collected, expense when paid). You can use a books-and-records inventory method under §471(c) — for many GCs this means materials get expensed when delivered to the jobsite rather than tracked in a formal WIP inventory. You can take CCM (completed contract method) for long-term contracts under §460(e)(1)(B) provided the contracts are expected to be completed within two years. Documentation to keep. Annual three-year gross receipts computation in your tax workpapers. Affidavit of controlled group analysis. Election statements for any accounting method choices. The exemption is automatic if you qualify, but in an audit the burden is on you to prove the math. What if you’re close to the threshold? At $30.5M average, you have $500K of room before triggering §263A. Consider deferring December billings into January if needed to stay under the cap. Once over, the compliance burden expands significantly: indirect cost allocation methodology, simplified production method election, mixed service cost computation, year-end WIP balancing, and possibly a switch to accrual accounting. Many GCs hold the line at the small-business threshold deliberately for the simplicity benefit. What if you’re under the threshold but want to use accrual or capitalize indirects anyway? You can voluntarily elect to use accrual under §446, voluntarily apply §263A under the regulations, voluntarily use PCM for long-term contracts. None are required, but a contractor that wants to match GAAP financial statements (for bonding, banking, or future sale purposes) might choose to apply these rules even when not required. The choice is made on a method-by-method basis and locked in by consistency. Common trap: family attribution. Section 1563(e) attribution rules say an owner’s spouse, parents, children, and grandchildren are treated as owning each other’s interests for purposes of the controlled-group test. So if your spouse owns 100% of a separate construction LLC with $5M of gross receipts, that LLC’s receipts are aggregated with yours via spousal attribution. The Family ownership trap is the leading cause of unexpected loss of small-business taxpayer status. Cross-state aggregation. Common ownership crosses state lines. If you own a Texas LLC and a Florida LLC under common ownership, both states’ gross receipts aggregate for the federal test. The federal test doesn’t care about state lines. Calendar year vs fiscal year. Most contractors are calendar-year. Fiscal-year contractors apply the three-year test based on their fiscal-year receipts. A June 30 fiscal year-end LLC for tax year ending June 30, 2026 looks at FY2023, FY2024, FY2025 (ending June 30, 2024 and 2025). When you start a new business. New entities use prior years’ actual receipts even if they don’t have three years yet. A startup in 2024 with $5M of receipts in 2024 and projected $35M in 2025: for tax year 2025, the three-year average is computed using only the years the business existed (annualized if a short year applies). Short tax years. Tax years of less than 12 months are annualized for the gross-receipts test. A six-month short year with $15M of receipts is annualized to $30M for testing purposes. Audit considerations. The IRS exam division routinely tests the §448(c) gross-receipts computation during audits. Have the computation in your working papers. Have the controlled-group analysis documented. Have the aggregation considerations addressed even if no aggregation applies (saying ‘no aggregation applies’ is a defensible position only if documented). Strategic considerations. If you’re trending toward $31M average, consider whether to actively manage receipts to stay under (defer December billings, delay project starts) or accept the threshold crossing and prepare for §263A compliance. Crossing the threshold permanently means restructuring the accounting system, updating the chart of accounts to support indirect cost allocation, training staff, and probably engaging a construction-specialized CPA. The annual compliance cost can rise by $10K-$20K. Some GCs stay deliberately under the threshold to avoid the complexity even when growth would otherwise suggest expansion. Bottom line: small-business taxpayer status is a meaningful benefit. Defend it. Document the math. Watch attribution and aggregation. Plan around the threshold rather than waking up over it.
What’s the difference between percentage-of-completion and completed-contract method for tax purposes, and when can my GC use CCM?
