Contractors' Sales Tax on Sales

April 13, 2006

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The following are some questions and answers that commonly arise for business owners involved in the construction industry:

Are supplies and materials subject to sales tax when I purchase them, or when I bill them to the construction customer? In general, all but five states (Arizona, Hawaii, Mississippi, New Mexico, and Washington, which treat construction contractors like retailers) will treat you as the consumer of supplies and materials used on a construction job for sales and use tax purposes. 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.

The five 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.

For tax purposes, does it matter whether the contract I have with my client is on a "lump-sum amount" or a "time and material" basis? 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. On the flip side, if you use a time and material contract, you are including actual rates for all workers at the site, and separate charge for actual materials used. In fact, you may even separately break out overhead and profit margin. (Your profit margin is the difference between your actual costs and what you charge your customers.)

What is my tax liability if I'm a subcontractor on a construction job? Depending on how big a job is, you may be working as either a "prime contractor" or a "sub-contractor." Being the prime contractor on a large construction job means that you will contract with a customer to perform all the work on a construction job and bill this customer for the entire amount of the job. As a subcontractor, however, you will be hired by the prime contractor and have little, if any, contact with the customer. The payment you receive will typically come from the prime contractor. However, you'll still be treated like an end consumer and have to pay sales and use taxes when you purchase supplies and materials.

The five states that don't tax construction contractors when they purchase supplies and materials - Arizona, Hawaii, Mississippi, New Mexico, and Washington (which treat construction contractors like retailers) - often provide an exemption for sub-contractors. Still, in some states, you're not completely off the hook for sales taxes if you're a sub-contractor. In Mississippi, for example, if the prime contractor doesn't pay tax on that portion of the job that you worked on, guess what? You're on the hook for it!

Warning

If you happen to take a sub-contracting job in any one of the five states that treat contractors as resellers, make it a point to check out the state laws to see what your liability for state sales and use tax is when the prime contractor doesn't pay. Remember, if the prime contractor files for bankruptcy or otherwise dissolves, you don't want to get stuck paying an unplanned-for tax bill.

Can a customer's exemption from state sales tax flow through to materials and supplies that I'm going to use in their building construction? If you have a customer that is exempt from sales and use tax, such as a nonprofit civic or community organization, then you may want your customer to purchase the materials that you're going to use in the construction.

Why? Well, for example, in some states, exempt organizations are allowed to buy materials and supplies for a construction project tax-free. If this exemption is allowed to flow through to materials they purchase for a construction job they have hired you for, then a large tax savings may result for you. However, tax assessors look at the transaction very carefully to make sure that either the exempt organization or an agent authorized to act on behalf of the exempt organization is making the purchase. Most states do not allow contractors to use an organization's exemption unless the contractor is the exempt organization's authorized agent. While the distinction of who can purchase the supplies and materials seems sort of trivial, states use it as a check to prevent abuse of the organization's exempt status.