Sales tax requirements for construction contractors

Construction management consistently ranks as one of the most stressful jobs in the country, and for good reasons. It’s tough to meet the needs of demanding clients, wrangle subcontractors, and ensure projects are completed on time and on budget. It’s also difficult to get construction sales tax right, especially for contractors doing projects in multiple states, because sales and use tax requirements differ from jurisdiction to  jurisdiction. 

The last thing any contractor needs on their punch list is a sales/use tax assessment, but unfortunately, construction contractors are  frequently flagged for sales tax audits.

Implementing an end-to-end sales and use tax compliance solution helps reduce audit risk by simplifying exemption certificate management, increasing job-level tax accuracy, automating AP use tax accruals, and helping to ensure  construction-specific returns are filed correctly across jurisdictions. Read on for more details.

Construction sales tax rules vary by state, contract type, and project scope. Sales tax requirements for construction contractors differ widely by state and even by project type. Liability for sales or use tax depends on the taxing jurisdiction, the type of labor performed, and the contract structure (e.g., lump sum vs. time and materials). Contractors working across multiple states must monitor changing rules to reduce audit risk and avoid unexpected tax assessments.

Taxability of construction labor and materials depends on how they’re used. Construction sales tax applies differently to labor, materials, fixtures, and supplies. Contractors are often considered the end consumer of materials incorporated into real property, meaning they owe sales or use tax at purchase. However, certain states treat contractors as retailers under certain circumstances, allowing them to purchase materials tax-free and requiring them to charge sales tax to customers. Misclassifying materials or labor is a common audit trigger.

Automating sales and use tax compliance helps reduce audit exposure. Because construction tax rules are complex and subject to change, manual compliance increases the risk of errors in tax calculation, exemption certificate management, and multistate filings. Automating sales and use tax compliance can help construction firms apply more accurate tax rates, streamline exemption certificate management, track job-level tax logic, and stay audit-ready across jurisdictions.

Sales and use tax compliance is complicated for construction contractors in part because of the intersection of real property, tangible personal property (TPP), and services, and the fact that sales and use tax rules and regulations differ from state to state. 

Construction contractors alter, build, or improve real property, and real property generally falls outside the reach of sales and use tax. Yet contractors also buy, sell, and consume tangible personal property, which is very much the purview of sales and use tax. Adding to the complexity, contractors incorporate some (but not all) TPP into real property. 

Whether a transaction is or isn’t subject to sales and use tax — and who is ultimately liable for the tax — depends on several factors, including the type and terms of the contract and the taxing jurisdiction. 

The services provided by construction contractors may or may not be subject to sales tax. It depends on 1) the jurisdiction, 2) the type of labor provided, and 3) the type of contract. 

The jurisdiction

Hawaii, New Mexico, South Dakota, and West Virginia are the only four states that tax services by default. Unless a specific exclusion or exemption applies — and there can be all sorts of exclusions and exemptions — construction labor is generally taxable in these states.

Many other states tax some services provided by contractors while exempting others. Taxability typically depends on the client, contract type, project, property, or other factors, including whether the service is provided by a subcontractor for a general contractor, by a general contractor for a homeowner, or by a general contractor acting as a developer. 

The labor

The type of service contractors provide can shape taxability, as can the way states define contractor for sales and use tax. 

Services to real property are often taxed differently than services to tangible personal property. Installation services may be taxed differently than maintenance or repair services. Taxability can also hinge on the type of property: nonresidential vs. residential.

For example, Texas does not tax labor to repair, remodel, or restore residential real property, but it does tax the total amount charged for remodeling, repairing, or restoring nonresidential real property. Contractors working on mixed-use buildings need to determine which rules take precedence, and to what extent. 

In North Carolina, sales and use tax doesn’t apply to gross receipts derived from a real property contract, which includes new construction, reconstruction, and remodeling. However, certain repair, maintenance, and installation services are subject to North Carolina sales and use tax. Regrettably, in North Carolina and other states, it can be challenging to identify the true nature of certain projects.  

It may be wise to discuss sales and use tax with a professional familiar with local regulations and requirements. In recent years, several states have broadened their sales tax laws to include services.

The contract

Whether labor charges are subject to sales and use tax depends on each state’s law. That said, who is responsible for paying any tax due can hinge on the contract. Liability for a lump-sum contract may differ from liability for a cost-plus job or a time-and-materials contract.  

