Construction Companies Face Unique and Complex Sales and Use Tax Challenges: Common Factors Affecting Tax Liability
This is the third in a series of blogs that examine the complex and unique challenges construction companies face in planning for and complying with the sales and use tax obligations they face in the states in which they do business. The increasing risks these businesses face have become much more compelling now that the 45 states (including the District of Columbia) that impose sales and use taxes have formally adopted the Wayfair-economic nexus standard to compel businesses with no physical presence in that state to collect and remit sales and use taxes. The challenges faced by construction businesses is particularly difficult because the construction process itself is inherently complex. There are many moving parts, subject to different rules and regulations in the various states and many localities.
This blog focuses on some of the most common factors that affect the determination of sales and use tax obligations of construction companies.
Business Practices and Taxation
The nature of your business, the types of projects that you engage in, your contractors, and types of customers and contracts all have an impact on the tax consequences of your transactions.Factors that affect the taxability of your transactions include:
- Commercial real estate is defined as buildings or land that is intended to generate a profit from capital gain or rental income.
- Residential projects are buildings designed primarily to be dwellings.
- New construction — Entirely new structures and/or significant extensions to existing structures, whether or not the site was previously occupied.
- Repair — A restoration to return a structure or property to operating or usable condition.
- Maintenance — Making or keeping a structure, fixture, or foundation (substrates) in proper condition in a routine, scheduled, or anticipated fashion.
Construction Contractors — Prime, Subcontractor or U.S. Contractor
In general, a construction contractor performs construction contracts. Construction contractors can include prime contractors, subcontractors, and United States construction contractors.
- Prime Contractors — The contractor that has a contract with the owner of a project or job and has the full responsibility for its completion. A prime contractor undertakes tasks to perform a complete contract and may employ (and manage) one or more subcontractors to carry out specific parts of the contract. This contractor may also be known as a main contractor.
- Subcontractors — A subcontractor is an individual or business contracting to perform part or all of another’s contract. Some prime contractors may do all or most of their work internally without the use of subcontractors; other contractors use subcontractors almost exclusively. In general, most contractors do some of the work themselves and use subcontractors for the rest.
- United States Construction Contractors — A United States construction contractor is a construction contractor who performs a construction contract for the United States government.
Your customers will also have an impact on the taxability of transactions, and the way you conduct your business can have a positive or negative effect.For example, if your customer is exempt from sales and use tax, such as a nonprofit civic or community organization, a good option may be to have your customer purchase the materials that you’re going to use in the construction. Why? Because in some states, exempt organizations are allowed to buy materials and supplies for a construction project tax‑free. If this exemption is allowed to flow through to the material purchased for a construction job they have hired you for, then you may realize a tax savings. However, keep in mind that tax authorities tend to look at these types of transactions very carefully to make sure that the exempt organization or an agent authorized to act on behalf of the exempt organization is making the purchase. Many states do not allow contractors to use an organization’s exemption unless the contractor is the exempt organization’s authorized agent. While the distinction of who can purchase the supplies and materials may seem trivial, states use it as a check to prevent abuse of the organization’s exempt status. There are also important distinctions between government contracts and private sector projects. And, not all governments are the same. In the same way, there are
important distinctions between state, federal and local contracts, especially when it comes to exemptions.
Sales and Use Tax Implications
Usually, the subcontractor becomes the contractor and the contractor becomes the customer. Each subcontractor has a contract that governs the subcontractor’s tax responsibilities. Under most circumstances, subcontractors may not accept a resale certificate from a prime contractor for fixtures that the subcontractor furnishes and installs. If the fixtures are furnished and installed by a subcontractor, the subcontractor is the retailer and the prime contractor is the consumer. As a result, no additional tax is due under the prime contractor’s contract with the real property.
Often, subcontractors pose a record keeping risk for the contractor. Invoices from subcontractors may lead to problems during an audit. Invoices from subcontractors need to be accurate, provide proper descriptions and have an adequate breakdown of all the items that were applied to and billed to each invoice. In addition, invoices that indicate “sales tax included” should specify the taxes that are included and the amounts.