A very strong indicator of future IRS examinations in construction is the update and reissuance in April 2021 of the IRS Construction Industry Audit Technique Guide (ATG).[1] Updated from the 2009 version,[2] the 176-page 2021 ATG is the handbook for agents to learn and understand the rules for the industry, as well as for contractors to be aware of the rules and possible areas of focus for examination of tax returns. For instance, the 2017 Tax Cuts and Jobs Act (TCJA) provided more options for accounting methods, adding to an already complex set of rules for the construction industry and making contractor tax returns prone to errors and prime for adjustments by IRS agents.[3]

The first 163 pages cover many of the rules for contractor taxes found in the Internal Revenue Code (IRC), regulations, and cases while the last part of the ATG — as well as in many places throughout the first part — recommends areas for the agents to examine.

Improvements to the Updated ATG

The current ATG is much more readable than the previous version with better formatting and organization. It contains many of the updates from the TCJA that are applicable to contractors as well as recent cases from the past few years. 

One of the most noticeable differences in the 2021 version compared to the 2009 version is the removal of about 100 pages of example square foot costs of construction materials and labor and the time in which it takes to install a square foot of the example product. Removing this from the 2021 version is a great change since it very likely gave examining agents a misguided preconception of what contract costs should be. With agents possibly expecting costs to be less than actual — as inflation, spoilage, etc., made actual costs more than the 2009 ATG listed — they may have explored the possibility of the contractor redirecting materials to projects for which the revenue was unreported or deducting more costs and not reporting revenue properly, which is one of the income probes recommended to agents in the ATG.

A remnant of those listed standard costs still appear in the 2021 ATG, which says that a 2,000 square foot home may require 13,127 board feet of framing lumber, 15 windows, 12 interior doors, etc.[4] If a contractor under examination has a house that size with 20 windows, for example, it may cause the agent to wrongfully suspect fraudulent diversion of deducted costs or unreported income. Such misguided suspicions can expand the examination needlessly, increasing the costs of representation for the contractor during the examination and in defending erroneous proposed adjustments to the tax returns.

The ATG Is a Great Tax Primer

The ATG is an excellent basic overview of contractor tax rules for new construction financial managers (CFMs); it describes the different types of contracts, bonding, participants in the construction process, and the many complexities of the tax law while providing a basic understanding of the many tax accounting methods available to contractors, the recognition of revenue, and the required accumulation of contract costs.