Two methods for long-term contracts under IRC §460. The default is PCM — you must use it unless you fit into a §460(e) exception. CCM is the exception. Percentage-of-completion mechanics. Each tax year, you recognize a portion of total contract revenue and total contract cost based on the percentage of estimated total cost actually incurred to date. If the contract is 30% done by costs (you’ve spent $300K on a project budgeted for $1M total cost), you recognize 30% of the contract revenue this year, and 30% of the total estimated costs. Year-by-year you remeasure: at year-end, you compute cumulative percentage complete based on revised estimates, multiply by total contract revenue to get cumulative revenue, subtract revenue already recognized in prior years to get current-year revenue. Same math for costs. The estimate matters. PCM punishes you for bad estimating. If you overestimated total cost (overhead margin gets included in cost), you recognized profit too slowly in earlier years and have to catch up later. If you underestimated total cost (actual exceeds estimate), you recognized profit too quickly. The Form 8697 look-back interest computation reconciles. Completed-contract method mechanics. No revenue or cost recognition until the contract is substantially complete. Treas. Reg. §1.460-1(c) defines substantial completion as the earlier of: 95% of total estimated costs incurred, the customer using the property for its intended purpose, or the contractor’s final acceptance. Until that moment, contract revenue and contract costs sit on the balance sheet as unrecognized. CCM eligibility. §460(e) provides two paths to CCM. Path 1: Home construction contract. A contract is a home construction contract if 80% or more of the estimated total contract costs are reasonably expected to be attributable to the construction of one or more dwelling units in real property (with 4 or fewer dwelling units) and improvements to real property directly related to and located on the site of those dwelling units. Single-family houses. Duplexes. Triplexes. Quadplexes. Larger residential projects (5+ units) don’t qualify as home construction — they’re ‘residential construction contracts’ under §460(e)(6)(A) which use a 70% PCM/30% CCM hybrid. Apartment complexes, condos with 5+ units, hotels — none qualify as home construction contracts. Path 2: Small contractor short-duration contract. Contracts expected to be completed within two years AND contractor has average annual gross receipts under $31M in 2026. A two-year-or-less timeline is checked at contract inception based on a reasonable estimate. A contract that ends up taking longer doesn’t get retroactively disqualified, but a contract that’s clearly slated to take 30+ months at inception fails the test. Mixed contracts. A GC might have some contracts on CCM (small-contractor home construction) and others on PCM (commercial work over $31M aggregated, or longer than 2 years). Each contract is evaluated separately. Why GCs prefer CCM. Income deferral. A custom home builder with a 14-month project that starts in May 2026 and finishes July 2027 reports zero gross profit for the project in 2026 under CCM. All income falls in 2027. Cash flow from progress billings is collected throughout the build, but the tax cost is deferred. Why the IRS limits CCM. Income deferral is the whole game. A contractor stacking up 30-40 open jobs at year-end, all on CCM, could indefinitely defer enormous amounts of income. The §460(e) limits — 4-or-fewer dwelling units, 2-year completion, $31M receipts cap — restrict CCM to small contractors and residential builders. Method change. To switch from PCM to CCM (or vice versa), file Form 3115. The change is generally non-automatic — requires IRS approval and is granted on a case-by-case basis. Section 481(a) adjustment computed as the difference between WIP under the old method and WIP under the new method, spread over four years for income increases. Practical advice. A small custom home builder (under $31M) should generally elect CCM for residential work. A larger commercial GC has no choice — PCM is required. A mid-sized GC at $35M aggregate receipts running 14-month projects is on PCM for everything and probably grumbling about it. Look-back interest under PCM. Form 8697 computes interest on the difference between what gross profit was reported each year and what it would have been with hindsight. The simplified marginal-impact method (most contractors elect it) limits the analysis to the contract level. The interest rate is the §6621 underpayment rate (currently 8%). Look-back is unavoidable on PCM contracts that don’t match estimates. Plan for it. Mechanics of the percentage calculation in detail. The percentage-of-completion formula: cumulative costs incurred to date ÷ total estimated cost at completion = percentage complete. Multiply by total contract revenue (including all approved change orders) = cumulative revenue to recognize. Subtract revenue recognized in prior years = current-year revenue. The estimate of total cost must be a reasonable, good-faith estimate as of year-end. Updating estimates is required when material changes are known. Treas. Reg. §1.460-1(b)(6) discusses the requirement to update estimates and report changes through cumulative catch-up adjustments in the year the change is identified. PCM with a loss. If at any point the total estimated cost exceeds total contract revenue (the contract will lose money), recognize the full estimated loss in the year the loss is identified. Don’t spread the loss over remaining percentage complete. This is the ‘expected loss’ rule. Change orders under PCM. Approved change orders increase total