IRS Audits in Riverside’s Construction Boom: A Contractor’s Survival Guide

Riverside County is currently experiencing one of the most significant construction booms in Southern California. From commercial logistics centers in Jurupa Valley to residential expansions in Menifee and French Valley, the industry is thriving. However, this visibility comes with a hidden cost: heightened scrutiny from the Internal Revenue Service (IRS) and the California Franchise Tax Board (FTB).

The IRS explicitly categorizes construction as a “Cash Intensive Business.” This designation automatically flags your business for specific types of audits that are far more invasive than a standard correspondence audit. If you are a general contractor, subcontractor, or tradesperson in the Inland Empire, understanding these specific audit techniques is the only way to protect your livelihood.

Why Riverside Contractors Are Under the Microscope

The IRS “Construction Industry Audit Technique Guide” instructs examiners to look for specific patterns common in our region. Unlike a tech company where every transaction is digital, construction often involves:

• High volumes of cash transactions for materials and day labor.
• Complex job costing that can mask profit margins.
• Variable workforce sizes that fluctuate with project demands.

The “Cash T” Method: How They Find Hidden Income

If you are audited, the IRS may not even look at your Quickbooks initially. Instead, they will perform a “Cash T” analysis. They look at your lifestyle in Riverside—your mortgage in Corona, your truck payments, your grocery bills—and compare it to your reported income.

If you reported $40,000 in net income but your personal bank statements show $80,000 in outgoing expenses, they will assume the difference is unreported cash income from your business. This “economic reality” check is difficult to fight without a forensic reconstruction of your accounts.

The AB 5 Worker Classification Nightmare

California’s Assembly Bill 5 (AB 5) has fundamentally changed how Riverside construction companies can hire workers. Under the “ABC Test,” a worker is presumed to be an employee unless you can prove all three of the following:

1. The worker is free from your control and direction.
2. The worker performs work that is outside the usual course of your business. (This is the hardest hurdle for general contractors hiring subs).
3. The worker is customarily engaged in an independently established trade.

If the EDD or IRS determines you have misclassified employees as independent contractors to save on payroll taxes, the penalties can be staggering. You may be liable for back taxes, unpaid workers’ compensation premiums, and massive fraud penalties that can pierce the corporate veil and attach to you personally.

3 Steps to Take If You Receive an Audit Notice

1. Do Not Speak to the Auditor Alone

The IRS manual specifically instructs auditors to interview the taxpayer before they have legal representation if possible. They want you to make off-the-cuff estimates about your cash flow or how you pay your crew. These statements can and will be used against you. Direct all communication to your tax attorney immediately.

2. Reconstruct Your “Lost” Expenses

Many contractors in Riverside lose receipts for cash purchases of materials. We help clients use the Cohan Rule, a legal doctrine that allows you to estimate expenses if you can prove the work was done. We can use supplier invoices, blueprints, and industry standard “cost-to-complete” ratios to reconstruct your deductions and lower your tax liability.

3. Review Your Bank Deposits

A common error is the “non-income deposit.” Did you transfer money from savings to checking? Did you get a loan from a family member to float a job? The IRS sees every deposit as taxable income unless you prove otherwise. We meticulously categorize every transaction to strip out non-taxable cash flow.

Protect Your License and Your Legacy

A tax audit does not just threaten your bank account; it threatens your CSLB license. Do not let a paperwork error destroy what you have built in the Inland Empire. Contact Kugelman Law today for a confidential review of your audit risk.