Construction Companies Face Unique Sales and Use Tax Challenges: Projects Complexity Issues to Consider
This is the second in a series of blogs that examines 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.
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 under the nexus rules.
Being aware of the sales and use tax consequences of construction jobs is crucial in managing the finances of a construction‑based business. Most understand that sales tax applies to retail purchases, but it comes as a surprise to many that construction jobs also have sales and use tax implications.
In construction, what you do and how you do it has an impact on how these jobs are taxed.
Example Of Construction Project Complexity
Consider this example. A Georgia contractor with a specialty in cabinets and a relationship with a restaurant group contracts for a build-out of a bar/restaurant in Fresno, California. He contracts to build and install cabinets for a set price, and invoices on
a percentage‑of‑completion basis. The contractor ships cabinets that they fabricated in Georgia to California. Subcontractors transport the cabinets to the site, along with their tools and some materials, stopping
on the way to pick up some incidentals. The subcontractors install the cabinets and send the contractor a receipt that says “Cabinet Installation — $1,000.00. Sales tax included.”
What Are The Sales And Use Tax Implications Of This Job?
You must consider questions such as who owes the sales and use taxes, when are they due, how are they reported and paid, and to which states? How are the taxes computed? Does it matter that the cabinets were built in Georgia and installed in California? Do the contract terms matter? Does the transportation matter? Are taxes different because this is a restaurant? Does the subcontractor’s invoice have the detail needed?
Sales and use taxes are usually imposed on the ultimate consumer — the person that buys and uses the item. When it comes to construction, however, it can be difficult to determine who that ultimate consumer is for each of the many transactions involved.
As it turns out, each of these questions must be analyzed separately to get to the correct overall sales and use tax “answer.” Those that run construction businesses must understand the tax consequences of all types of construction transactions to avoid or reduce penalties, interest and tax assessments in the future.
Except for the simplest of businesses, determining the correct amount of sales and use tax for a construction business is not a “do‑it‑yourself” project.
Most construction businesses convert tangible personal property, e.g., raw materials, into real property, e.g., buildings. But there is where the similarity ends. Each business goes about it differently. Keeping appropriate records is crucial when a sales tax auditor comes knocking. Most construction businesses should expect to face a sales tax audit sooner rather than later. The auditor will need your records to help understand your business for the purpose of the audit and as proof that you have complied with the law. Keeping comprehensive records frequently results in audits proceeding more smoothly and will likely help to reduce potential liability resulting from findings of errors in compliance.