Sales and Use Tax Fundamentals for Construction Companies July 24, 2014 Presented by: Michael L. Colavito, Jr., JD Michael P. Corcoran, CPA © 2014 | All Rights Reserved | 805 King Farm Boulevard | Suite 300 | Rockville, Maryland 20850 | 301.231.6200 P | 301.231.7630 F | www.aronsonllc.com Agenda • General sales tax treatment of contractor purchases • Common exemptions – – – – Impact of contract type Contracts for exempt entities Dual contractor/retailer Sales in interstate commerce • Other issues – – – – Repairs and maintenance Fabricators/manufacturers Non-resident bonding Tax clauses and indemnification agreements © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 2 Factors That Can Impact Sales Tax Treatment Where is the project located? How is the service being billed: lump sum or time and materials? Are the materials/supplies purchased in one state and used in another? Is the customer claiming an exemption? Are the services being performed onsite and/or in a shop? When does title to the goods pass? Is repair work treated the same as “construction” work? © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 3 General Rules and Concepts • “Construction contractor” typically includes any person who performs services that constitute an improvement to real property or a conversion of tangible personal property into real property. • This includes: – Any person who engages in constructing, improving, or repairing any building or structure on land – Road, grading and excavation contractors – Demolition – Fencing – Elevator and escalator installation – Electrical, plumbing and heating/air conditioning contractors • State sales and use tax laws typically include subcontractors in the definition of “contractor”. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 4 General Rules and Concepts (cont.) What is “Real Property”? • Includes land, buildings, and structures attached to land • When does tangible personal property become real property? – Factors • Permanently affixed to or embedded in the realty • Property after installation is necessary to the intended usefulness of the building or other structure • Difficulty of removal • Intent of the parties – Examples of tangible personal property that become part of real property (i.e. fixtures) – - Cabinets - Water heater - Ceiling fan - Garbage disposal - HVAC System - Lighting © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com - Fencing - Alarm systems - Faucets Slide: 5 General Rules and Concepts (cont.) General Sales Tax Rule (applicable in most states) • Construction services are generally not subject to sales tax – Why? They are typically treated as: • a nontaxable service; or • the transfer of real property. • Construction contractors are typically considered the consumer of all items they purchase to perform their contracts (i.e. raw materials, tools, supplies, machinery, and equipment). Thus, the sale for resale exemption is generally not applicable. • Contractors are typically liable for sales/use tax on the items they purchase. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 6 General Rules and Concepts (cont.) Economic/Practical Considerations – The contractor generally does not collect the tax from its customer. This can be simpler from a compliance perspective (no collection and remittance). – The contractor recovers the cost of sales tax as part of the purchase price for its services (but not itemized as sales tax on bill). – The contractor needs to know upfront how much sales tax to factor into a bid. – Registration requirements need to be considered when conducting business in a new state. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 7 General Rules and Concepts (cont.) NOT ALL STATES FOLLOW THE GENERAL RULE • The following states do not impose sales tax on purchases of materials by construction contractors: – Arizona – prime contractor taxable on 65% of gross proceeds from a contract. – Hawaii – imposed on contractor gross receipts; purchases of materials taxable at 1% wholesale rate. – Mississippi – construction activities taxable at reduced rate. – Nebraska – contractors option. – New Mexico – construction services subject to tax. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 8 Common Exemptions Common Exemptions/Exceptions to General Rule – Structure of the contract/pricing terms – Contracts for Exempt Entities (i.e. government or nonprofit) • Sales to certain entities such as government or charities. • Customer’s exempt status may flow through to contractor. • Some states require that property be actually purchased by exempt entity rather than “on behalf of” exempt entity. – Dual contractor/retailer – Sales in interstate commerce © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 9 Structure of Contract/Pricing Terms How is price defined in the contract? • Lump Sum – General rule typically applies in most states. • Time & Materials (T&M) – Some states treat the sales of the materials as a separate retail sale by the contractor. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 10 Sales Tax Impact of Contract Pricing Taxable Contracts • Lump Sum Contracts – Arizona, Hawaii, and New Mexico have gross receipts privilege taxes imposed on the service provider; most gross receipts from services are taxable. • Time & Materials Contracts (T&M) – States that treat itemized T&M contracts as a retail sale of tangible personal property include: • • • • • California Colorado District of Columbia Florida (if contract is considered a retail sale plus installation contract) Texas – Contractor’s purchase deemed non-taxable sale for resale. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 11 Sales Tax Impact of Contract Pricing (cont.) DC Treatment of Time & Materials Contract • DC regulations state when a contractor agrees to sell materials used at an agreed price with the work to be done for an additional price or on the basis of time, the contractor is a retailer. • Contractor must give its supplier a resale certificate. • Contractor must file returns, pay the tax, and collect reimbursement for the tax from the buyer. