Construction contractors’ primary taxability challenge stems from converting tangible personal property (TPP)—such as lumber, steel, sheetrock, and cement—into real property. This conversion creates a complex issue for taxing authorities who typically impose tax on these items. The key question they face is determining at what point the contractor becomes liable for sales or use tax during the conversion process.
Sales and use tax management is critical for construction companies. They apply to the sale, purchase, and use of goods and services, and as rates approach 10%, the financial implications of not following your state-specific contract closely can significantly impact your profit margin. To remain compliant, construction companies must remain diligent and continually navigate complex regulations.
Thompson Tax’s Two Most Important Rules of Engagement
- D.O.T.S. (Depends on the State) – Each state has its own set of rules. It is imperative to know the rules of each state where you are conducting business.
- Documentation! Documentation! Documentation! – Make sure to document all sales properly. Proper documentation is the key to positively responding to an audit.
How Sales and Use Tax Applies to Construction Contractors
The Construction Contract, a legal document that governs the relationship between the Project Owner, General Contractor, and Subcontractor, plays a crucial role in determining the applicability of sales and use tax. This document holds the authority to control tax matters, making it a key player in ensuring tax compliance within the construction project. It’s important to determine the type of contract and property you are using before commencing work, as per below.
Taxability of Construction Contracts
Lump-Sum Contracts
In a lump-sum contract, the contractor agrees to complete a project for a single fixed price. The contractor is generally deemed the consumer of the materials and must pay sales or use tax when purchasing these materials.
Time-and-Materials Contracts
In a time and materials contract, the contractor bills the customer separately for labor and materials. The contractor is generally considered the retailer of the materials and must collect sales tax from the customer on the sale of these materials (exceptions apply).
Cost-Plus/Mixed Contracts
Some contracts may have elements of both lump-sum and time-and-materials contracts. Contract value states the cost of labor and materials, and fees are determined as a percentage or a fixed amount. The Project Owner carries the risk of cost overruns. Determining the primary nature of the contract is essential to applying the correct tax treatment.
U.S. Government Contracts
Projects for government entities and certain nonprofit organizations may be exempt from sales and use tax. Obtaining an Exemption Certificate is a key factor in determining taxability.
Types of Property
Tangible Personal Property (TPP)
- TPP is any personal property that can be “seen, weighed, measured, felt, or touched” or otherwise is “perceptible to the senses.”
- TPP includes electricity, water, gas, steam, and prewritten computer software.
- Typically, does not include “real property” (*Beware, some states do have sales tax on real estate transactions)
Fixtures
- Items permanently attached to a building, such as light switches and door handles.
- Objects permanently affixed or built into the property, like a fitted kitchen, boiler, baths, sinks, and toilets.
Machinery and Equipment
- Machinery refers to mechanical or electrical devices designed to perform specific tasks. This category encompasses a wide range of items, from heavy industrial machines used in manufacturing to smaller tools used in construction or maintenance. Machinery is typically engineered to perform a particular function and is often automated or semi-automated to enhance efficiency.
- Equipment, on the other hand, includes tools, instruments, or devices used for specific tasks. Equipment can range from hand tools used in construction to medical equipment used in healthcare settings. Equipment is generally designed to be portable and versatile, making it suitable for use in various environments.
Tools and Consumable Supplies
- Tools refer to devices or implements used by workers to perform tasks on a construction site. They can be hand tools or power tools and are typically durable items that are used repeatedly over time. Examples include hammers, wrenches, drills, saws, and screwdrivers. Tools are essential for various construction activities such as cutting, shaping, assembling, or fastening materials.
- Consumable supplies are materials or items that are used up or depleted during the construction process. These supplies are typically non-durable and are not intended to be reused. They are necessary to complete specific tasks but are consumed or discarded after use. Examples include nails, screws, adhesives, sandpaper, welding rods, masking tape, cleaning solvents, and personal protective equipment (PPE) like gloves or dust masks.
Resale Certificates *Beware*
Construction companies can use resale certificates to purchase materials without paying sales tax, provided these materials are for resale to customers. A resale certificate must be presented to the supplier at the time of purchase.