contract revenue. Pending or disputed change orders are not included until approved. Some contractors include ‘probable’ change orders based on reasonable estimates, but this is a gray area subject to IRS scrutiny. Subcontractor payments and PCM. Subcontractor invoices increase costs incurred when paid (cash basis) or when received (accrual basis). The increase in costs increases the percentage complete and accelerates revenue recognition. Form 8697 look-back interest in detail. After contract completion, the contractor recomputes what percentage complete should have been each year using actual final costs. If actual gross profit was higher than reported, additional tax is owed for prior years; interest is charged from the original due date to the date of completion. If actual gross profit was lower than reported, refund of overpaid tax with interest. Simplified marginal-impact method election. Most contractors elect this method on Form 8697 — it limits the look-back to total income tax impact rather than recomputing each year’s full tax return. Less computationally intensive. Election is permanent without IRS consent. Look-back interest threshold. Look-back interest doesn’t apply if the actual gross profit differs from reported by less than 10% per year (de minimis rule). So contractors with reliable estimates that come in close to actual avoid look-back altogether. CCM and AMT. Long-term contracts on CCM for regular tax purposes must be reported on PCM for alternative minimum tax. The AMT preference under §56 captures the deferral benefit of CCM. For S-corp and partnership owners, this is computed at the owner level. CCM cumulative tax effect over a project lifecycle. A 14-month residential construction project: CCM defers all gross profit to the year of completion. Owner’s individual tax bracket in that year may be different from what it would have been if income had been recognized over 14 months. If the owner has a high-income year for other reasons in the year of completion, CCM can stack income unfavorably. Conversely, CCM can be used to time income recognition to a low-income year (the owner takes a sabbatical, has medical expenses, etc.).
How do I allocate my office overhead between jobs for 263A purposes when I run 5-10 open jobs at any time?
This is the heart of §263A implementation. The regulation is in Treas. Reg. §1.263A-1(f) and §1.263A-2. Multiple methods are acceptable. The right one depends on the GC’s records and the materiality of indirects. Step 1: Identify total indirect costs subject to 263A. Treas. Reg. §1.263A-1(e)(3) lists capitalizable indirects. For a GC the typical capitalizable indirects are: rent on jobsite trailers or staging yards, depreciation on equipment used across multiple jobs (excavators, trucks, generators), repair and maintenance of equipment, insurance on equipment and construction in progress, taxes on construction-purpose real property, utilities at jobsite facilities, indirect labor (foreman wages allocated across jobs, bookkeeper allocated to job-cost coding, dispatcher), purchasing department wages, handling and storage of materials, employee benefits for production-side workers, officer compensation allocable to production oversight. Step 2: Identify what’s expensed currently (not capitalizable). Selling and marketing, advertising, post-completion warranty work (current-year period expense, not capitalizable), most owner draws and distributions, income tax expense, interest (separate §263A(f) capitalization rules for interest), general office overhead not allocable to production. Step 3: Pick an allocation method. Method A: Simplified Production Method (SPM) under Treas. Reg. §1.263A-2(b). Ratio: (additional §263A costs) ÷ (total §471 costs incurred during the year) × (§471 costs in ending inventory/WIP). Easy to compute. Doesn’t require job-level cost data for the allocation. Works for a contractor with a basic job-cost system. Method B: Modified Simplified Production Method (MSPM). Separates pre-production §263A costs from production §263A costs. More accurate for a contractor with significant pre-construction activity (engineering, design, permitting). Slightly more record-keeping. Method C: Specific identification. Each indirect cost is traced to specific jobs based on actual use or benefit. Most accurate. Most labor-intensive. Best for a GC with a small number of large jobs (custom home builder, commercial GC with 3-5 jobs in process). Worst for a GC with 20+ open jobs. Method D: Facts-and-circumstances allocation. Treas. Reg. §1.263A-1(f)(4) lets you use any reasonable allocation method as long as it’s applied consistently. The ‘reasonable’ standard is broad. Common GC methods within facts-and-circumstances: Labor-hours method. Allocate indirects across jobs based on the ratio of direct labor hours per job to total direct labor hours. Simple. Reflects the fact that overhead generally tracks labor activity. Direct-cost ratio method. Allocate indirects based on the ratio of direct costs (materials + labor + subs) per job to total direct costs. Tracks economic activity. Burden rate method. Compute a burden rate (indirect costs ÷ direct labor cost) at year-end. Apply the burden rate to direct labor in WIP for each open job. If burden rate is 25% of direct labor, a job with $60,000 of direct labor in WIP gets $15,000 of indirect cost added to WIP. Step 4: Allocate to open jobs at year-end. Compute the total indirect allocation. Distribute across open jobs using the chosen method. Add to job WIP balance. Step 5: Document. Write a methodology memo describing the allocation method, the data sources, the math, and the supporting workpaper. Keep year-over-year. Apply