Not So Simple Sales Tax Rules for Contractors

At first glance, the sales and use tax requirements for a contractor seem quite simple. Contractors are typically considered the end-user/consumer of all tangible personal property purchased and used by them in conjunction with the performance of a contract to improve real property. As such, all purchases by a contractor are usually subject to sales and use tax. Since contractors are considered service providers, charges by them for real property improvement services are typically exempt from sales and use tax. Sounds simple... but like most things in sales tax, it isn’t as simple as it seems.

Most states define tangible personal property as property which can be seen, weighed, measured, felt, touched, or that is perceptible to the senses.

Generally, once tangible personal property is affixed to real property, it loses its identity as tangible personal property and becomes real property. This is a critical distinction for sales and use tax purposes as the sale of tangible personal property is subject to sales and use tax while the sale of real property is generally not taxable.

One of the difficulties faced by many contractors is determining when tangible personal property becomes real property vs. retaining its character as tangible personal property.

For example – a contractor performs an installation of a hot water heater.  Is this considered a real property improvement? Does the hot water heater  become affixed to real property and change form from  tangible personal property? Or, is this a taxable sale and installation of tangible personal property?

Generally, we would consider the installation of a hot water heater  an improvement to real property and the contractor would be  deemed the end- user/consumer – required to pay sales or use tax on the  purchase price of the water heater. However, this isn’t the case in every state or situation.

What about carpeting, cabinets, or an oven? And what about industrial machinery that is cemented into the ground or affixed to a wall? How do states treat these types of transactions for sales and use tax purposes? The short answer is – it depends on the state.

Of course there are exceptions to the rules, like most areas of sales tax there are entities, organizations and situations in which contractors could be exempt from sales tax.

In some states, the contractor may purchase tangible personal property exempt from sales and use tax when the contract is directly with a government agency or nonprofit exempt organization. This is commonly referred to as a “pass-through exemption” – meaning the contractor steps into the shoes of the exempt property owner relative to sales and use taxes on purchases of materials which will be affixed to the real property. This pass-through exemption typically flows down to subcontractors as well.

To qualify for the exemption, the contractor is required to obtain and present to the vendor some form of documentation from the government or nonprofit entity substantiating the exempt use of the tangible personal property being purchased by the contractor. The form of documentation varies by state.

When a state doesn’t afford a pass-through exemption, a contractor can become a purchasing agent for the exempt entity. In this capacity, the contractor purchases tangible personal property on behalf of the exempt entity, obligating the exempt entity for payment of the property.

But what about if you aren’t working with an exempt entity, or are working in multiple states with differing tax laws? This is where sales and use tax is most challenging – identifying the nuances in each state that apply to your business. Educate yourself on the laws of the state before bidding on a construction job – it could save you from making a 10% gross margin error. When in doubt, seek out the expert guidance of a sales and use tax specialist that can guide you appropriately.

Get in touch to talk to one of our experts! Or learn more about sales and use tax for contractors in our eBook – Sales and Use Tax for Contractors. https://www.taxconnex.com/sales-and-use-taxes-for-contractors-whitepaper