Although most states do not impose sales tax on construction services, contractors must be aware sales tax rules when they purchase and bill for supplies that they use. Lump-sum contracts and time and materials contracts can create very different sales tax obligations.
The construction industry consists of businesses that construct or make improvements to houses, buildings and undeveloped land (real property). In the majority of states, construction firms do not have to collect sales taxes on the services they provide. However, they’re treated as a consumers of supplies and materials used in construction projects and generally have to pay sales or use taxes at the time of purchase.
When Are Construction Materials Subject to Sales Tax?
In most states, construction contractors must pay sales tax when they purchase materials used in construction. This means that any materials and supplies you purchase are taxable at the time of purchase. However, you won’t have to pay sales or use tax upon the sale of the finished construction. In some cases, this can be an advantage because any markup you charge to your customer on the materials, supplies and labor, won’t be subject to sales tax.
A few states treat construction contractors like resellers, who purchase materials solely for resale to an end user. and do not require that the contractor pay sales tax when purchasing materials. More states provide this treatment for itemized contracts than lump-sum contracts.
- Lump-sum contracts: Arizona, Hawaii, Mississippi, Nebraska, and New Mexico
- Time and Material (Itemized) contracts: Arizona, Colorado, District of Columbia, Hawaii, Indiana, Mississippi, Nebraska, New Mexico and Texas
In addition, the states that require construction contractors to pay sales tax on purchases may provide exemptions to this general rule. Whether you qualify for the exemptions will depend not only on the type of contracts that you negotiate with your clients, but also who your clients are (for example, are they non-profit or governmental agencies.)
Generally, work is done under a signed written agreement with your customer that lays out the terms of the work to be done, the type of materials to be used, and an estimate of the total cost of the job. It is up to you whether you want to include a stated provision in your contract for the payment of sales taxes. However, when you negotiate a contract with a customer, make sure that you account for the right sales or use tax rate when bidding on a job. To do this, you should check with the states that you operate in to verify that you have included the right tax rate either to roll into the contract or to pass directly onto the customer.
When negotiating a construction contract, most contractors use either a “lump-sum” contract or a “time and material” contract. While other types of contracts may be used in contracting with the government, these two are the most typical for nongovernmental contracts. If you use a “lump-sum” contract, you are agreeing to perform the contract for a single stated amount. This amount will include materials, supplies, services, overhead and profit all “lumped” together in one line item.
Using a time and material contract, the stated contract amount will be based on and include actual rates for all workers at the site, and separately charge for supplies and materials used. In fact, you may even bill separately for overhead and profit margin.
In some states, the type of contract you use may effect when you will have to pay sales taxes on materials and supplies purchased.
Davie, a building contractor in Florida, enters into a lump-sum contract with a Cydney for the construction of her new home. He will be required to pay sales or use taxes when he purchases supplies and material because the construction contract is a lump-sum contract. If Davie had used a time and materials contract, which required him to separately state and itemize the materials, supplies and labor, then Florida would have treated him as reseller. Resellers are exempt from sales tax on their purchases, so he would not pay sales tax when he bought the materials and supplies. Instead, Davie would be required to charge Cydney sales tax on the materials and supplies.
The states that treat construction contractors like retailers let you buy materials and supplies for a job tax-free—usually after you present a vendor with a valid resale certificate. However, when you finish the construction project, you’re going to have to cut the state a check for sales or use tax on the basis of gross sales for the new construction.
Source: By Mike Enright, Operations Manager, BizFilings