consistently. Mixed service costs. Treas. Reg. §1.263A-1(h) addresses costs that partially benefit production and partially don’t — most your office overhead. Office rent, office utilities, office furniture depreciation, accounting/bookkeeping fees, administrative salaries. The simplified service-cost method (SSCM) allocates these between production and non-production based on a labor-cost ratio: production-related labor cost ÷ total labor cost = production allocation percentage of mixed service costs. Example. Total office overhead for the year: $200,000. Production-related labor (foremen, dispatchers, bookkeepers coding job cost): $400,000. Total labor (production + sales + admin + officers): $1,200,000. SSCM ratio: $400K/$1.2M = 33.3%. Allocate $66,667 of office overhead to production (subject to §263A capitalization). The other $133,333 of office overhead remains a current period expense. Then the $66,667 production allocation gets distributed to open jobs using whichever method you chose in Step 3. 1% de minimis. Treas. Reg. §1.263A-1(e)(3)(iii)(C) permits expensing of any single category of indirect cost that’s less than 1% of total §471 costs, subject to an aggregate 5% limit. Marginal categories can be excluded from the allocation to simplify record-keeping. Software. Construction-specific accounting software (Foundation Software, Sage 300 Construction, Procore Financial, Viewpoint Vista, ComputerEase) have built-in §263A allocation modules. Cheaper alternative: Excel template applied to job-cost reports exported from QuickBooks. Audit defense. The auditor will ask: what method? Why? How applied? Show me the calculation. Be ready with the methodology memo and the workpaper showing the math. Consistency year-over-year is the IRS’s main concern. Changing methods without filing Form 3115 is a red flag. Common audit findings on indirect cost allocation. The IRS routinely reclassifies costs from current-deduction to capitalizable under §263A. Examples of frequent reclassifications: equipment maintenance and repairs treated as current expense by the contractor (the IRS argues these are indirect costs of production). Foreman wages allocated 100% to direct labor (the IRS argues a portion is supervisory/managerial and should be allocated). Officer compensation treated as administrative (the IRS argues a portion oversees production and should be capitalized). Equipment depreciation expensed on the assumption equipment is general overhead (the IRS argues if equipment is used at jobsites, it’s production overhead). Cost-tracing for direct vs indirect. The starting point for any allocation methodology is identifying which costs are direct (specifically traceable to a particular job) and which are indirect (benefit multiple jobs or production generally). Job-cost accounting software typically tracks direct costs by job. Indirect costs sit in general overhead accounts. The §263A allocation distributes the indirect bucket. Period costs vs production costs. Treas. Reg. §1.263A-1(e)(4) identifies certain costs as ‘period costs’ that aren’t capitalized to inventory or WIP. Selling, marketing, advertising, owner compensation for non-production activities, professional services for general business matters (legal fees for litigation, tax preparation fees), and most general/administrative expenses. The contractor’s office overhead might be a mix of period costs and indirect production costs — the simplified service-cost method allocates between them. Indirect cost capitalization for the contractor at year-end. Step-by-step: First, identify total indirect production costs for the year. Second, determine the §471 (direct) costs in ending WIP for each open job. Third, apply the chosen allocation method to distribute indirects to WIP. Fourth, the indirects added to WIP increase the basis of the WIP and will be deducted as part of COGS when the job closes. Negative adjustment from method change. A contractor switching from a more aggressive expensing approach to compliant §263A allocation has a Section 481(a) adjustment. If currently expensing indirects that should be capitalized, the cumulative effect is to add inventory to the balance sheet and reduce a prior period deduction. This creates a positive §481(a) adjustment (income recognition). Spread over four years for positive adjustments. Year-over-year consistency. The method chosen in year 1 must be applied consistently. Switching methods (e.g., from SPM to specific identification) requires Form 3115. Inadvertent changes (a different ratio applied without methodology change) get scrutinized as either an error or an unauthorized method change. Software-assisted §263A allocation. Foundation Software, Sage 300 CRE, Procore Financial, and Viewpoint Vista all have §263A allocation modules. The contractor sets up the allocation rules once and the software generates the year-end WIP allocation automatically. For mid-size GCs ($10M-$30M), the cost of construction-industry software ($5K-$15K/year) pays for itself in compliance simplicity. Audit-ready documentation. The methodology memo. The mixed service cost analysis. The labor-cost ratio for §1.263A-1(h) allocation. The reconciliation of book to tax WIP. Schedule M-3 reporting on book-tax differences (for entities required to file Schedule M-3). Job cost reports showing the allocation. Election statements for method choices. Reviewing your accountant’s work. If you outsource tax preparation, ask your CPA for the §263A allocation workpaper. Review the methodology. Make sure the math reconciles to job cost reports. Many contractor audits find that the CPA computed §263A but the contractor didn’t understand or review the computation.
