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A new construction project, a renovation or expansion of a property, ongoing management of a property: All these and more can come with a ton of sales tax nuances. Particularly for those construction companies with projects beyond the borders of their home state, where they may have done well with sales tax compliance for many years.

For sales tax purposes, a “contractor” is generally an entity or person engaged in the construction, alteration or improvement of real property. In most cases and states, contractors are deemed end-users/consumers. If you’re one of these professionals, generally much of what you do (your service) isn’t subject to sales tax – but almost everything you buy to do a project (the materials) is. But what works for sales tax in one state in this industry doesn’t always work in another.

Among key points from our recent webinar on construction and sales tax, we’ll start in the first of two blogs with some definitions basic to the industry.

Contract types

Most construction projects have a “lump sum” contract that includes labor and materials, with no separately stated labor or materials on an invoice. These are the simplest construction contracts for most states’ sales tax obligations. But there can be other types of construction contracts:

A separated contract for time and materials. Some states will distinguish between a lump sum and separated contract. In a lump sum contract, the state may deem the contractor the end user who pays all the tax when the materials are purchased, and no sales tax gets charged to the customer. In a separated (of time and materials) contract, the contractor may be required to charge tax on the materials to the customer and then exempt the labor components.

Capital improvements. New Jersey, North Carolina, New York and a few other states have specific rules around capital improvements, often distinguishing material improvements to the property (extending the life of the property or expanding its usefulness). In these states, it’s essential that the owner provide a capital improvement exemption to the contractor. In the absence of that, the contractor must pay tax on all the material and then charge tax on the labor component of that contract.

New versus existing construction. In Texas, to cite one state, new contraction generally falls in that simple sales tax scenario we discussed above. In some cases, however, a state might consider a remodeling to be a retail sale, in which case the contractor becomes a retailer contractor (see below) who can buy materials exempt from tax and charge sales tax on the gross price of that contract.

(Defining whether a project is a remodel or a new project is often a complicated matter for sales tax purposes – contact us for specifics).

Residential vs. commercial. Contractors improving residential real property may simply be providing a service and, in many states, are not required to charge sales tax to a customer. Yet in that same state, doing the same job for a commercial customer, a contractor may have to charge tax either on the material portion or the entire price of the project.

(A note here about installment payments: Whether sales tax is charged and due installment by installment or when the project price is paid off depends on different factors. For example, with equipment that is tangible personal property, sales tax applies when possession of the equipment is transferred. Though the magnitude of the contract can matter, it’s generally best to establish a repeatable, consistent method of sales tax collection, either with installments or at completion of a construction project.)

Additional definitions

Sales tax consequences can differ greatly state to state for prime (general) contractors versus subcontractors. Contractors with special sales tax considerations can include:

  • A retailer-contractor who buys inventory used in projects but also sells some inventory at retail – potentially a different flow for sales tax depending on the state.
  • A manufacturer-contractor who buys raw materials that can be exempt from sales tax but may also provide the labor of installation for the manufactured product. There has to be some cost basis for the sales and use tax, and some states will mandate you include the labor in that basis.

Prime contractors are usually contracted directly with the property owner. In some states, there will be a requirement to tax components of the contract or the entire contract. In essence, the prime contractor in that state (where they must charge tax on the labor or the profit margin) will look like a retail contractor, essentially registered as such and able to issue their subtractors sales tax exemption certificates. (We see this often in Arizona and Hawaii and with types of projects in North Carolina and Texas, among other examples.)

Some subtractors are also pure service providers, but services can be taxable in some states, meaning that resale/exemption certificates could need to be issued for those services.

These details can be especially complicated for subtractors who are participating in projects with prime contractors in other states. All parties must have a good idea of their responsibilities, which can get especially complex when dealing with such tax-exempt entities as governments (again, contact us for examples).

In our next entry on sales tax and contracting, we’ll look at construction work with exempt entities as well as the tax implications of dealing with different types of property and materials and how contractors can protect themselves from a sales tax audit.

Learn more in our webinar - Sales & Use Tax Considerations for Real Property Improvement Services.”

TaxConnex provides ongoing compliance services for many construction businesses, ensuring they remain compliant and have a solid grasp on when and where their services and associated costs are taxable. Get in touch to learn more.

Robert Dumas
Post by Robert Dumas
January 23, 2025
Accountant, consultant and entrepreneur, Robert Dumas began his public accounting career on the tax staff at Arthur Young & Co., followed by a brief stint at Grant Thornton. In 1998, Robert founded Tax Partners, which became the largest sales tax compliance service bureau in the country, and later sold it to Thomson Corporation. Robert founded TaxConnex in 2006 on the principle that the sales tax industry needed more than automation to truly help clients, thus building within TaxConnex a proprietary platform and network of sales tax experts to truly take sales tax off client’s plates.