Construction Companies Face Unique Sales and Use Tax Challenges: Contracts
Construction companies face more complex sales and use tax planning and compliance rules than other businesses mainly because the construction process itself is inherently complex. There are many moving parts, subject to different rules and regulations. And the Wayfair-economic nexus rules have furthered this complexity by subjecting more companies to sales and use tax collection and remittance rules in more states and localities.
Construction Process Is Complex
Many construction projects have many moving parts that may affect when, where and by whom tax must be collected — from bids, cost estimates and contracts to materials purchasing, subcontractors, inspections, progress billings (cash flow), change orders, retention and completion. Different sales and use tax rates and rules may apply not only to each of these components of the process, but to each state and locality in which the business is deemed to operate.
This is the first blog of a series on the unique sales and use tax planning and compliance challenges faced by the construction industry. Here we deal with the various types of contracts that are being used by construction companies and how they are likely to affect sales and use tax responsibilities and liabilities.
The nature of your contracts may affect the taxability of transactions. In some states, the type of contract you use may affect when you will have to pay sales taxes on materials and supplies purchased.
Generally, construction contracts are agreements to erect, construct, alter, pave or repair a structure, building or infrastructure. Tax can also apply to owners that manage their own construction projects. Regardless of the nature of the construction, it is likely that sales and use tax will be assessed on the use of tangible property and services applied to the project.
For tax purposes, contracts should be detailed, but not technical where possible. Remember that a tax auditor will be reviewing the contract and will need to be able to understand it. As with any contract, be sure to include the scope of work, the price and the tax responsibility. If you intend to pass tax costs on to the customer, be sure to estimate the costs and communicate the costs in your bids, quotes and contracts.
There are some instances where credits or exemptions can apply.
Although every state treats these types of contracts differently and must be evaluated individually, in general, a lump‑sum contract is one in which the agreed‑upon contract price is one lump‑sum amount. The charges for materials are built right into the job and are not separate from the charges for labor.
Separated or Time and Materials Contracts
A separated or time and materials contract is one in which the agreed‑upon contract price is divided into separately stated agreed-upon prices — one for materials and one for labor.
Sales and Use Tax Implications
Under this type of contract, the contractor is considered a retailer of the materials and must collect sales tax from the customer. The contractor may maintain a tax‑free inventory of items held for resale. Items purchased exclusively for resale may be purchased tax‑free by issuing a resale certificate to suppliers. The contractor must hold a sales tax permit to issue a resale certificate. However, the contractor owes tax on the purchases of equipment, accessories, most consumable items and in some states, taxable services (e.g., Texas).
A cost‑plus contract is used when the contractor is paid for all allowed expenses — plus additional payment — to allow for a profit to be made.
Sales and Use Tax Implications
With a cost‑plus contract, the state may determine a sale to be part property, which would be subject to sales tax, and part service, which is tax exempt. This type of contract is not a standard method of contracting, and although clients might think that it’s more cost‑effective, lenders will often not issue a loan to projects using cost‑plus contracts.