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Common Construction Exclusions and Exemptions

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Transfers of tangible personal property are included within the tax base of every state sales and use tax program. Transfers involving realty, services, and intangibles may or may not be excluded from a given state's tax base, and the component categories may be subject to varying definitions. For example, an electronic transfer of software is defined as a transfer of intangible (and therefore excluded/nontaxable) property in some states and a transfer of tangible (and therefore included/taxable) property in others.

The exclusions most applicable to construction contractors involve services, which have been addressed in previous articles. Most sales and use tax exemptions fall into the following categories:

- Sales to certain entities, such as government or nonprofit agencies;

- Sales of property or services intended for resale by the purchaser;

- Sales outside the taxing jurisdiction (to buyers outside the seller’s state);

- Sales of property to be used in a manner qualifying for a specific state exemption (e.g., manufacturing or agriculture);

- Sales or use of property exempted due to its nature (e.g., food products);

- Occasional sales, contributions to capital, and some kinds of business reorganizations.

Of these categories, the first three are most commonly encountered by contractors. Sales to exempt entities will be the subject of a separate article, as will construction performed outside the contractor’s home state.

Of all the sales and use tax deductions, sales of property and services for resale comprise the largest single category. Like almost all taxpayers, contractors may be involved in sales for resale as either buyers or sellers.

In states where construction contractors are regarded as consumers of installed materials and/or fixtures, they may not buy such property for resale (e.g., by issuing a resale certificate) unless they’re also in the business of selling it without installation. In the latter case, they may buy the property for resale only if they don’t know at the time of purchase whether the property will be installed or sold over the counter. If property bought for resale is later installed by the contractor, use tax must be reported in the period the property is allocated to the project.

As discussed in prior articles, a few states regard contractors as retailers of everything they install, and several states regard contractors as retailers of some categories of installed items but not others. Where contractors are regarded as retailers of installed property, they generally should buy that property under the appropriate resale or exemption certificate and report tax on the sale prices to their customers. If they do pay tax to their vendors, however, they may claim a deduction or credit for their tax-paid purchases when they report the tax on the sale.

In general, contractors may not regard themselves as making sales for resale of property they install, and they should not accept resale certificates for such property from their customers. This is because materials and fixtures lose their status as tangible personal property upon installation, making their subsequent sale at retail by the customer a logical impossibility. (Note that this consideration may not apply to fixtures that state laws specifically designate as retaining their status as tangible personal property after installation. The same is true for items included in state definitions of “machinery and equipment,” since they also retain their status as tangible personal property after installation. Contractors may buy subcontractor services for resale in a few states, which will be addressed in a subsequent article.)

Of course, contractors are free to sell materials and fixtures for resale if they won’t be installing them. They must document the exempt status of such sales and accept the documentation in good faith, which means they must have a reasonable basis for believing that the buyers really will resell the merchandise. In most states, the required documentation is a fully executed resale certificate. (Resale certificates and other exemption documentation will be addressed in more detail in the following installment.)

Several jurisdictions allow exemptions for property purchased for installation in other states, but more than half of the states do not. States without such exemptions include the following: Arkansas, Colorado, Florida, Georgia, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Missouri, Nebraska, New Jersey, North Carolina, Oklahoma, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Wisconsin (for property regarded as consumed), and Wyoming. New York and Connecticut require payment of tax on all property bought in-state for installation, but they allow claims for refund of the tax when the property is installed in a different state. Idaho, North Dakota, Ohio, Vermont, and Virginia allow exemptions either for purchases of materials to be installed in jurisdictions without sales or use taxes or for purchases of materials to be installed in jurisdictions that exempt similar installations by local contractors. All other purchases within those states for out-of-state installation are considered taxable.

Sales of uninstalled property to buyers outside the seller’s state are exempt from the home state’s sales tax under the following circumstances:

  1. The buyer does not take possession of the property within the seller’s state;
  2. The provisions of the contract do not pass title to the buyer within the seller’s state;
  3. The property is delivered by common or contract carrier, or by facilities of the retailer, to the buyer’s out-of-state location.