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 12 Sales Tax Impact of Contract Pricing (cont.) Tax Impact of Lump Sum v. Time & Materials • Example – – – – Contract Material Cost - $60,000 Contractor Markup - 10% Assume 6% tax rate Tax if lump sum contract (paid by contractor) • $3,600 – Tax if T&M contract (collected from customer on markup) • $3,960 © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 13 Contracts for Exempt Entities • Issue – Is a contractor required to pay sales tax on materials that will be incorporated into the real property of a customer that is exempt from sales tax? • Many states have exempt entity exceptions, but the devil’s in the details: Factors to Consider When Dealing with Exempt Entity Rules Scope of the Exemption Logistics • Government, nonprofit, etc. • Contractor exemption certificate • Government only (federal and/or state) • Contractor to use customer’s exemption certificate • Nonprofit, religious, etc., only • Pre-approval required • Materials only • Direct purchase by customer © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 14 Contracts for Exempt Entities (cont.) • Flow-Through of Customer Exempt Status – Alabama – Eff. 1/1/14, no sales tax applies to purchases of materials and supplies that will become part of a structure that is the subject of a contract with a Alabama government entity (excludes highway, road, or bridge contracts). – District of Columbia – Materials/supplies incorporated into real property for contract with “semipublic institution” or federal/DC government agency exempt from tax; contractor must provide supplier “Contractor’s Exempt Purchase Certificate.” © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 15 Contracts for Exempt Entities (cont.) • Flow-Through of Customer Exempt Status – Illinois/Texas – Sales of materials to construction contractors are exempt when the materials are for incorporation into real property owned by government bodies, charitable, religious, and educational organizations. – Pennsylvania – Purchases of “building machinery and equipment” transferred to state or federal government agency or other taxexempt organization in connection with a construction contract. • Examples include: HVAC, communications equipment, traffic control systems, building/parking lot access systems, alarms, etc. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 16 Dual Contractor/Retailer • Some contractors make both retail sales of materials and incorporate materials into construction projects. • A number of states do not address this issue, the remainder address it through regulation. • If no specific rule exists in the state, follow the general rules that apply to the business in which you are predominantly engaged (i.e. contractor or retailer). © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 17 Dual Contractor/Retailer (cont.) • Example – Company installs fences and sells fencing materials to other contractors. – Company maintains an inventory of items for resale and uses a portion of such inventory to perform its own fence installations for customers. • Impossible to identify, upon purchase, the materials for use by contractor and those being resold. • Issue – Does the contractor/retailer pay tax on the purchase of the materials? © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 18 Dual Contractor/Retailer (cont.) State Approaches • Allow contractor/retailer to purchase all materials tax-free with resale certificate. – Use tax remittance is required on items used in their own contracts. – Sales tax collection required for items resold. • Require contractor to pay sales tax on all purchased materials. – Refund claim permitted for items resold to other contractor. – The state gets their money upfront. • Predominant nature of taxpayer’s business. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 19 Dual Contractor/Retailer (cont.) Specific State Examples • West Virginia – Considers companies that regularly maintain an inventory of items for resale as a “contractor-retailer” that can make tax-free purchases. – However, if a company only occasionally resells items, sales tax is due upon purchase with a credit/refund allowed against sales tax collected from customer on items resold. • Florida – “Dual operators” may issue a resale certificate for purchases of materials they can use themselves or resell; use tax remitted on used items and sales tax collected on items resold. • New York – All sales of materials to contractor are taxable; refund allowed on items resold. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 20 Interstate Sales What happens when the property is purchased in one state and used in another? • Factors to consider: – Where does delivery take place? (in-state or out-of-state) – Is there any in-state use of the property before transporting to the other state? – Who is the customer? – What are the requirements in the other state? • Use tax due • Credit for taxes paid • Exempt sale © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 21 Interstate Sales (cont.) State Approaches • Kansas – “No deduction, exclusion, refund, or credit for sales tax is allowed when a contractor purchases material in Kansas even though the material may be used in an out-of-state construction project.” Kan. Admin. Regs. § 92-19-66(d) • Maryland – “If you buy materials in Maryland for a real property contract in another state, you must pay the Maryland sales tax on the materials. You may apply for a refund of the taxes paid if the purchase of materials would not have been subject to sales and use tax in the state where you used it.” Maryland Tax Tips, No. 18, 01/01/2010 • Virginia – “Construction contractors may purchase exempt from tax construction materials for temporary storage in Virginia to be used in exempt construction projects in other states or foreign countries.” Request for exemptions certificates must be made in writing to the DOT. Va. Admin. Code 10-210-410 © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 22 Interstate Sales (cont.) Use Tax Issues – Do I owe use tax in the state of use? – What if I already paid tax in the state of purchase? – Pennsylvania • Use tax due on construction materials, equipment and supplies purchased outside of Pennsylvania if used for more than 7 days in Pennsylvania. • Tax Base – Orig. purchase price; FMV if 6 months from orig. purchase date. • Credit – Credit for taxes paid if state of purchase offers similar credit. – West Virginia • Use tax on tangible personal property purchased or leased in another state and brought into West Virginia for contracting activity, but property placed in substantial use in another state before being brought into West Virginia is exempt. • Credit allowed for lawfully imposed sales tax paid to another state. