Like many business owners, contractors tend to focus most of their tax-related attention on federal, state and local income tax liability. However, if your construction business operates in other states, there’s something else you should keep an eye on: sales and use taxes.
More than four years ago, the U.S. Supreme Court issued a landmark decision in South Dakota v. Wayfair. The Court ruled that a state may require out-of-state sellers to collect and remit sales tax if they have an “economic nexus” with the state. Previously, states were limited to imposing sales tax collection obligations on sellers with a physical presence in the state.
Economic nexus laws impose sales tax collection obligations on businesses that exceed certain sales thresholds in a state, regardless of physical presence. The South Dakota law upheld in Wayfair applied to businesses with more than $100,000 in annual sales or more than 200 separate annual transactions in the state.
Today, nearly every state with a sales tax has followed suit, though the annual sales and number-of-transaction thresholds for establishing economic nexus vary dramatically from state to state. For example, some states require sales as high as $500,000; others base nexus only on sales, regardless of the number of transactions. Still others require businesses to meet both sales and number-of-transaction thresholds.
What contractors should know
For construction businesses, managing sales and use taxes can be challenging. Generally, you’re treated as the consumer of materials that you use on your jobs. Thus, you either pay sales tax to your vendors or, for out-of-state vendors that don’t collect sales tax, you self-assess use tax and remit it to the state. You probably don’t typically collect sales tax from the owners you contract with.
As with most general rules, however, there are exceptions. For instance, some states treat contractors as retailers of certain materials. In such cases, you buy the materials tax-free under a resale exemption and collect sales tax from the owner. Examples can include appliances, window treatments, window air conditioning units and carpeting. Some business fixtures treated as personal rather than real property might qualify for this treatment as well.
A few states impose sales tax on specified construction services, requiring contractors to pay sales tax on their materials and collect sales tax from customers. And in others, the sales tax treatment depends on the type of contract. With a lump-sum contract, for example, the state treats the construction company as the consumer of materials incorporated into the real estate.
However, with time and materials contracts, in which material charges are itemized separately from labor and other charges, the state views the construction business as a retailer. This allows the builder to buy materials tax-free for resale but requires it to collect sales tax from the owner.
In many states, certain types of entities — such as schools, hospitals and nonprofits — are exempt from sales tax. In some of these states, the exemption “flows through” to the construction business. That means the contractor can buy materials tax-free under an exemption certificate for use on a project involving an eligible entity. However, in other states, the exemption is available only if the entity itself buys the materials.
How to protect yourself
Because of Wayfair, contractors need to understand the sales and use tax rules in states where they operate. Be prepared to issue resale or exemption certificates to your vendors — or have exempt owners buy materials directly, if necessary — to take advantage of the sales tax exemptions available.
In addition, look closely into how the contract types that your business usually operates under affect your sales and use tax obligations. Consider those obligations when developing bids. Finally, if your construction business buys building materials, supplies, equipment and other items in several states, consider conducting a reverse sales-and-use tax audit.
Keep on truckin’
If out-of-state projects beckon, don’t let sales and use taxes alone stop you from pursuing these opportunities. Your CPA can help you understand and manage your exposure.
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