In our first blog, we looked at how complicated sales tax can be for construction professionals, including how the form of the contract and location of the work can make even the simplest job complex for compliance. In short, what works for sales tax in one state in this industry often doesn’t work in another.
Here are a few more key points from our recent webinar on construction and sales tax.
Real property vs. tangible personal property
There are clear and obvious activities in construction that result in real property – foundations, frames and drywall, plumbing and electrical fixtures – and that are, for practical purposes, permanently affixed to real property. Simply, these generally fall within the general contractor rules for sales tax and taxability in a particular state.
There is also tangible personal property (TPP) that maintains its tax status as TPP at end of a construction project, such as a refrigerator, custom blinds or drapes, a washer/dryer or other items that can typically be plugged in and moved when the occupants of the property leave.
Yet often when a contractor builds a house and includes the refrigerator, the oven and maybe the washer/dryer and so on that could be permanently affixed, the contractor generally pays sales tax on those items, and they become part of the lump sum contract agreement. If they’re segregated on an invoice, the contractor will generally have to charge sales tax on them.
Manufacturing equipment is even more complicated. Most states allow for some type of exemption for manufacturing equipment; if a contractor is building a full industrial facility, there will be massive pieces of manufacturing equipment brought into that project and much will be exempt from sales tax.
But depending on the size of the equipment, there might also be railings, steps, platforms and so on built around that equipment for operation, cleaning or maintenance. Often those additions will be permanently affixed to the property but not necessarily essential to the manufacturing equipment. Such a situation can create even more nuances of what’s exempt from sales tax and what isn’t.
Other items – and audits
Varieties of many items commonly used in a project and how those items are managed can change the tax treatment.
In the case of HVACs, for instance this could be a retail sale if a contractor buys one and hires someone else to install it. This equipment could also be a removable window unit that isn’t affixed, meaning it might be TPP and incur different tax treatment depending in how the state in question defines “permanently affixed.”
Other similar items that could incur differing sales tax treatment include water heaters, lighting, doors, window treatments, landscaping, cabinets or swimming pools. Further, in some states a carpet installer is also considered a real property improvement contractor and in other states a seller of TPP and who has installation services.
Above all, contractors don’t want to be in a scenario where they’re operated in a state for years and treated all these items as real property improvements, paid tax at every purchase and didn’t charge tax to customers. An auditor looking at that contractor’s records and segregate the transactions, pointing out that this wasn’t a real property improvement but a sale and installation of TPP where you, the contractor, should have charged tax on your property.
You might reply that you’ve already paid tax to your vendor. The auditor will probably in turn reply that what you did with your vendor is a separate transaction and not part of the transaction with your customer.
Situs
This is the location in which a taxing event occurs. Situs is easy to determine when the entire transaction occurs at the point-of-sale but is more difficult when the transaction involves numerous sites – as often happens with contractors. Among considerations:
Holding/housing inventory. A qualified retailer contractor can generally hold inventory exempt of tax. But that inventory may incur tax if a certain kind of contractor uses a state to house inventory. Where a contractor’s inventory sits and where it’s deployed matters.
Leases. Leases carry special sales tax rules concerning where equipment is deployed and how long it’s used in a state – which can become a serious sales tax matter for contractors who operate in bordering cities such as Kansas City or Charlotte, North Carolina. If, for instance, a contractor leases equipment in North Carolina and uses it in South Carolina, the latter state might argue that sales tax paid in North Carolina is immaterial. Auditors pay sharp attention to nuances like this.
Sales/use tax reciprocity. Many states respect the tax determinations of other states, much as one state might honor the legal or accounting certification of a professional in another state. But tax is only respected to the extent that the sales tax of a one state, county, city or district matches. A contractor may have to pay any mismatch in the sales tax rates (given that there are more than 10,000 tax jurisdictions in the U.S., tracking this reciprocity and comparing sales tax rates can generally make construction companies’ heads spin).
Fabrication labor. This often falls under the category of custom building, not manufacturing. The question for contractors is, if there’s labor involved, does that labor become part of the tax base?
Exempt entities. Generally, these entities (governments, schools, non-profits and so on) do not pay sales tax, though this can vary greatly jurisdiction to jurisdiction. One solution for contractors is to enter a purchasing-agent relationship with a tax-exempt, under which the agency essentially becomes the purchaser of the items for the project.
Also, in a few states if an exempt entity buys materials and hires a contractor, the contractor must calculate, accrue and remit consumer use tax on the cost basis of the materials. This uncommon sales tax law can catch contractors by surprise.
Audit defense
These may seem like far-flung and even minor potential tax problems for a sizable contractor. But can a contractor really afford to not be in compliance?
As with audits in many areas of tax, documentation is the best defense. In construction, these can include affidavits proving that an outside contractor paid the appropriate tax in another state or written proof of tax already paid to vendor on taxable contracts in some states. Copies of long-term contracts can be especially valuable in sales tax, as generally states that have raised their rates will give contractors the original rate for the term of project.
Hear more on our webinar “Sales & Use Tax Considerations for Real Property Improvement Services.”
TaxConnex provides on-going compliance services for many construction businesses, helping them stay on top of their many and far-flung sales tax obligations. Get in touch to learn more about TaxConnex services.
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