5 things construction contractors should know about sales tax
Many areas in the country are undergoing a building boom, which means your construction business might be booming, too.
That’s a good thing, but increased revenue can bring increased scrutiny from state and local tax officials. If you don’t stay on top of your sales tax obligations, you might find tax authorities can wield a pretty mean hammer in their own right.
That’s why it’s important to understand the impact of tax rules and regulations before you get hit with an audit. It’s not easy — sales tax can be confusing. Tax laws can be different depending on the type of project, where it is and who it’s for. Whether you use lump-sum contracts or bill on a time-and-materials basis can make a difference, too.
You know better than anyone that a solid foundation is necessary for success, so we’ve compiled five general tax guidelines to give your business something to build on.
Tax on construction services
While several states don’t require construction companies to charge sales tax on their services, some states tax certain projects and not others.
For example, in Connecticut, construction services for existing industrial, commercial or income-producing real estate is subject to sales tax. In other states that tax services, you’ll need to check the laws regarding different property types and the work you perform.
Tax on construction materials
This is where it gets a little more tricky. Construction companies in many states must pay sales tax when they purchase the materials they’ll use for a project,which can actually be a good thing, because depending on the particular project it could mean the markup you charge to your customer won’t be subject to sales tax.
However, in other states, contractors are treated as resellers (or companies purchasing things ultimately intended for resale to an end customer) depending on the type of contract they use.
The tax implications of contract types
In general, there are two types of contracts for construction businesses: lump sum or time and materials. With lump-sum contracts, all materials, supplies, labor, and other charges are added together to create one price. Time-and-materials contracts are itemized, with the customer paying separate charges for labor, supplies, materials, etc.
If a state treats contractors as a reseller, you don’t pay sales tax when you purchase construction materials. Instead, you’ll need to charge sales tax to the customer as appropriate — either by factoring it into your lump-sum price, or adding it to each line item as appropriate for a time-and-materials approach. Either way, you’ll be required to remit sales and/or use tax based on the project.
Tax exceptions and exemptions
As is nearly always the case with sales tax, there are unique rules that can complicate construction projects and services even further. You could be required to pay sales tax for fixtures you purchase for a project, for example, but not have to pay tax on other construction materials.
In many states, if you perform construction work for a tax-exempt organization, such as a church, that organization’s exemption also applies to materials you purchase for the project. You’ll probably need an exemption certificate from the organization or, depending on local laws, you may be able to have the organization itself purchase the materials if the tax exemption does not extend to you.
The tax impact of the bidding process
Incorrectly estimating sales tax can have a big impact on a construction project. If you use a lump-sum contract and don’t factor in the right amount, you could end up underbidding and making less money on the deal (or worse, losing money). Prior to bidding any job, get some answers:
- Do you need to pay sales tax on the materials you purchase for the project, or will you be treated as a reseller who charges sales tax to the end customer?
- Are there any tax exemptions you need to know about?
- Are you in a state that requires you to charge sales tax on construction services as well as materials?
- What other project- or state-specific tax rules apply?
Because each construction project has its own challenges and requirements, we’ve only scratched the surface here. For information specific to your company and your needs, it’s best to talk with a tax professional. But figuring out your obligations is only half the battle — meeting them can be just as frustrating.
If you want to spend more time looking at building plans and less time fighting through tax forms, be sure to check out Avalara’s solutions for small businesses.
The 2021 sales tax changes report: midyear update
Your guide to navigating the complicated world of tax compliance and preparing for the future
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