Tax rules specific to the construction industry
Most states don’t impose sales tax on construction services, but construction contractors usually have to pay sales tax when purchasing the materials that are used in construction. Sales and use taxes in the construction industry are based upon:
- The state involved with the construction contract, the location of any purchase, and of the project
- The role of the contractor (general vs subcontractor)
- Residential vs commercial project
- Lump sum contract vs itemized contract
- The ultimate use of the purchased materials
- Services involved in the project
- Ambiguous state tax codes providing incomplete guidance
In most of states, contractors are considered to be consumers of the supplies and materials used in their projects and have to pay sales or use tax at the time of purchase. Therefore, the contractor doesn’t have to submit sales tax when the finished construction is sold.
There may be a tax advantage to paying a sales tax on purchased materials vs the services provided because any markup on the materials, supplies, and labor won’t be subject to a tax. A few states consider construction contractors to be re-sellers and don’t require them to pay a sales tax for itemized contracts.
Because tax rules in the construction industry are more complex, these businesses are more likely to be subject to sales and use tax audits. To reduce their audit exposure, contractors need to be cognizant of the tax rules and be better at managing their sales and use tax liability. While many contractors try to manage this by using in house accounting, using the services of a hired CPA firm can help to reduce audit exposure.
Sales tax and subcontractors
Depending upon the size of the project you may be the “prime contractor” or a “sub-contractor”. Subcontractors are hired and paid by a prime contractor. However, you’ll still be considered an end consumer and will have to pay sales tax on any supplies and materials that you’ve purchased.
These sales tax liabilities differ by state. The five states that don’t tax construction contractors — Arizona, Mississippi, Hawaii, New Mexico, and Washington — often offer exemptions for sub-contractors. In California, sales and use tax as they apply to construction contracts depends upon:
- The type of contract
- How the contractor purchases materials, fixtures, machinery, and equipment
- How such items are installed under contracts to improve real property
Under California law, construction contractors are considered consumers of the materials that they use and retailers of fixtures that they install. This applies to subcontractors as well.
CTA – Your tax planning guide
Staying ahead of changes
Tax rules are always subject to change. Whether you’re a large construction business or an SMB, hiring a CPA firm for construction companies to help you stay on top of current tax rules for your construction company can make the difference between having to undergo an audit vs being in compliance.
The specialists at GYL have years of experience when it comes to assisting construction companies, contractors and subcontractors with all their accounting needs. Contact our office to schedule your free consultation.