Gail Cole Jan 12, 2023
Construction contractors have a tough job. Meeting the needs of clients, wrangling subcontractors, ensuring projects are completed on time and on budget … it’s no wonder construction management ranks as one of the most stressful jobs in the country. And dealing with sales and use tax can intensify the pressure.
The last thing any contractor needs on their punch list is a sales/use tax assessment. Unfortunately, construction is one of the most frequently audited industries because it’s hard for construction businesses to get sales tax right.
To help contractors build a solid foundation in sales tax, we’ve put together answers to some common questions about construction sales tax:
There’s no such thing as a “construction sales tax,” technically. But in many states, sales and use tax apply to the sale or use of certain construction services and/or materials.
Sales tax on construction work is governed by sales and use tax laws, rules, and regulations. Specific requirements vary by state (and sometimes by city or county), as well as by the type of project, the client, and a host of other factors.
There’s no statewide sales/use tax in New Hampshire, Oregon, Montana, Alaska, or Delaware (often called the NOMAD states because of their initials). Yet many jurisdictions in Alaska levy local sales and use tax, and some tax certain construction materials and services.
Many states exempt most services, including construction labor. Thus, sales tax generally doesn’t apply to construction services in Illinois, Minnesota, and Pennsylvania.
Only Hawaii, New Mexico, South Dakota, and West Virginia tax services by default; in those four states, all services are taxable unless a specific exception or exemption applies. Of course, exceptions and exemptions often apply.
You should never assume all construction services are exempt if one construction service is exempt, because states frequently tax some services while exempting others. Taxability typically depends on the client, project, property, or other factors, including whether the service is provided by a subcontractor for a general contractor, by a general contractor for a homeowner, or by a general contractor acting as a developer.
If you’re taking on a new project, make sure to discuss sales and use tax with a professional who’s familiar with local regulations and requirements. In recent years, several states have broadened their sales tax laws to include services.
While most tangible personal property is subject to sales and use tax in most states, whether sales tax applies to construction materials depends on a variety of factors, including:
When materials are subject to sales tax, the rate is typically the rate in effect at the project’s location.
To illustrate the point, let’s look at how construction materials are taxed in Washington state.
General (aka, prime) contractors must pay sales or use tax on all materials they consume, such as masking tape, plastic sheeting, tape measures, and tools.
When doing a project for others at retail, general contractors don’t pay sales tax on materials purchased to become a permanent part of the building (e.g., drywall, lumber) — so long as they provide a reseller permit to the supplier. The general contractor must then charge the client sales tax on the materials, at the rate in effect at the location of the job.
For the most part, the same rules apply to subcontractors hired by a general contractor. Subcontractors need to pay sales or use tax on materials they consume, like tape, but not on materials that become a permanent part of the building, like lumber (if they provide the supplier with a reseller permit when purchasing those materials).
A general contractor acting as a developer or speculative builder must pay sales or use tax on all materials used and on all billings from other contractors.
Different rules may apply to public road contractors, logging road contractors, and government contractors, or to projects for nonprofits or tribes. And sometimes, even how you think about a project can impact taxability in Washington.
The type of contract can also affect how sales tax applies to materials. Two common types of contracts are:
Florida generally considers contractors operating under either a lump sum or time and materials contract to be the final consumer of the materials and supplies. Contractors therefore must pay the tax due at the time of sale and can’t collect sales tax from the real property owner. This is true even if the project is for a tax-exempt or government entity.
California also generally considers contractors operating under a time and material contract to be the consumer of the materials and liable for the tax. However, under a “time and material plus tax” contract, the contractor can purchase the materials tax free (with a resale certificate) then collect the tax from the client. Contractors are considered the consumers of the materials they furnish and install under a lump sum contract in California.
Overall, it’s best to avoid generalizing because requirements differ from state to state. When in doubt, ask a trusted tax professional for advice.
The following examples illustrate how different states tax different construction services. It’s far from comprehensive and should not be taken as tax advice.
Connecticut sales tax applies to a contractor’s labor charges when the service is to existing commercial, industrial, or income-producing real property. But Connecticut provides an exemption for labor on new construction projects, owner-occupied residential property, and a number of other construction projects.
Hawaii’s general excise tax (GET) is assessed on construction services, labor, and other services in the state. The general 4% rate applies to most construction services, including labor, but some construction services may qualify for a reduced rate of 0.5%.
Idaho sales tax law typically treats contractors as the consumers (end users) of all the goods they use. Therefore, contractors “must pay sales tax on all purchases, including all the equipment, tools, and supplies they use to build, improve, repair, or alter real property.” If they don’t pay sales tax at the point of sale, they owe the state the equivalent use tax. If the client is exempt from sales tax for some reason, the exemption doesn’t carry over to the contractor.
New Mexico gross receipts tax applies to most construction activities in the state, but the state exempts or provides a deduction for construction services related to certain hospitals, low-income housing, and other projects.
In South Dakota, construction services are generally exempt from sales and use tax but subject to a 2% contractor’s excise tax.
Washington requires general contractors to collect retail sales tax on the total contract price when performing work for others at retail. Retail sales tax also applies to a subcontractor’s total charges (contract price) to a general contractor, unless the general contractor gives the subcontractor a reseller permit.
Construction services (labor) are generally subject to West Virginia sales and use tax but exempt if the work results in a “capital improvement” to the real property. A capital improvement is defined as any addition or alteration to real property that meets all the following requirements:
1. It substantially adds to the value of real property or appreciably prolongs its useful life
2. It becomes part of the real property or is permanently affixed to the real property so that removal would cause material damage to the property or article itself
3. It’s intended to become a permanent installation or to remain there for an indefinite period of time
Haines Borough, Alaska, provides a local sales and use tax exemption for construction services and materials permanently incorporated into a structure, but only if the charges exceed $5,000 per construction project in a 12-consecutive-month period. Purchasers must initially pay sales tax on these transactions then complete a sales tax refund form (along with qualifying receipts) to obtain the allowed sales tax refund.
Ultimately, the laws and rules that apply to your business will depend on where you’re doing business, the project, and how construction labor and materials are taxed.
Before you take on new or complex projects, it’s important to consult with a sales tax professional familiar with the construction industry. They can help you avoid the pitfalls of noncompliance (and maybe even uncover exemptions and tax breaks).
Another way to ease the burden of tax compliance is by implementing a sales tax automation solution, like Avalara. Automating everything from tax research to tax returns can help you become more compliant while freeing time to do what you do best.