As the contract is the primary document auditors will consider when determining who is responsible for the tax, it’s important to consider sales and use tax before finalizing a contract. Unclear terms can result in disputes or unexpected costs. 

We cover contracts in more depth in the following section.

Sales or use tax usually applies to tangible personal property whether it remains stand-alone TPP or becomes part of real property. What changes is who is responsible for the tax: the contractor or the property owner.

Deciding factors include:

• Whether the materials are consumed by the contractor or become a permanent part of a building
• Whether the contractor is doing a job for a client or acting as a developer/speculative builder themselves
• The type of contract

Consumed by the contractor vs. part of real property

The contractor is generally the consumer of equipment and supplies that don’t become part of real property (e.g., builder paper, paint brushes, power tools, scaffolding). As the consumer, the contractor must pay sales or use tax on equipment and supplies.

Because real property is generally exempt from sales and use tax, contractors are usually also liable for the tax on fixtures (e.g., HVAC units and plumbing systems) and materials (e.g., concrete and lumber) that become part of real property. However, the rules vary by state, and some states don’t provide clear guidelines on when tangible personal property becomes real property.

Compliance can be challenging even in states that offer guidance, especially for contractors working in more than one state. In Ohio, for example, a contractor is considered a retailer and must charge their customer sales tax on tangible personal property that “retains its status as personal property” after being permanently affixed to real property. Ohio law gives carpeting as an example (including adhesive, carpet padding, and tack strips).

Yet, Ohio treats contractors as the consumer of tangible personal property that becomes a “business fixture” — meaning it becomes permanently attached or affixed to the land or to a building, structure, or improvement, and primarily benefits the business conducted by the occupant. As the consumer, the contractor must pay tax when purchasing such materials, which include air conditioning, heating, and ventilation systems.

Jobs for a client vs. speculative jobs

Contractors acting as a developer or speculative builder are generally seen as the consumer of all material incorporated into real estate so must pay sales or use tax on those materials as well as on all taxable billings from other contractors. The contractor doesn’t collect retail sales tax on the sale of the property.

In Washington, any contractor performing construction services for a speculative builder must charge sales tax on the total contract price.

Lump-sum contracts vs. time-and-materials contracts

In some states, the type of contract dictates who is responsible for the sales tax on materials. Two common types of contracts are:

• Lump-sum contract: The project is completed for an agreed-upon amount that includes labor, materials, overhead, supplies, etc.
• Time-and-materials contract: The project is completed for the actual rates for labor, materials, overhead, profit, supplies, etc.

Specific rules vary by state, as the following examples show.

Florida generally considers contractors operating under a lump-sum contract or a time-and-materials contract to be the final consumer of the materials and supplies. Contractors therefore must pay sales tax to suppliers and should not charge sales tax to the customer (the real property owner).

California also generally considers contractors operating under a lump-sum contract or a time-and-materials contract to be the consumer of the materials and liable for the tax on the purchase price. However, if a contractor bills their California customer for sales tax computed on the marked-up billing for materials (a “time-and-materials plus tax” contract) the contractor is the retailer of the materials, and the measure of tax is the amount on which tax reimbursement is charged.

Colorado treats lump-sum and time-and-materials contracts differently for sales tax. Contractors do not need a sales tax license for lump-sum contracts because they’re considered the consumer of construction and building materials included in lump-sum contracts and must pay sales or use tax on those purchases. (Non-building materials sold and/or installed by the contractor are not considered part of a building contract).

Yet contractors engaging in time-and-materials contracts do need a Colorado sales tax license because they’re treated as the retailer. Per the Colorado Department of Revenue, “A contractor does not pay sales or use tax on construction and building materials acquired for a time-and-materials contract. Instead, the contractor must collect [and remit] sales tax from its customer on the marked up price of the materials included in the time-and-materials contract.” In time-and-materials contracts, construction labor charges are not subject to Colorado sales tax.

In Texas, a contractor is the consumer of tangible personal property they furnish and incorporate into the property for a customer under a lump-sum contract. But with time-and-materials contracts, the contractor is the seller of the tangible personal property they furnish and incorporate into the property. As the seller, the contractor must collect tax from the customer. Under Texas law (section 151.056(b)), “the tax rate is applied to the price of the materials as agreed in the contract or the price of the materials to the contractor, whichever is the greater.”

