Sales tax and the construction industry
by April 5, 2024
Please note: This blog was originally published in 2021. It’s since been updated for accuracy and comprehensiveness.
If you have a construction business are you required to collect sales tax from your customers? Are you required to pay sales tax when purchasing materials and supplies? Let’s have a look.
The “construction industry” is an expansive term and can refer to all sorts of businesses. In this post, we’re going to mainly refer to businesses such as general contractors or subcontractors who actually get out there and build buildings and other constructions.
Do construction companies need to charge sales tax?
This is the million dollar question. And I wish I were kidding. But getting this one wrong can result in big fines and penalties when it comes to sales tax compliance.
Sales tax on construction services
In the US, sales tax is generally charged on tangible personal property such as a toothbrush or a lamp. And it’s generally not charged on labor such as accounting services or, you guessed it, construction.
But “generally” is the operative term here. In most states services, including construction labor, are still considered a non-taxable service. But some states like Arizona, New Mexico, and Hawaii treat construction labor as a taxable service. That means if you perform a construction job in one of those states you’ll be required to charge that state’s version of sales tax. Further, it pays to keep up with sales tax laws here, because more and more states, like Texas and North Carolina, have been expanding their definition of “taxable services.”
Sales tax on construction materials
A traditional retailer is used to this model: buy inventory without paying sales tax, and then collect sales tax from buyers when reselling that inventory. But construction doesn’t quite work that way.
First of all, whether or not a construction company collects sales tax often depends on how that company charges for the job. There are two main methods:
- Lump sum – The construction company figures up the cost of all parts, materials and labor, and then charges the buyer in one lump sum.
- Time and materials – In this billing method, the construction company itemizes materials, labor, and maybe even administration and other overhead and charges the buyer for each item.
In most cases, construction companies are considered by state taxing authorities to be the end users when it comes to the materials they purchase for construction projects. This means that, as the construction company, when you go to buy say, a truckload of lumber, you’d be responsible for paying sales tax to the vendor at the time of purchase. Construction companies who bill by the “lump sum” method often just figure any sales tax paid into the lump sum charged to the customer.
Example:
Your construction company is charging your customer a lump sum of $50,000 for their basement remodel. In most cases, you’d simply purchase all the supplies and pay sales tax at the point of sale. In this case, you are considered the end-user of the building materials that you purchase. You are not required to charge sales tax to your customer.
However, some states consider construction companies to be “resellers.” This means that, as a construction company, you can present a resale certificate to the vendor and not pay sales tax on any materials at the time of purchase. But by presenting a resale certificate and buying materials tax free, you have committed to charging sales tax to your customer.
If you charge your customer sales tax for various parts and materials you must be sure to charge the correct sales tax rate on that material. And since sales tax rates can vary from local area to local area, it’s important that you calculate the right sales tax rate when itemizing a bill for time and materials. You must also periodically remit any sales tax collected to your state.
Example:
Your construction company chooses to bill a customer for time and materials. In this case, you are “reselling” the materials to your customer. To avoid paying sales tax at the point of sale when purchasing a truckload of lumber, you can show your vendor a resale certificate to prove that you will be charging sales tax down the line to your own customer. A resale certificate proves that you are a registered reseller in your state and that your vendor will not be penalized for not charging you sales tax. From there, after you’ve collected the sales tax from your end customer, you must then remit that sales tax collected to your state in the form of a sales tax filing.
Note: Again, this is all “in general.” Sales tax treatment of construction companies varies from state to state. We always recommend working with a vetted sales tax expert to ensure your business is protected when it comes to sales tax.
Common construction sales tax scenarios
When it comes to sales tax, everything is an “it depends.” Each of the forty-six US states with a sales tax gets to set their own rules and laws, and those laws change frequently, too. Here are some of the more common sales tax scenarios you might encounter as a construction business.
Working for nonprofits or government agencies
What if you’re doing a job for a government agency or a nonprofit? Then you may be in for added complexity.
For example, many government agencies and some nonprofit organizations are exempt from paying sales tax. In this case, you, acting as their agent, may be able to purchase materials tax free. But in other cases, such as a state that does not allow you to act as your customer’s agent, you may simply want to have your customer purchase the materials using their sales tax exempt status. Of course, this adds complexity to the billing process.
Further, exercise caution when it comes to nonprofits and sales tax. Many states consider that nonprofits can buy items or materials tax free when those items directly support their mission. For example, if a nonprofit dedicated to childhood enrichment hires your construction company to build a sensory room then those materials may well be tax exempt. However, if that same nonprofit hires your company to remodel their employee break room, then those materials may not be tax free simply because the employee break room does not specifically impact their mission.
Construction projects for resale
In some cases, you might be hired to build a project for resale. For example, your customer might be a developer who hires you to build a house in a new residential development that that developer plans to resale to the individual homeowner.
In this case, you might be considered a reseller and be allowed to buy construction materials tax free. Or, in cases where you are required to pay sales tax on construction materials, the state’s taxing authority may allow you to claim a sales tax credit on your next sales tax filing for sales tax paid on supplies that were ultimately used for resale.
Subcontracting
As a subcontractor, your customer is generally another construction company and not the construction project’s end user. For example, a general contractor building a house might hire your electrical company to wire that house. In this case, you would likely purchase and provide wiring, breaker boxes and other electrical materials. Most commonly, you are paid by the general contractor, not the person who will actually live in the house when it’s finished.
In most cases as a subcontractor, you are responsible for paying sales tax on any supplies and materials you purchase. You should, of course, factor this into your pricing for the job.
However, some states might allow you to consider yourself a reseller and “resell” the materials to your customer, the general contractor, as part of the job. In this case, you must be very careful to dot your i’s and cross your t’s.
Why? Because somebody has to collect sales tax on these materials when they are finally sold to the end user. If you use a resale certificate and purchase the materials tax free from your buyer, and then turn around and sell them to the general contractor, you are required to collect sales tax from the general contractor at the point of sale. That is unless the general contractor can also provide you with a resale certificate proving that they will charge sales tax on these materials to their customer.
In the worst case scenario, the state finds that nobody (your original supplier, you the subcontractor, or your customer the general contractor) actually collected sales tax on the materials. They are going to demand that someone pay that sales tax and if you can’t prove that you were off the hook to collect sales tax by presenting a valid resale certificate from your customer (the general contractor) then you could be the one stuck paying sales tax out of your pocket.
Ensuring your construction company handles sales tax the right way
We always recommend that a company with complicated sales tax needs contract with a vetted sales tax expert. They can help you determine your sales tax liability for every job, as well as how to bill or quote so as to minimize any out-of-pocket sales tax expenses. The construction field is often subject to special tax breaks, such as when you build something in an “economic opportunity zone,” and a vetted sales tax expert can ensure that your company takes advantage of any tax breaks, sales tax-related or otherwise.
When speaking with a sales tax expert, be sure to ask:
- Are you required to charge sales tax to your customer? Does this mean you need to register for a sales tax permit with your state?
- Is labor taxable in the state where you are performing the job?
- Are you required to pay sales tax when purchasing supplies and materials?
- How should you structure your invoice or fee schedule?
- Are you required to provide or obtain resale certificates from vendors or customers?
- How does sales tax work in this state if the customer is a nonprofit organization or government entity?
- Are you eligible for any tax breaks or credits for this job?
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