How are contractors’ purchases taxed?
Generally speaking, contractors owe sales or use tax when buying materials to be incorporated into real property. Sales tax is generally imposed on the “ultimate consumer.” The ultimate consumer is usually the last person to purchase and use the item. In the construction or improvement of real property, the contractor usually is considered the ultimate consumer of the tangible personal property incorporated into the realty.
The contractor is selling real estate or an improvement to real estate and this is generally not subject to sales and use tax. The contractor may pass the cost of the tax on to the purchaser as part of the contract price but is not allowed to display the tax as an add-on tax when the tax burden is on the contractor as the purchaser.
Most states do not tax real property construction and services. However, some do.
Contractors are generally not resellers of materials incorporated into real property; they are considered users and consumers of materials purchased for a job. However, the type of contract can change the tax implications.
In many states, the structure of the contract can have an impact on the taxability of the transaction. A lump-sum contract generally imposes the tax liability on the contractor for the tax on the materials.
However, in a separated contract or a cost plus contract, the state may deem the sale to be part property subject to sales tax, and part the sale of a service, which is exempt. In a separated or a cost plus contract, or when property retains its character of tangible personal property, the contractor may be considered a retailer and may be able to purchase tangible personal property for resale.
In some states, for time and material contracts where materials are separately stated from the labor, a contractor may be considered a retailer and can purchase the items that become components of the realty for resale. In some states, if the contractor is providing a taxable service, such as taxable real property remodeling, the contractor can purchase the items that are incorporated into the realty for resale. In both cases, sales tax must then be charged on the selling price of the taxable materials.
Most states include in their regulations lists of items which they consider tangible personal property when sold by a contractor. Examples includes: window treatments, most appliances, window air conditioners, tacked down carpet, and other items which can be removed without damage to the structure.
Contractors are considered consumers when they purchase items of tangible personal property that is used or consumed in their construction activity even if it isn’t incorporated into the real property. Sales or use tax should be paid on the purchase of these items when they are purchased. Additionally, all equipment used by the contractor is taxable.
When contracted by agencies or organizations that qualify for a sales or use tax exemption, contractors are not always exempt. Each state needs to be reviewed individually.
Looking for more information? Check out the following resources:
- Register for our Construction and Real Property Sales Tax Deep Dive webinar on December 20, 2018
- Find up-to-date news items on construction in our News & Tips section