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 23 Interstate Sales (cont.) Credits – Practical Application • Have policies and procedures in place for tracking property used in more than one state. • Confirm reciprocal credits in state of purchase and use. • Use tax will likely only be due on rate differential in state of use. – Example: Purchased in DC (5.75% rate); used in MD (6%) rate; MD use tax due at .25%. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 24 Regional Comparison Issue DC MD VA T&M Contracts Tax-free purchase; tax collected from customer on materials. General rule applies – purchases taxable despite T&M contract. General rule applies – purchases taxable despite T&M contract. Exempt Entity Contracts Contractor can issue exempt. cert. (includes govt.). Contractor can use exempt. cert. of exempt entities (excludes govt.). No exemption, unless contractor is officially designated as the purchasing agent. Dual Contractor/ Retailer No rules No rules Retailer treatment for specific installs. (e.g. fencing, blinds, cabinets, etc.). Interstate Jobs Sales tax due on in-state purchases; use tax for items used in DC if no tax paid in state of purchase. Sales tax due on in-state purchases; refund avail. if items used in tax exempt state; use tax due on rate diff. Purchase exempt if temp. stored in VA for use in tax exempt state; use tax due on rate diff. Refer to T&M rules © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 25 Other Issues: Repair/Maintenance Services Most states only tax specifically enumerated services. – Services not specifically taxable are generally excluded from tax. – Most states tax certain specified repair services (may tax both services and materials regardless of type of contract). – Necessary to distinguish between improvement services and repair services. • Did the service maintain the existing value or was there a capital improvement? © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 26 Other Issues: Repair/Maintenance Services (cont.) – New Jersey • Maintenance and repair services to real property, when rendered by a contractor, are generally subject to the state sales tax. • Only the labor is taxable; contractor pays tax on the materials used in the performance of the repair work. – Wisconsin • Treats certain types of property (e.g. a furnace) as real property for installation purposes, but as tangible personal property for repair purposes. • Contractor pays tax on materials used for the installation, but charges sales tax on repair and maintenance to the customer for repair parts and labor. – DC • Taxes service charges for repair to tangible personal property, but not repair work on real property. • However, minor repairs could be considered “real property maintenance,” which is a taxable service in the DC. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 27 Other Issues: Fabricators/Manufacturers Fabrication (performed at shop) or construction services (performed onsite) . . . OR BOTH • Various Approaches – Tax on Material Cost - The tax base is on the value of raw materials (cost) used to manufacture the good. No tax is due on any labor component applied by the seller. – Tax on Total Sale Price to Customer - The tax base is the seller’s normal retail selling price (i.e. fabricator's material and labor costs included in sales tax base). – How is interstate fabrication/installation handled? (i.e. fabricated in one state and installed in another) © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 28 Other Issues: Fabricators/Manufacturers (cont.) Examples • Minnesota – Fabrication only - Total charge, including labor, is subject to sales or use tax. Labor taxable even if separately stated. – Fabrication as part of a construction contract - Labor is not taxable. The contractor must pay sales or use tax on materials used. • Florida – Requires construction contractors to remit use tax on “fabrication cost” of items that are manufactured/processed at the contractors shop for their own use in performing a construction contract (e.g. customer cabinetry or ductwork). – Use tax reduced by amount of tax paid on purchase of materials . • Subtle Distinction – Use tax on material cost only (MN) v. material plus labor cost (FL). © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 29 Other Issues: Non-Resident Bonding • Other states may impose a bond: • Connecticut • Georgia • Massachusetts • Mississippi • West Virginia • Wisconsin *Note: Louisiana, Maryland, and Nebraska have eliminated bonding requirements in recent years. • Bonding requirements often in lieu of registration, prepayment of applicable taxes and/or size of contract. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 30 Other Issues: Tax Clauses and Indemnification Agreements • Taxes are affected by the type of contract involved, the nature of what the contractor is selling, and whether an exemption applies. – The contractor is not always in control of the contract format, and disagreements regarding the availability of exemptions often arise. – Contractor may legally protect itself from having to pay additional taxes through the use of tax clauses and indemnification agreements. • Tax clauses: – Inserted in proposals or contracts to indicate to the customer which taxes are included in the bid/contract price and which have been excluded. It also serves to assign any additional taxes to the customer, as well as to separately invoice any additional amounts as additions to the price quoted. • Indemnification agreements: – Used when a customer requests that taxes not be included in the proposal or contract because the customer believes it is entitled to an exemption and the contractor believes otherwise. It protects the contractor from paying additional taxes on use or purchases of materials without recourse to the customer. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 31 Know Your State Rules! • State Rules Vary Significantly – Never assume uniform treatment for any sales tax issue. – Refer to state publications specific for construction contractors. – States rules may have changed since last project. © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 32 QUESTIONS © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 33 Contact Information Michael L. Colavito, Jr., JD 301.231.6298 mcolavito@aronsonllc.com Michael P. Corcoran, CPA 301.231.6223 mcorcoran@aronsonllc.com © 2014 | All Rights Reserved | Aronson LLC | www.aronsonllc.com Slide: 34