If you’re a construction contractor – especially if you’re engaged in contracts in different states – you have to evaluate your sales tax responsibilities in each state where you have customers.
Generally, a business that considers themselves in the construction industry is performing a service and most services are excluded from sales and use tax. So you might think you have nothing to worry about from a sales and use tax perspective. That might be true in some states but different states have different rules when it comes to construction services.
Here are some of the complications you could face in the construction industry when it comes to sales tax.
1. Real Property Improvement vs. the Sale and Installation of TPP
Most states have general guidelines regarding sales tax requirements for contractors, and they hinge on the definitions of real property improvement (RPI) versus the sale and installation of tangible personal property (TPP). The definition is important as each type of transaction will potentially have different sales and use tax obligations. In defining RPI, states’ statutes will use terminology 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. Examples of RPI include foundation and excavation, building of framing and drywall, plumbing and electrical work. Sales tax on the sale and installation of TPP would apply to the TPP but not the installation work. In a real property improvement transaction, there would generally be on sales tax charged and the contractor would either pay sales tax or accrue use tax on their purchase of materials.
2. Understanding Tax Obligations: Matter of 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, those services are not subject to sales tax but the supplies and materials used in performance of the service are subject to tax
There are exceptions though. The state of Washington, for example, considers a general contractor essentially a retailer. So instead of paying tax on materials when they buy them, contractors buy the materials exempt from sales tax and then charge tax on their gross receipts from contracting.
One possible problem: If you buy a project’s materials in one state and pay the appropriate sales tax, but then utilize these materials in a different state. Even though you have paid sales tax on the materials at the time of purchase, there may be additional use tax due depending on the state in which you utilized the materials. There is reciprocity amongst many of the states, but that is typically only at the state level and not so much at the local level.
3. Working with Tax-Exempt Entities
Contracts with tax-exempt entities, such as government entities or nonprofits, can be challenging.
Most states allow you to purchase materials for those contracts exempt from tax (aka, a “pass-through exemption”) by using a special form from the state in question. Other states have no pass-through exemption but treat the contactor as making direct, tax-exempt purchases on behalf of the entity.
And a few states, such as South Dakota, mandate that the contractor must accrue and remit use tax on the fair market value or purchase price of the materials, which are deemed “property” of the entity itself.
(For more, see our webinar on sales tax complexities for the construction industry.)
TaxConnex has assisted companies in many industries to alleviate the burden of sales tax. We are experts when it comes to navigating tax regulations. Contact us to learn more about how TaxConnex can take sales tax off your plate entirely.