Other Special Areas of Note
Manufacturing and Industrial Projects
Construction companies working on manufacturing or industrial projects may qualify for exemptions on the purchase of certain materials and equipment used directly in the manufacturing process. Many states offer tax incentives for energy-efficient construction projects, including exemptions or reductions in sales and use tax on qualifying materials and equipment. These exemptions vary by state and require specific documentation.
- Solar or Green Plants
- Manufacturing Plants
- Public Works Projects
Government and Nonprofit Projects
Projects for government entities and certain nonprofit organizations may also be exempt from sales and use tax. Contractors should obtain (and retain) exemption certificates to document these transactions.
- Nonprofit (e.g., hospitals)
- Native American Indian tribal land projects
- U.S. Government
*ALERT* Determination of Title passage is critical for these types of entities
Compliance and Record-Keeping
Maintaining accurate and detailed records is crucial for compliance with sales and use tax regulations. Records should include:
- The contract – it is the most important document for any project as it controls its overall taxability.
- Purchase invoices and receipts between vendors and subcontractors
- Resale and exemption certificates – when should they be issued?
- Documentation for out-of-state purchases that clearly distinguish who is responsible for sales tax and who is responsible for use tax.
- Contracts, billing statements, and progress payments (which are a significant audit issue).
Audits = Tax, Penalty, and Interest
Contractor vendors and subcontractors are regularly audited, and these audits often trigger audits of the General Contractor and Project Owner. Failure to comply with sales and use tax regulations can result in audits, fines, and penalties. Construction companies should regularly review their tax practices and consult with tax professionals to ensure compliance.
Thompson Tax Is Here to Help
Navigating sales and use tax regulations is essential for construction companies to avoid costly mistakes and ensure compliance. Understanding how these taxes apply to different aspects of your business, from purchasing materials to structuring contracts, will help you manage your tax obligations effectively.
Contact Thompson Tax today for guidance and advice tailored to your construction company’s specific needs. We are just a phone call away.
FAQs on Sales and Use Tax for Construction Contractors
What is the difference between sales tax and use tax?
- Sales Tax: Collected by the seller at the point of sale on the purchase of goods and services.
- Use Tax: Applies to the purchaser for use, storage, or consumption of goods when sales tax has not been paid, typically on out-of-state purchases.
When do I need to pay use tax?
Use tax is due when you purchase materials or equipment from out-of-state vendors without paying sales tax and then use these items within your state.
Are construction materials always taxable?
D.O.T.S. – Not always. Materials purchased for resale or incorporation into a project can be exempt from sales tax if proper documentation, such as a resale certificate, is provided.
How do I use a resale certificate?
D.O.T.S. – Present the resale certificate to your supplier at the time of purchase to avoid paying sales tax on items that will be resold as part of a construction contract.
Do I have to pay sales tax on tools and equipment?
Generally, contractors are deemed consumers of tools, machinery, and equipment (including leased equipment) used in construction, which are usually subject to sales tax when purchased.
What is a lump-sum contract, and how does it affect tax obligations?
In a lump-sum contract, the contractor agrees to complete the work for a fixed total price. In many states, the contractor is deemed the consumer of the materials and must pay sales or use tax on the purchase of these materials.
What is a time-and-materials contract, and how does it affect tax obligations?
A time-and-materials contract separates labor and materials charges. In many states, the contractor acts as the materials retailer and must collect and remit sales tax from the customer on the material portion of the contract.
Are there any exemptions for construction projects?
Yes, there are several potential exemptions, including projects for government entities, nonprofits, manufacturing and industrial projects, and energy-efficient constructions. Each exemption requires specific documentation.
How can I ensure compliance with sales and use tax regulations?
Maintain detailed records, including invoices, receipts, resale and exemption certificates, and documentation of out-of-state purchases. Regularly review your tax practices and consult with tax professionals.
Are there special considerations for multi-state projects?
Yes, multi-state projects require an understanding of each state’s tax laws, including registration, filing requirements, and applicable exemptions. It is highly recommended that you coordinate with tax professionals.