As a part of our series aimed at helping you navigate the impact of sales and use tax on your business, periodically we will focus on the impact of these taxes on specific industries, beginning with a high-level look at construction.
Construction contractors face many complexities when navigating the sales and use tax impacts to operations, with missteps often leading to significant tax assessments and loss of profits. Below are a couple initial questions and concepts contractors should consider that will help minimize the tax impact and maximize profits of the job.
Do Contractors Have to Collect Sales Tax from the Project Owner?
Most states follow the general rule that contractors are consumers of the materials used to fulfill their construction contract. Under the general rule, you as a contractor would pay sales tax directly to your vendor or remit use tax when you purchase materials. You would not be required to collect sales tax from the project owner.
This general rule applies when the contract is for the construction of real property, but, of course, there are exceptions. For example, Connecticut requires contractors to pay tax on its material purchases but also collect sales tax on certain construction services. In other states, contractors may also be treated as retailers, depending on the nature of the project. If the contractor is treated as a retailer, it may be able to purchase materials tax free as sale for resale, but would be required to collect sales tax from the project owner. As a retailer, the contractor would be required to register with the state to collect and remit sales tax.
When (and How) Should Contractors Begin Thinking About Sales and Use Tax?
Start looking at the potential impact early in the process, so you can properly account for sales and use tax in your bids. Come to an agreement with project owners on the true nature of the project and its tax impact or, at the very least, include language in the contract, such as an indemnification provision, to protect yourself in the event of a sales and use tax audit.
When discussing the project with the project owner during the bidding process, the following areas should be considered and resolved:
- What is the nature of the project?
- What type of contract will be used?
- Will the project owner’s tax exemption flow through for contractor use?
Nature of the Project
Whether the project is for the construction of real property or the installation of tangible personal property is a state specific analysis. States may look at the manner of affixation and permanence when determining if the project is construction of real property. Some states provide statutory or regulatory guidance that outlines its presumptions of the types of property that become real property upon installation versus the types that remain tangible personal property.
Other states, such as Ohio, may go a step further to consider the usage of the property upon installation. Ohio broadly defines construction contracts to include agreements where tangible personal property will be transferred and incorporated into real property to become part of the real property. However, Ohio excludes business fixtures from the definition of construction contracts. Business fixtures include tangible personal property that is incorporated into real property but primarily benefits the business conducted on the premises, not the real property itself. For example, an air conditioning unit that maintains specific environmental conditions in a computer room would be classified as a business fixture; however, if the air conditioning unit maintains environmental conditions for the entire building, it would be classified as real property. Business fixtures retain their character of tangible personal property for sales and use tax purposes, which means that the contractor would be treated as a retailer.
The differing state rules could result in identical contracts having different tax impacts depending on the job site state.
Type of Contract
The form of the contract can impact its classification and tax treatment. Lump-sum contracts do not separately state charges for materials, labor, overhead and similar charges. Under lump-sum contracts, you as the contractor are generally treated as the end consumer of materials incorporated into real property. You would be responsible for paying tax on the materials.
Time and material contracts itemize charges for material, labor, supplies and other charges. Several states will presumptively treat time and material contracts as sales of tangible personal property with installation. Under time and material contracts, you would be able to purchase materials transferred to the project owner as nontaxable sales for resale, but would then need to collect sales tax upon installation of the property.
When determining the form a contract should take, discuss with the project owner whether you want to the contract to be treated as tangible personal property with installation to take of advantage of available exemptions.
Flowthrough of Project Owner Exemptions
This is an area that can cause significant issues to a contractor. Project owners often assume their sales tax exemption applies to all their purchases, whether made directly or through a contractor. This is an incorrect assumption. Whether or not a project owner’s exempt status can flow through to a contractor is a state dependent analysis.
Most states will not allow contractors to use a project owner’s exempt status to make tax-free purchases of the materials. Others may allow the project owner’s exemption to flow through in limited circumstances, such as purchases related to manufacturing. In states that allow the flowthrough of exemptions there may be specific documentation requirements and prior approval requirements.
Contact Hannah Prengler at firstname.lastname@example.org or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.