Sales Tax and Construction
Although most states do not impose sales tax on construction services, contractors need to be aware of 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, and it’s beneficial to be aware of certain organizations’ tax-exempt status and how it could translate to your contractor.
When negotiating a contract, most contractors use either a “lump-sum” contract or a “time and material” contract. While others can be used, these two are the most typical for non-governmental contracts. If you use a “lump-sum” contract, you are agreeing to perform the contract for a single stated amount. When using a “time and material” contract, the stated contract amount will be based on and include actual rates for all workers, and separately charge for supplies and materials used. In some states, the type of contract you use may affect when you will have to pay sales taxes on materials and supplies purchased.
In the majority of states construction firms do not have to collect sales taxes on the services they provide. However, they are treated as consumers of supplies and materials used in construction projects and generally have to pay sales or use taxes at the time of purchase. This means that any materials and supplies you purchase are taxable at the time of purchase. But you won’t have to pay sales tax upon the sale of the finished construction.
In addition, the states that do require construction contractors to pay sales tax on purchases may provide exceptions to the rule, and these exemptions will depend on the type of contract negotiated with the client as well as who your clients are (for example, if they are government or non-profit agencies.)
This is important, because in many cases the clients’ tax exemption may not flow to the contractor. So if the client is exempt, then it may be wise to have the customer actually purchase the materials. In some states, exempt organizations are allowed to buy materials and supplies for a project tax-free. However, tax assessors look at the transaction very carefully to ensure that either the exempt organization or an agent authorized to act on their behalf is indeed making the purchase. Most states do not allow contractors to use an organization’s exempt status unless they are the organization’s authorized agent; the distinction may seem trivial, but states use it to ensure as a check to prevent abuse of the organization’s exempt status.