Understanding Sales Tax Rules for the Construction Industry
Although most states do not impose sales tax on construction services, contractors must be aware sales tax rules when they purchase and bill for supplies that they use. Lump-sum contracts and time and materials contracts can create very different sales tax obligations.
The construction industry consists of businesses that construct or make improvements to houses, buildings and undeveloped land (real property). In the majority of states, construction firms do not have to collect sales taxes on the services they provide. However, they're treated as a consumers of supplies and materials used in construction projects and generally have to pay sales or use taxes at the time of purchase.
When Are Construction Materials Subject to Sales Tax?
In most states, construction contractors must pay sales tax when they purchase materials used in construction. This means that any materials and supplies you purchase are taxable at the time of purchase. However, you won't have to pay sales or use tax upon the sale of the finished construction. In some cases, this can be an advantage because any markup you charge to your customer on the materials, supplies and labor, won't be subject to sales tax.
A few states treat construction contractors like resellers, who purchase materials solely for resale to an end user. and do not require that the contractor pay sales tax when purchasing materials. More states provide this treatment for itemized contracts than lump-sum contracts.
- Lump-sum contracts: Arizona, Hawaii, Mississippi, Nebraska, and New Mexico
- Time and Material (Itemized) contracts: Arizona, Colorado, District of Columbia, Hawaii, Indiana, Mississippi, Nebraska, New Mexico and Texas
In addition, the states that require construction contractors to pay sales tax on purchases may provide exemptions to this general rule. Whether you qualify for the exemptions will depend not only on the type of contracts that you negotiate with your clients, but also who your clients are (for example, are they non-profit or governmental agencies.)
Generally, work is done under a signed written agreement with your customer that lays out the terms of the work to be done, the type of materials to be used, and an estimate of the total cost of the job. It is up to you whether you want to include a stated provision in your contract for the payment of sales taxes. However, when you negotiate a contract with a customer, make sure that you account for the right sales or use tax rate when bidding on a job. To do this, you should check with the states that you operate in to verify that you have included the right tax rate either to roll into the contract or to pass directly onto the customer.
When negotiating a construction contract, most contractors use either a "lump-sum" contract or a "time and material" contract. While other types of contracts may be used in contracting with the government, these two are the most typical for nongovernmental contracts. If you use a "lump-sum" contract, you are agreeing to perform the contract for a single stated amount. This amount will include materials, supplies, services, overhead and profit all "lumped" together in one line item.
Using a time and material contract, the stated contract amount will be based on and include actual rates for all workers at the site, and separately charge for supplies and materials used. In fact, you may even bill separately for overhead and profit margin.
In some states, the type of contract you use may effect when you will have to pay sales taxes on materials and supplies purchased.
Davie, a building contractor in Florida, enters into a lump-sum contract with a Cydney for the construction of her new home. He will be required to pay sales or use taxes when he purchases supplies and material because the construction contract is a lump-sum contract. If Davie had used a time and materials contract, which required him to separately state and itemize the materials, supplies and labor, then Florida would have treated him as reseller. Resellers are exempt from sales tax on their purchases, so he would not pay sales tax when he bought the materials and supplies. Instead, Davie would be required to charge Cydney sales tax on the materials and supplies.
The states that treat construction contractors like retailers let you buy materials and supplies for a job tax-free—usually after you present a vendor with a valid resale certificate. However, when you finish the construction project, you're going to have to cut the state a check for sales or use tax on the basis of gross sales for the new construction.
Subcontractors May Have Sales Tax Liabilities
Depending on how big a job is, you may be working as either a "prime contractor" or a "sub-contractor." Being the prime contractor on a large construction job means that you will contract with a customer to perform all the work on a construction job and bill this customer for the entire amount of the job. As a subcontractor, however, you will be hired by the prime contractor and have little, if any, contact with the customer. The payment you receive will typically come from the prime contractor. However, you'll still be treated like an end consumer and have to pay sales and use taxes when you purchase supplies and materials.
The five states that don't tax construction contractors when they purchase supplies and materials (Arizona, Hawaii, Mississippi, New Mexico, and Washington) often provide an exemption for sub-contractors. Still, in some states, you're not completely off the hook for sales taxes if you're a sub-contractor. In Mississippi, for example, if the prime contractor doesn't pay tax on that portion of the job that you worked on, guess what? You're on the hook for it!
If you happen to take a sub-contracting job in any one of the five states that treat contractors as resellers, make it a point to check out the state laws to see what your liability for state sales and use tax is when the prime contractor doesn't pay. Remember, if the prime contractor files for bankruptcy or otherwise dissolves, you don't want to get stuck paying an unplanned-for tax bill.
Can a Customer's Sales Tax Exemption Flow through to a Contractor?
If your customer is exempt from sales and use tax, such as a nonprofit civic or community organization, then you may want your customer to purchase the materials that you're going to use in the construction.
Why? Because in some states, exempt organizations are allowed to buy materials and supplies for a construction project tax-free. If this exemption is allowed to flow through to materials they purchase for a construction job they have hired you for, then a large tax savings may result for you. However, tax assessors look at the transaction very carefully to make sure that either the exempt organization or an agent authorized to act on behalf of the exempt organization is making the purchase. Most states do not allow contractors to use an organization's exemption unless the contractor is the exempt organization's authorized agent. While the distinction of who can purchase the supplies and materials seems sort of trivial, states use it as a check to prevent abuse of the organization's exempt status.
When Is Sales Tax Due on Materials Purchased for Resale?
If you operate in a state that requires construction contractors to pay sales or use taxes on purchases of supplies and materials, you should check to see if your state provides an exemption that allows construction contractors to buy materials and supplies tax-free if the property is specifically designated as resale property. If there's such an exemption, then you can buy resale property tax-free and collect sales taxes when you resell the material.
However, if the state you operate in does not allow construction contractors to buy material for resale tax-free, you're going to have to check with the state to find out the procedure for applying a credit for sales taxes paid against the tax incurred when the material is resold.
Is Sales Tax Due on Materials Purchased in One State but Used in Another?
Some states provide an exemption for purchases of materials and supplies that are to be used for an out-of-state construction job. If you're in a state that has such a provision, become familiar with the process for obtaining and using any required exemptions. This will help you to avoid cash shortages from having to pay unplanned for use tax in your home state.
As a construction contractor, you are generally responsible for paying sales tax on all supplies and materials at the time they are purchased. However, if your home state law is similar to that found in California, you may buy materials and supplies tax-free if they're going to be used on a construction job out-of-state. The way you go about getting this exemption is by providing a written document, such as an exemption certificate, to the California vendor you're buying the supplies and materials from.
Now, even though this may get you out of paying sales tax in your home state, don't forget that you've still got to pay use tax in the state where the construction job is being done. You didn't really think they'd let you get away that easy, did you?
What Happens If the Tax Rates Changes After Purchase, But Before Delivery?
As states find themselves strapped for cash, an easy way to generate revenues is to bump up the sales tax rate. How this will affect the contract price of materials and supplies not yet delivered will depend on the state where you have the contract. While most states will give you a break and let you complete the purchase at the old tax rates, you should touch base with your state tax assessor just to determine if they allow old tax rates to apply to current periods for uncompleted contracts.
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