Construction sales and use tax requirements differ from state to state and situation to situation, so when in doubt, ask a trusted tax professional for advice. Automating sales and use tax compliance can also be helpful.

The following examples further illustrate how different states can tax different construction services. It’s far from comprehensive and should not be taken as tax advice.

Connecticut sales tax generally applies to services to existing commercial, industrial, and income-producing real property. Some services to residential property are also taxable. But Connecticut provides an exemption for labor on new construction projects, owner-occupied residential property, and certain other construction projects.

Hawaii’s general excise tax (GET) is assessed on construction services, labor, and other services in the state. The general 4% rate (plus any applicable county surcharge) applies to most construction services, including labor, but some construction services may qualify for a reduced (wholesale) rate of 0.5%. Sales of materials that are incorporated by the contractor into the finished work and remain perceptible to the senses are subject to the 0.5% rate.

Idaho sales tax law typically treats contractors as the consumers (end users) of all the goods they use. Therefore, contractors “must pay sales tax on all purchases, including all the equipment, tools, and supplies they use to build, improve, repair, or alter real property.” If they don’t pay sales tax at the point of sale, they owe the state the equivalent use tax. If the client is exempt from sales tax for some reason, the exemption doesn’t carry over to the contractor.

Nebraska allows contractors to elect to be taxed as a retailer of building materials with a tax-exempt inventory or as the consumer of building materials with a tax-paid inventory.

New Mexico gross receipts tax applies to most construction activities and all construction materials that will become part of the construction project. However, the state allows certain construction deductions (e.g., for construction services related to certain hospitals, and low-income housing).

In South Dakota, construction services are generally exempt from sales and use tax but subject to a 2% contractor’s excise tax.

West Virginia sales and use tax generally applies to construction (labor) services and to appliances, equipment, or materials sold to customers in conjunction with those services. Yet work resulting in a “capital improvement” to the real property is “contracting” and is not taxable. (Click on the link to learn what qualifies as a capital improvement.)

There’s no statewide sales tax in Alaska as of March 2026, but many jurisdictions have a local sales and use tax. Haines Borough provides a local tax exemption for construction services and materials permanently incorporated into a structure, but only if the charges exceed $5,000 per construction project in a 12-consecutive-month period. Purchasers must initially pay sales tax on these transactions then complete a sales tax refund form (along with qualifying receipts) to obtain the allowed sales tax refund.

The $5,000 construction cap jumps to $12,000 beginning April 1, 2026, and to $22,000 on April 1, 2028.

Ultimately, the laws and rules that apply to your business will depend on where you’re doing business, the terms of the contract, and how the jurisdiction taxes construction labor and materials.

Before you take on new or complex projects, it’s important to consult with a sales tax professional familiar with the construction industry. They can help you avoid the pitfalls of noncompliance (and maybe even uncover exemptions and tax breaks).

Another way to ease the burden of tax compliance is to implement a sales tax automation solution. Automating everything from tax research to tax returns can help you become more compliant while freeing time to do what you do best.

Avalara for Construction is purpose-built for construction firms, automating project-based sales and use tax, multijurisdictional compliance, AP use tax accrual, exemption certificate management, and returns filing. The solution integrates natively with leading ERPs, supporting job-level tax logic, material and labor classification, and certificate tracking by project or PO. It supports more accurate real-time tax calculations, reduces manual reconciliation, and helps teams stay audit-ready across every project and job.

Which states have a construction sales tax?

In most states, sales and use tax apply to the sale or use of materials and supplies used in construction and certain construction services. Specific requirements vary by state (and sometimes by city or county), as well as by the type of project, the client, and a host of other factors.

There’s no statewide sales/use tax in New Hampshire, Oregon, Montana, Alaska, or Delaware (often called the NOMAD states because of their initials). Yet many jurisdictions in Alaska levy local sales and use tax, and some tax certain construction materials and services.

What are the top audit risks for construction contractors?

Common audit risks for construction contractors include misclassifying materials and labor, overlooking use tax liability, accepting invalid exemption certificates or allowing the documents to expire, poor recordkeeping, and taxability errors. Contractors who work in multiple jurisdictions may also struggle to register as required and keep licenses up to date.

Can a customer’s sales tax exemption flow through to a contractor?

Some states, like Illinois, permit a customer’s exemption to flow through to the contractor, but others do not. States that do not permit such flow-throughs may allow exempt entities to purchase construction materials and supply themselves, so they can claim the exemption.