Can a sole-proprietor general contractor with a $50K profit deduct the home office where he does bookkeeping and estimating, even though all the actual work is on jobsites?
Yes — and this is exactly the situation that the 1999 amendment to IRC §280A(c)(1) was written for. Pre-1999, the home office had to be where the principal income-producing activity occurred. The Supreme Court in Soliman (1993) ruled that an anesthesiologist’s home office didn’t qualify because the anesthesiology happened at hospitals, not at home. Congress overrode Soliman in 1999 by amending §280A(c)(1)(A) to add: ‘For purposes of subparagraph (A), the term ”principal place of business” includes a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer if there is no other fixed location of such trade or business where the taxpayer conducts substantial administrative or management activities of such trade or business.’ Reading the statute applied to a GC. The GC uses the home office for administrative or management activities — bookkeeping, scheduling, estimating, client phone calls, supplier coordination, payroll, invoicing. Check. Is there another fixed location where substantial admin/management happens? Jobsites are not fixed locations of the contractor’s business — they’re customer locations where the contractor performs services. The contractor’s truck is not a fixed location. If the contractor has a separate office at a yard or shop where significant administrative work also happens, that complicates the analysis — but a one-person GC running everything from a home office, with no other office, clearly qualifies. Exclusive use requirement. §280A(c)(1) requires the home office area to be used regularly and exclusively for business. A dedicated room is best. An enclosed corner of the basement is fine. A converted garage workshop is fine — as long as it’s used only for business. The kitchen table is not exclusive use. The corner of the master bedroom where you put a desk is questionable — the IRS has won cases disallowing partial-room offices on exclusive-use grounds, and other cases the taxpayer has won when the partial-room is clearly demarcated. Regularly used means consistent use, not occasional. A daily 1-2 hour work session at the home office qualifies. Once-a-month bookkeeping at the kitchen table doesn’t. Computation methods. Two paths. Simplified method. $5/sq ft × business-use square footage, up to 300 sq ft. Max deduction $1,500. No depreciation. No depreciation recapture later. Form 8829 not required. Tracked on Schedule C line 30 with the optional simplified-method indicator. Most one-person GCs use this for simplicity. Regular method. Actual costs × business-use percentage. Form 8829 required. Tracks: mortgage interest, real estate taxes (with SALT cap interaction), home insurance, utilities (electricity, gas, water, internet), repairs and maintenance to the home, security system, depreciation on the office portion of the home (39-year non-residential commercial life applied to office portion of basis). Business use percentage = office sq ft ÷ total home sq ft. Example regular method. 250 sq ft office, 2,500 sq ft home = 10% business use. Annual home expenses: mortgage interest $14,000, real estate tax $6,000, utilities $4,800, insurance $1,800, repairs $1,500 = $28,100. Business portion: $2,810. Depreciation on $500K home (excluding land, say $400K building) = $400K × 10% × 1/39 = $1,025/year. Total home office deduction: $3,835. Simplified method comparison. 250 sq ft × $5 = $1,250 (capped at 300 sq ft × $5 = $1,500). Regular method wins by $2,335. But — depreciation recapture on regular method. When you sell the home, the portion of basis attributable to the home office is taxable as §1250 depreciation recapture (maxes at 25%, often less). The §121 exclusion ($250K single / $500K MFJ for primary residence) applies only to the residential portion. For a long-held home with significant accumulated home office depreciation, the recapture can offset 5-10 years of home office tax benefits. Income limitation. §280A(c)(5). The home office deduction can’t reduce business net income below zero. Excess is carried forward. For a $50K profit GC, the limit isn’t typically binding. Schedule C placement. The home office deduction reduces Schedule C net profit. Lower net profit means lower SE tax. So a $3,835 home office deduction saves federal income tax (15-24% depending on bracket) plus SE tax (15.3%). Effective savings on a 22% bracket: ($3,835 × 22%) + ($3,835 × 15.3%) = $843 + $587 = $1,430. S-corp owner home office. S-corp owners can’t take the home office deduction directly on the S-corp return because the corporation doesn’t own the home. Two