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Construction Contractors as Consumers

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Most states regard construction contractors as consumers (end users) of the materials and fixtures they install. In today’s blog, we’ll examine the implications of this concept and list the states that apply it with few or no exceptions.

Under virtually all state sales and use tax laws, property that contractors affix to real estate is considered to fall within one of the following three broad classifications:

- Materials are generally items that lose their individual identity when incorporated into real estate. Examples include nuts, bolts, nails, screws, lumber, roofing shingles, wires, pipe, asphalt, and concrete. (Some states that treat materials and fixtures similarly simply refer to both categories as “materials.”)

- Fixtures are items that remain readily identifiable after installation. Examples are sinks, toilets, bathtubs, light fixtures, water heaters, and rooftop air conditioning units.

- Machinery and equipment are installed units that will be used directly in operating the customer’s (usually the property owner’s) business. Manufacturing machinery is the most common example.

In the states addressed in this segment, contractors (rather than the contractors’ customers) are regarded as the end users of both the materials and the fixtures that they install. However, all states with sales and use tax laws regard contractors’ sales of machinery and equipment as retail sales to their customers, whether or not the property is installed. Thus, contractors must collect and remit sales tax on the retail selling prices of machinery and equipment provided to end users, unless some other exemption (e.g., a manufacturing exemption) applies.

Although the general definitions of materials, fixtures, and machinery/equipment are fairly universal, specific items included in each category may vary from state to state. This is particularly true for fixtures vs. machinery/equipment, and an item regarded as a fixture by one state may be regarded as machinery in another. Therefore, it’s important to check on the specifics for each applicable state.

The states that regard construction contractors as consumers of installed materials and fixtures with only minor exceptions are: Alabama, Georgia, Idaho, Illinois, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Missouri, Nevada, North Carolina, North Dakota, Oklahoma, Pennsylvania, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Virginia, and Wyoming. The minor exceptions are:

- Certain types of installed property such as carpet, linoleum, drapes, wallpaper, cabinets, and landscaping may be subject to special rules.

- In Iowa and Utah, property affixed pursuant to a repair rather than a property improvement must be treated as a retail sale by the contractor.

- Some states regard installed property as sold at retail if the contractor segregates materials and tax as separate line items within the contract. (For sales and use tax purposes, it is generally preferable to enter into lump-sum contracts rather than separated contracts such as time and materials. This topic will be addressed in more detail in subsequent installments.)

Where contractors are regarded as consumers, they are expected to pay sales tax to their vendors on all materials and fixtures that they purchase for installation. When their vendors do not charge the tax (e.g., where the items are purchased from an out-of-state source), contractors are expected to report use tax on the costs of the applicable purchases, which is done on the sales and/or use tax return for the state where the property will be installed. (Exceptions: Some states provide exemptions for property purchased to fulfill contracts with governmental and/or nonprofit entities. These exemptions will be addressed in a future installment. Of course, contractors purchasing machinery and equipment for their customers should always buy these items for resale from their vendors, since they will be regarded as sellers rather than end users of such property.)

In the states under discussion, a sales and use tax audit of a contractor who only makes improvements to realty (i.e., who makes no over-the-counter or Internet sales) would primarily focus on the costs of materials and fixtures bought for installation. The auditor would review the recorded purchases of materials and fixtures and trace a sample to the underlying purchases invoices to determine whether sales tax had been paid to the vendors. The auditor also might cross check by identifying the major vendors and going through their paid bills files to ensure that the tax was consistently paid.

If any materials or fixtures were found to be purchased without tax, the auditor would examine the contractor’s sales and use tax returns to determine if such purchases had been reported as taxable. If the purchases were not reported, use tax would be asserted in the audit.

Although this audit process sounds straightforward, it can become problematic if the contractor’s records are inadequate and/or the auditor arrives at the unreported tax by sampling or some other means of estimation. These topics also will be addressed in future installments.

Three final notes:

(1) Wherever a contractor is regarded as a consumer of installed property, the tax is due at the rate applicable to the location where the installation is completed. This is significant in states that have varying local tax rates.

(2) If tax is not paid to a vendor, it must be reported on the contractor’s return for the period in which the consumable purchases are allocated to a specific job.

(3) Sales and use tax nexus is automatically established when contractors, or their agents, begin work within a state. This applies to all construction contractors, in every state that has a sales and use tax.

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

BTW - In our next installment, we’ll address sales and use tax rules in states where contractors are primarily regarded as consumers but where the exceptions to that rule are significant.

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Comments

7 Responses to Construction Contractors as Consumers

  • Posted by leeshin on March 10, 2016 11:33pm:

    nice post, thank you for sharing

  • Posted by Adam on June 11, 2015 8:16am:

    We own a service company in Indiana. One of our services is installing attic insulation in homes for our residential customers. We provide the insulation and the labor; we never sell just the insulation (ie homeowner installs themselves). We also never sell just the labor to install (ie customer-provided materials). We bill one price for the job. We use employees, we don't sub the work out. We pay sales tax to our vendors when we purchase the insulation. Are we required to charge sales tax to our customers on the full price of the job?

    • Posted by Author photo of Dan DavisDan Davis on June 15, 2015 7:33am:

      Adam,
      As an Indiana lump-sum construction contractor, your company is regarded as the consumer of products it installs, and the installation labor is not taxable. You're only obligated to pay tax on your costs of product installed (which you're already doing), and you should not charge sales tax to your customers.

  • Posted by Casey on May 12, 2015 2:52am:

    We subcontracted a construction job in Kentucky. We billed it lump sum to the prime contractor. We fabricated the materials in Texas and paid use tax to all of our vendors in Kentucky. We subcontracted the labor to install and affix the material to real property in Kentucky. I am working on our sales and use tax report and I do not see where I can deduct lump sum contracts. Is Kentucky a state where they do not exempt construction contracts from sales tax & use tax?

    • Posted by Author photo of Dan DavisDan Davis on June 4, 2015 6:01am:

      Sorry it took this long to respond - I didn't see your post until today.
      Kentucky regards both prime contractors and subcontractors as consumers of the materials they install, even in the case of materials that are fabricated. In addition, construction labor is not taxable in Kentucky. If you paid Kentucky sales or use tax on all of the materials you installed, you have no further liability to the state. On the return, you can deduct the contract as exempt labor, or include it in a "miscellaneous" category (with a description such as "construction contract proceeds") if available on the return. Note that if you bought any of the fabricated materials in Texas, you'll owe Kentucky use tax on them. However, you can offset any Texas tax you paid against the Kentucky tax due, which on an item-by-item basis would probably eliminate the Kentucky liability since Texas rates tend to be higher.

  • Posted by Shawn on March 20, 2015 12:30am:

    We are a cleaning company in FL. We are pursuing construction contracts for final cleaning of construction projects. We pay sales tax on all our supplies purchased to perform the construction cleaning service which is billed as one line item to include our labor. Should we charge and collect sales tax on construction cleaning services?

    • Posted by Author photo of Dan DavisDan Davis on March 26, 2015 9:27am:

      Shawn,
      Final cleaning of construction projects is a nontaxable service in Florida. As long as you're paying sales tax to your supplies vendors, you have no further liability and should not collect sales tax on your services.

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