By Karen J. Poist, CPA, and Kimberley D. Tarnakow, CPA
Did you know that construction contracts, specifically the type of construction contract, can determine the sales taxability of a project? Not only will sales tax vary by type of contract, but it will also vary by state. Regardless of the type of contract, a contract should include details as to the scope of work, the price, and who is responsible for the tax. As a contractor, if the tax is to be passed on to the customer, be sure to include and communicate this in your bids and quotes and final contract. Be aware that there may be some circumstances where credits or exemptions could apply.
TIME AND MATERIALS CONTRACTS
A time and materials contract is a contract in which the agreed‑upon contract price is separately stated for materials and labor. Generally, under this type of contract, the contractor is considered a retailer or seller of the materials to the customer and must assess and collect sales tax. In addition, some contractors may keep an inventory of items held for resale to customers. To do so, any items that they purchase for resale can be purchased tax‑free by providing a resale certificate to suppliers. Note, the contractor must have a sales tax license to be able to issue a resale certificate. The contractor will then assess sales tax on the sale of goods sold to the customer. States will differ on how sales tax is applied to this type of contract. Some states will require the contractor to pay sales tax on the purchases of equipment, and other items, as well as any taxable services.
LUMP‑SUM CONTRACTS
In general, a lump-sum contract is a construction contract in which the contractor agrees to complete a project for one lump-sum price. The contractor will not bid on specific items such as materials, labor, etc. Charges for materials are included in the job and are not separated from labor charges. When engaging in a lump-sum contract, the contractor is considered the user or consumer of the goods used in the project. That means the contractor will owe tax when they purchase materials, equipment, and other supplies as well as any taxable services. The contractor will not collect any tax from a customer. Again, every state treats these types of contracts differently and state rules must be considered for accurate compliance.
COST‑PLUS CONTRACTS
A cost‑plus contract is a contract that is used when a contractor gets paid for allowed expenses, plus additional payments to allow for a profit. With a cost‑plus contract, the state may determine a sale to the customer to be part property and subject to sales tax, and part service, which may be tax‑exempt. Note, this type of contract is not a standard method of contracting. Although, some believe this is a more cost-effective method.
Customers may also purchase items for projects. When these customers purchase and hire a contractor to install the items, the customer is generally responsible for the sales tax on the item.
SALES TAX EXEMPTIONS
While many states may exempt materials from sales tax that are purchased for use in a contract with a governmental agency or other tax-exempt entity, the steps to take advantage of these exemptions will be different in each state. Just because your customer is tax-exempt does not mean that your purchases will automatically be tax-free. One possible step is to have the exempt entity (customer) make the purchases directly for the project. Another is having the governmental agency provide an exemption certificate based on the specific project. Or, if the governmental agency has its own exemption, then the contractor may be able to use the exemption when purchasing materials. Also, there are some states that require the contractor to obtain a “Purchasing Agency Agreement,” in order for the materials to be tax-exempt. This allows the contractor to purchase goods tax-free for the project, and the exempt-entity directly billed for payment.
Exemptions may also apply if a contractor is purchasing materials to be used in another jurisdiction (state). They may be able to utilize a state specific exemption to purchase materials tax-free in the state of purchase if it is known they will be consuming or using them out of state. However, use tax will be due to the state in which the materials are being consumed or used. (Refer to our MCS March 2021 article for a discussion on taxing equipment and materials across state lines.) State rules are different for every state and should be considered early in the process to be able to obtain any applicable exemptions before a job begins.
CLOSING THOUGHTS
Understanding your contracts and the various nuances between the state tax laws is critical to the success of your projects and in keeping in compliance with state tax laws. Sales tax is a transaction-based tax that is very specific to the details of each transaction. Sometimes the most innocuous difference can completely change the taxability of the transaction. Before entering a contract, take time to understand the sales tax rules of the specific state in which the contract work will be performed. Determine if any sales tax exemptions may apply and what steps are necessary to obtain the exemption certificates. Sales tax is a key component of the construction industry. Understanding it and managing it … that’s the challenge.
For More Information
Karen J. Poist, CPA, is SALT director with Stambaugh Ness. She can be reached at kpoist@stambaughness.com.
Kimberley D. Tarnakow, CPA, is senior manager with Stambaugh Ness. She can be reached at ktarnakow@stambaughness.com.
Modern Contractor Solutions, April 2021
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