This is part one of a four-part series that will provide insight into sales tax and the bidding process for construction contractors.
In the construction industry where time is money, being prepared and asking the right questions might just save you both. To put your business in the best possible position, it is always recommended to address sales and use tax as a part of your bid process rather than after a project has already started.
Below are three important questions to ask yourself to ensure you’re not leaving money on the table, or worse, paying unexpected tax assessments after a job has been completed.
- Who is the customer? Gaining an understanding of who the customer is, what they do, and whether there are any applicable exemptions is an important step to consider in the beginning phases of a bid. An area that typically creates issues for contractors is contracts with tax exempt entities. The assumption that an exemption flows through customers to contractors can significantly affect the margins of a project if not addressed appropriately.
Each state treats contracts with tax exempt entities differently. Most will not allow contractors to use their customer’s exempt status to purchase materials and supplies tax free. Those states that do allow some type of flow through of an exemption require specific documentation in order to support the exemption.
- What activities are we performing under this contract? Most states put contractors in one of two boxes – either performing construction activities or performing sales activities. Those contractors performing construction activities are generally considered to be consuming materials, equipment, and supplies used in the performance of the contract and have the responsibility to pay sales tax at the time of purchase. Contractors selling tangible personal property that will not be permanently installed in real estate are considered to be making purchases for resale and therefore would not pay sales tax at the time of purchase. However, sales tax would need to be collected at the time of sale.
- How will we bill our customer? Construction contracts are typically billed under a lump sum contract or under a time and materials contract. Depending on the state, how the contract is billed can ultimately determine how sales tax is handled. A lump sum contract does not separately break out charges for materials, labor, overhead, etc. Under a lump sum contract, the contractor is generally treated as the end consumer of the materials and ultimately is responsible for the sales tax.
Time and material contracts separately state each charge under the contract. Purchases under a time and materials contract are generally for resale and tax is to be charged by the contractor. Time and material contracts might provide the opportunity for customers with applicable exemptions such as manufacturing to save on sales tax.
Most states provide an exemption for equipment directly used in the manufacturing process. Contractors would separately charge for the equipment being sold that would be used directly in the manufacturing process, potentially saving the customer the related sales tax that otherwise would have been included in a lump sum contract.
With industry margins already competitive and the cost of materials and supplies continuing to climb, it is important to take action so your company is prepared. Taking time to think about your customer, what activities are being performed, and how you will be billing is key to addressing the complexity of sales and use tax during the bid process.
The three considerations outlined above merely touch the surface of what to ask during the bid process so that your company is well positioned as it relates to sales and use tax. Stay tuned for the rest of our series, which will explore each of these three considerations in more detail.
If you have any questions or would like to discuss this topic in further detail, please reach out to Reed Brown, Manager, State and Local Tax, at Email or contact any member of our State and Local Tax team or our Construction Industry Group.
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Information contained in this alert should not be construed as the rendering of specific accounting, tax, or other advice. Material may become outdated and anyone using this should research and update to ensure accuracy. In no event will the publisher be liable for any damages, direct, indirect, or consequential, claimed to result from use of the material contained in this alert. Readers are encouraged to consult with their advisors before making any decisions.
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