Generally out-of-state sales that are exempt from the seller’s state sales tax are subject to the destination state’s use tax, unless some other exemption applies. Sellers regarded as having a physical presence (nexus) in the destination state are required to collect and report that state’s use tax; where the seller lacks such nexus, the buyer is expected to self-report and remit the tax. (Note that delivery by the seller’s facilities may in itself create nexus, which would require the seller to register in the destination state and collect its use tax.)

The most important aspect of any exempt sale is its documentation. Legitimate deductions are regularly disallowed by sales and use tax auditors solely because the business under audit either lost, failed to obtain, or failed to retain the necessary documentation.

As always – your questions and comments are not only welcomed – but greatly appreciated.

Proper documentation will be the subject of next month’s article. (BTW - Let us know if there are any particular issues you'd like us to address in that post.)

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Comments

4 Responses to Common Construction Exclusions and Exemptions

  • Posted by Julia on March 3, 2015 5:10am:

    We are an Illinois-based exempt non-profit 501C3 org. We are renovating/remodeling our building including replacing our furniture and cubicles. We need to figure out if there would be any sales/use tax implications from having our Illinois-based contractor (1) purchase furniture on our behalf from a seller located in Michigan to be shipped to and installed in Illinois and (2) purchase carpeting from a vendor in Georgia to be shipped to Illinois for installation. Would it be better/safer from a tax perspective if we purchased the furniture or carpeting directly from the vendor or have the contractor do it as part of the contract? I don't think it will matter as our federal exemption determination will cover the sales tax side concerning Michigan (Form 3372) and our Illinois Exemption will cover the Use Tax (flow-through too) and the GA ST-6 Form will cover exemption of Georgia sales tax for both. I see there are non-resident contractor bonds in GA but I think that means for an out-of-state contractor coming into the state of GA to perform the service-which wouldn't apply in our case.
    Please Advise. Thank You! P.S. Your articles make good reading.

    • Posted by Author photo of Dan DavisDan Davis on March 4, 2015 6:49am:

      Julia,
      In Georgia and Michigan the rules for contractors are different from those in Illinois, in that there are no comparable exemptions for property purchased for attachment to realty owned by exempt organizations (even when the organizations are in a different state). In addition, the rules applicable to property that will not be affixed to realty (e.g., free-standing furniture) are different from those for property that will be attached. Overall, your safest approach is to buy all of the Michigan/Georgia furniture and carpeting directly from the vendors rather than having the contractor make the purchases. Advantages: (1) You won't have to concern yourselves with property that will be affixed to realty vs. property that will retain its status as tangible personal property; (2) The vendors will be able to claim the sales as exempt sales in interstate commerce (without the added complication of selling to an installing contractor/consumer); and (3) Once the property arrives in Illinois, your home state exemptions will absolve you of any use tax obligations.

  • Posted by Thea on February 11, 2015 3:38am:

    We’re commercial tile installers in NYS. If we’re working on a capital improvement project, specifically a new store that hasn’t opened yet, and a forklift (not ours) cracks some tile and we replace them, would a change order be taxable as a repair? The capital improvement job is still ongoing, so my inclination is that it’s part of the overall job and not taxable. What do you think?

    • Posted by Author photo of Dan DavisDan Davis on February 11, 2015 5:11am:

      Thea,
      This one's a little tricky. In general, if you're working on a capital improvement project and in the course of the job, you damage something and have to make the repair, the repair will be considered part of the capital improvement and thus not taxable. However, if you're working on a capital improvement project and you perform a separate repair that was not caused by the capital improvement work, the repair is taxable. You seem to be somewhere in between: your own project didn't create the need for a repair, but the whole store is still under construction, so the damage was still created in the course of a capital improvement. Therefore, I believe the repair should fall within the capital improvement category and should be nontaxable.

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