workarounds. Workaround 1: Accountable plan reimbursement. The S-corp adopts an accountable plan and reimburses the owner-employee for actual home office expenses (computed using regular method). Reimbursement is deductible to the corp, tax-free to the owner. No 1099 issued. Workaround 2: Rental agreement. The owner rents the office space to the S-corp under a written agreement. S-corp deducts rent. Owner reports rental income on Schedule E offset by home expenses (mortgage interest, taxes, depreciation, etc.). Net rental income (or loss) flows to Form 1040. Caveat: rental losses from related parties may be limited under §267 or §469 passive activity rules. Audit risk. Home office deductions are statistically over-audited (about 2x base rate for Schedule C filers). Defense: photos of the home office showing dedicated business setup, floor plan with measurements, copy of computation in working papers, no holiday lights or kid’s drawings in the photos. Cell phone and internet allocation. Many GCs use a personal cell phone and home internet for business. §280F(d)(4) used to require strict substantiation for listed property; the 2017 TCJA removed cell phones from listed property treatment. So cell phone bills used regularly for business are deductible based on a reasonable allocation (the percentage of business use). Internet allocation typically follows the home office allocation percentage if the same internet line is used for both. Furniture and equipment in the home office. Desk, chair, computer, monitor, printer — these are tangible business assets, separately depreciable (or §179 expensable) regardless of home office deduction. A $2,000 computer used 100% for business is fully §179 expensable. Don’t fold home office equipment into the home office deduction — track separately. Detached home office structures. A separate structure on the property used exclusively for business (converted garage workshop, freestanding office building, shed converted to dispatch center) qualifies under §280A(c)(1)(C) regardless of whether it’s the principal place of business. The exclusivity requirement still applies. Calculation can be more favorable than an in-home office because the detached structure is more easily measured. Multiple business activities at home. If a GC has multiple businesses (a construction business and a separate rental property business, for example), the home office can be claimed for the construction business under §280A(c)(1)(A) (principal place of business for admin/management). The rental property business can’t claim a home office deduction as easily — rentals are passive activities under §469 typically, and §280A’s principal-place test doesn’t fit a passive rental activity. Improvements to the home for the office. Adding a separate entrance, building a partition to enclose the office space, finishing a basement for office use — these are capital improvements to the home. Allocate to the office portion and depreciate over 39 years (non-residential). The portion attributable to non-office use of the home is non-deductible personal expense. Renting from spouse or other related party. If the GC operates as an S-corp and the home is owned jointly by spouses, the spouse can rent office space to the S-corp at fair-market value. The S-corp deducts rent (compensation deduction). The spouses report rental income. Limited by §280A(g) (the ’14-day rule’) if the rental period is less than 15 days per year. If rental is regular (year-round office space), §280A(g) doesn’t apply. Recordkeeping for home office in audit. Photos of the office showing dedicated business use. Floor plan with square footage measurements. Time logs showing regular use. Calendar entries showing client meetings or work sessions at the home office. Computer login records showing daily use during business hours. Selling the home — depreciation recapture. When the home is sold, the portion of basis attributable to depreciation taken on the home office is taxable as §1250 unrecaptured gain (taxed at a max 25% rate). The §121 primary residence gain exclusion ($250K single / $500K MFJ) applies to the non-office portion. Some preparers recommend skipping home office depreciation (using the simplified method which doesn’t depreciate) to avoid recapture, accepting a smaller annual deduction. Over a 20-year ownership with significant depreciation, the recapture can be material. Foreign GC home offices. A US citizen GC working abroad and maintaining a US home doesn’t claim US home office deduction for non-US business activity. Foreign-located home offices for foreign-conducted business: deductible based on facts and circumstances, with international tax considerations.
