When it comes to sales taxes, the construction industry can be especially complicated. States very greatly in the ways that they administer their sales taxes (or sales tax-equivalent) in just about every way -- from what is taxable, who owes the tax, and what documentation is needed to keep to prove to an auditor that you properly handled exempt transactions. Failing to understand and plan for these complex issues can lead to significant penalties and even legal consequences down the road.
So, what exactly do construction contractors need to know when it comes to tax planning? Read on to explore the basics of tax planning in construction and discover some actionable tips to keep more money in your pocket while remaining in compliance with state and local tax laws.
A critical question is what aspects of a construction project are taxable. For example, while contractors may be responsible for the sales tax on materials and supplies, most states do not tax construction labor.
However, while Texas does not tax new construction labor costs, it does tax remodeling and repair labor on nonresidential projects.
When a project is a mixed project, involving both residential and nonresidential property, various potential issues arise that could be avoided by using proper contractual language.
Another factor to consider is use tax, which is essentially the flip side of sales tax and is due when taxable materials are purchased in one state and brought into another state for a construction project.
When those materials are brought into a state, that state will expect use tax to be paid on those materials. Contractors need to make sure that they are paying the correct state, and if they mistakenly paid tax to a different state, they need to make sure they are either getting credit for that paid or getting a credit or refund.
Many states will always treat the construction contractor as the ultimate consumer of all the materials its purchases. Therefore, the contractor would pay sales tax to its vendors (and reflect those costs in its bid to its customer) and collect no tax from its customers.
However, some states (like Texas or Colorado) treat some contractors differently depending on whether they are working under a lump-sum contract (a single price for the project) or a separated contract (separate invoicing for labor and materials).
Under a separated contract, Texas would treat the contractor as a retailer, meaning that it would provide its vendor with a resale certificate and charge and collect sales tax from its customer.
These rules can have a dramatic impact on taxability. For example, since Texas treats a lump-sum contractor as the ultimate consumer of materials, the contractor is incapable of providing a vendor with an exemption certificate for manufacturing equipment because the contractor is not itself the manufacturer. In that fact pattern, the only way for the manufacturing exemption to work is for the contractor to operate under a separated contract.
This example highlights the importance of getting this right at the start of the project and documenting it accordingly. A seemingly straightforward question about whether a contract is lump-sum may not be as obvious as it seems . For example, there may be no contract or invoices may be poorly worded.
Many states have taxes that are commonly referred to as “sales taxes” but actually are different types of tax. For example, New Mexico imposes a gross receipts tax that is imposed on all services, including construction services.
Arizona imposes a transaction privilege tax (TPT), which provides special rules for construction contractors. Arizona divides construction into three categories: "MRRA" (maintenance, repair, replacement or alteration), "Modification" and Speculative Building (taxable by cities only). Further, TPT may be calculated based on a certain percentage of an overall project cost that varies depending on the type of project.
Other states have special exemption certificates for contractors to provide their vendor in order to make a tax-free purchase.
Contractors often perform work for projects that are entitled to a sales tax exemption, such as schools, government buildings and manufacturing facilities.
States vary greatly in how they expect taxpayers to document these exempt transactions and making sure you provide and/or receive the correct exemption certificate can be the difference between an auditor finding a project taxable or exempt.
From staying on top of your state and local tax laws to determining responsibility for taxes on materials and labor, the world of taxes in construction can be complicated.
As a construction contractor, of course, your expertise lies not in finances and tax planning, but in project planning and execution. The good news? With these practical tips and best practices in mind, you can be better prepared for the coming tax year and plan accordingly.
At the same time, if you're feeling overwhelmed and looking for additional guidance on your taxes as a construction contractor, there are always experienced professionals ready and able to help.
Specifically, scheduling a consultation with a tax professional can help you better understand your own unique tax situation, explore options to reduce your tax burden and prepare to file your business taxes with added confidence and peace of mind.