Sales and Use Tax
Fundamentals for
Construction Companies
July 24, 2014
Presented by:
Michael L. Colavito, Jr., JD
Michael P. Corcoran, CPA
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Agenda
• General sales tax treatment of contractor purchases
• Common exemptions
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Impact of contract type
Contracts for exempt entities
Dual contractor/retailer
Sales in interstate commerce
• Other issues
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Repairs and maintenance
Fabricators/manufacturers
Non-resident bonding
Tax clauses and indemnification agreements
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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?
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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”.
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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
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- 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.
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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.
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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.
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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
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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.
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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.
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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.
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Slide: 12
Sales Tax Impact of Contract Pricing (cont.)
Tax Impact of Lump Sum v. Time & Materials
• Example
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–
–
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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
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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
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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.”
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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.
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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).
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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?
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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.
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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.
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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
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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
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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.
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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%.
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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
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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?
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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.
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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)
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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).
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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.
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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.
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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.
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Slide: 32
QUESTIONS
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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