I’m a $5M-revenue residential GC. Should I S-corp elect to save on self-employment tax? What’s the break-even?
At $5M revenue with typical residential GC margins, S-corp election almost certainly makes sense — but the calculation depends on net profit after reasonable comp, not gross revenue. Here’s the math. Step 1: Start with net profit before owner comp. Residential GCs typically run 12-18% net margin. At $5M revenue, that’s $600K-$900K of pre-owner-comp profit. Let’s use $750K. Step 2: Schedule C scenario (no S-corp). All $750K is self-employment income. SE tax computation: – Schedule SE Part I: net earnings from SE = $750,000 × 0.9235 = $692,625 – Social Security portion: $184,500 (2026 wage base) × 12.4% = $22,878 – Medicare portion: $692,625 × 2.9% = $20,086 – Additional Medicare 0.9%: ($692,625 + $0 W-2 income – $200,000 single threshold) × 0.9% = $4,434 (assuming single filer) – Total SE/Medicare tax: $46,356 – Half-SE deduction (above the line): $21,836/2 + $20,086/2 = $20,961 deduction – Net SE tax cost after half-deduction at 32% bracket: $46,356 – ($20,961 × 32%) = $46,356 – $6,708 = $39,648 effective SE tax. Step 3: S-corp scenario. Need to set reasonable comp. RC for a $750K-profit residential GC owner-operator: hard to peg exactly, but RCReports studies for construction owners typically suggest $120,000-$180,000 for the operations + supervision role. Use $150,000 W-2 wages. Distributions = $750K – $150K – employer FICA share = $750K – $150K – $11,475 = $588,525 distributable. – Owner W-2 FICA/Medicare: $150,000 × 7.65% = $11,475 (employee share, reduces W-2 net pay) – S-corp employer FICA/Medicare: $150,000 × 7.65% = $11,475 (deductible to corp) – Total payroll tax on $150K wages: $22,950 – Distributions of $588,525: zero employment tax (S-corp distributions to shareholders are not subject to FICA or SE) – Additional Medicare 0.9% on wages over $200K: not applicable here since wages are $150K – Net Investment Income Tax 3.8%: does NOT apply to S-corp distributions for materially participating shareholder-employees (active trade or business income is exempt under §1411). Total payroll/employment tax in S-corp scenario: $22,950. Savings: $39,648 – $22,950 = $16,698/year of payroll/SE tax savings. Step 4: Subtract S-corp costs. – Payroll service fee: $500-$1,500/year – Additional CPA fees for Form 1120-S and state corporate filings: $2,000-$4,000/year – State franchise tax (CA $800 min, IL replacement tax, NY MTA, others vary): $500-$2,500/year – Workers’ comp for owner-employee may add cost vs. sole prop Total additional costs: $4,000-$8,000/year. Net annual savings: $16,698 – $6,000 (average) = approximately $10,700/year. Step 5: Consider QBI 199A interaction. Above the QBI threshold ($241,950 single / $483,900 MFJ 2026), the QBI deduction is limited to the greater of 50% of W-2 wages or 25% of W-2 wages + 2.5% of UBIA. For a $750K profit GC, the QBI deduction is limited. Schedule C scenario: no W-2 wages. QBI deduction limited based on UBIA only (if any qualified property). For a service-heavy GC with minimal owned equipment, QBI deduction may be zero or near zero. S-corp scenario: $150K W-2 wages → 50% W-2 wage limit = $75K → 20% × QBI = 20% × $585K = $117K → QBI deduction limited to $75K. Federal tax savings at 32%: $24K. S-corp wins on QBI too. Total combined S-corp benefit: $10,700 (payroll savings) + $24,000 (QBI) = $34,700/year. Step 6: Other considerations. Reasonable comp risk. If the IRS challenges $150K as too low (because owner-CEOs of $5M residential GCs often command $200K-$300K), additional comp gets reclassified from distribution to wages, increasing payroll tax. RCReports or similar third-party study is critical. 401(k) implications. S-corp owner-employee can defer $23,500 from W-2 wages + corp can contribute 25% of W-2 wages = $37,500 = $61,000 max. Schedule C owner can defer $23,500 + 25% of net SE income (after half-SE deduction) = much higher. So S-corp limits retirement plan capacity. Health insurance. Self-employed health insurance deduction is available for both Schedule C and S-corp owners but with different mechanics. S-corp owner-employee health insurance must be paid by the corp and reported as W-2 box 1 wages (not box 3/5). Owner then deducts on Form 1040 Schedule 1. Multi-state filings. S-corp adds state corporate filings in every state where the corp operates. For a GC working in 2-3 