Construction Contractors and Sales Tax

Published on
Apr 11, 2024
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From our partners at TaxConnex:

Construction contractors have a tough job these days, given labor shortages, supply-chain headaches, and mushrooming regulations. If you’re in this industry, the last thing you need added to your load is sales tax.

Generally, a business in the construction industry is performing a service, and most services are excluded from sales and use tax. But construction sales tax has to be your concern if you engage in contracts in different states.

And no two states are alike, it seems, when it comes to sales tax.

General complications

RPI vs. TTP. Most states have guidelines regarding sales tax requirements for contractors, often hinging on definitions of real property improvement (RPI) versus the sale and installation of tangible personal property (TPP).

Each type of transaction will potentially have different sales and use tax obligations. For instance, when defining RPI states will use terms such as “permanently affixed.” If the item in question can be easily removed (say, a big-screen TV bolted to a wall), it’s generally considered the sale and installation of TPP and not property improvement.

Examples of RPI include foundation and excavation work, building of framing and drywall, plumbing and electrical work. Construction sales tax on the sale and installation of TPP would apply to the TPP but not the installation work.

Lump-sum and separated (itemized) contracts. Lump-sum contracts don’t distinguish between the charges for materials and the charges for labor. Separated contracts separate material and labor charges.

The Sales Tax Institute confirms that in many states the structure of the contract can have an impact on the taxability of the transaction. A lump-sum construction contract generally imposes tax liability on the contractor, who must pay tax on materials incorporated into the real property purchased for the project. In a separate contract, the contractor is “selling” materials prior to incorporating them into real property for the project by listing them on the invoice. In some states, contractors may be considered retailers of the materials in this type of contract and are able to purchase tangible personal property for resale. Sales tax is collected on the selling price of the materials between the contractor and the property owner/customer.

State, job and client. Most states think of the contractor as the end user of the property (supplies and materials) bought to perform services. In those states, such services are not subject to sales tax but the supplies and materials used in performance of the service are subject to tax.

Tax-exempt entities. Most states allow you to purchase materials for contracts with tax-exempt entities, such as government entities or nonprofits, exempt from tax (aka, a “pass-through exemption”) by using a special form. Other states have no pass-through exemption but treat the contractor as making direct, tax-exempt purchases on behalf of the entity.

Different activities in different areas. You may buy a project’s materials in one state and pay the appropriate sales tax but then use these materials in a different state. Even though you have paid construction sales tax on the materials at the time of purchase, there may be additional use tax due depending on the state in which you finally used the materials.

Some state examples

A snapshot of a few states’ statutes clearly shows the sales tax confusion that can result for construction contractors.

Hawaii: Sales of materials incorporated by a contractor into a finished work and that “remain perceptible to the senses” are considered wholesale transactions taxed at 0.5%. Wholesale purchases require the applicable resale certificate; all other sales, such as sales of equipment, are retail transactions taxed at 4% (plus a county surcharge if applicable).

Massachusetts: Out-of-state contractors must register with the state and are responsible for a guarantee bond form or a surety deposit for any project valued at $20,000 or more (including materials). Such contractors are also responsible for presenting a state Certificate of Compliance to the hirer before the completion of a project, among other conditions.

New York: Installation, repair, or maintenance services either to TPP or to real property are generally taxable. Capital improvement beyond installation, repair, or maintenance is not taxable. (Ditto in West Virginia.)

South Dakota: Any person entering a contract for construction services or engaging in services that include the construction, building, installation, or repair of a fixture to real property must have a South Dakota contractor’s tax license. The excise tax imposed on the gross receipts for construction projects is at a rate of 2%.

Washington: Nothing short of a matrix details this state’s take on construction and sales tax, broken out by half a dozen types of contractors and applicable taxes (sales, B&O, use). Available in a printer-friendly version, which could be fortunate.

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