states, this can mean $1,500-$3,000/year of additional state CPA work. Conclusion. At $5M revenue / $750K profit, S-corp election saves roughly $25K-$35K/year combined for a residential GC. Above $100K profit, S-corp generally wins. Below $80K profit, the administrative costs eat the savings. The sweet spot for new S-corp elections is $100K-$300K profit, where savings are clean and complexity is manageable. At $5M revenue you’re clearly in the win column. Other factors in the S-corp decision. Multi-owner businesses. Partnerships with multiple owners can elect S-corp for the same SE tax savings, but K-1 reporting becomes mandatory for shareholders. Each shareholder must take W-2 wages proportional to ownership and services performed. Disproportionate compensation among shareholders triggers IRS scrutiny. Health insurance for S-corp owners. The S-corp pays health insurance premiums for the owner-employee and reports them as W-2 box 1 wages (not box 3 or box 5). The owner then claims the self-employed health insurance deduction on Form 1040 Schedule 1. Net effect: same federal income tax outcome as a Schedule C, but no FICA/Medicare tax on the premium portion. Disability insurance. Premiums paid by the S-corp are deductible to the corp and taxable to the owner-employee. Benefits received are tax-free. Many small S-corps overlook this — disability insurance can be a tax-effective benefit for owner-employees. Loanout entities for high-wage states. In California, owner-operators with significant W-2 wages can use a loanout corporation (an S-corp that ‘lends out’ the owner’s services to clients) to limit SDI (state disability insurance) exposure and to structure compensation packages. For construction GCs, loanout structures are unusual but might fit owner-operators with significant ancillary income streams. S-corp built-in gains tax. If a C-corp converts to S-corp and has built-in gains at conversion, those gains are taxed at the corporate level if recognized within 5 years post-conversion. For most construction GCs starting as LLCs, this doesn’t apply. For C-corps converting (uncommon), this is a planning consideration. S-corp basis tracking. Each shareholder’s basis in S-corp stock and debt determines the deductibility of losses. Maintaining accurate basis is essential. Distributions in excess of basis are taxable as capital gains. Many small S-corps neglect basis tracking and find problems years later. Conversion costs. Converting from sole prop/LLC to S-corp requires: filing Form 2553 (S election) within 75 days of formation or beginning of tax year. Setting up payroll for the owner-employee. Updating bookkeeping to track shareholder basis and AAA (accumulated adjustments account). Estimated additional setup cost: $1,000-$3,000. Reasonable comp documentation. The single biggest audit risk for S-corp owners is reasonable compensation. The IRS challenge typically takes the form of reclassifying distributions as wages, with retroactive payroll tax and penalties. Defense: RCReports study or similar third-party comp analysis showing the W-2 wages match market rates for the GC’s role, geography, experience, and time spent. Watson v. Commissioner (8th Cir. 2012). The leading court case on reasonable comp. A CPA owner of a small firm took $24K of W-2 wages and $200K+ of distributions. The IRS reclassified $93K of distributions as wages. Court affirmed. The case is a warning for all S-corp owners — too-low compensation will get reclassified. When NOT to S-corp. Owner-operators planning to sell the business within 5 years should evaluate carefully — S-corp basis rules and AAA can complicate sale structuring. Owners with significant passive losses should consider that S-corp losses are subject to basis and at-risk limitations that don’t apply to sole props. Owners in states with high franchise/replacement taxes on S-corps (CA $800 min, IL replacement tax) need to factor those costs. Solo 401(k) capacity differences. Schedule C: max retirement plan contribution is roughly 20% of net SE income after half-SE deduction, plus $23,500 employee deferral, up to $70K combined. S-corp: 25% of W-2 wages plus $23,500 deferral. For a $250K profit GC, Schedule C allows ~$70K of retirement contributions. S-corp with $90K W-2 allows $23,500 + $22,500 = $46,000. S-corp loses $24K of retirement plan capacity per year. This is often missed in the S-corp election decision.