For sales and use tax purposes, a manufacturer is someone who converts some form of tangible (generally personal) property into another form that has a different function or purpose. Construction contractors may be regarded as manufacturers when they substantially modify materials or fixtures before installing them, rather than just buying such items in a ready-to-install state. For purposes of this article, all references to “materials” and “fixtures” will pertain to property that contractors affix or otherwise convert to realty.
Most states require contractors to pay sales or use tax on only the costs of the physical components of materials and fixtures they install, regardless of whether the installed property is bought ready-made or is self-manufactured from purchased components. For example, in these states, whether a contractor directly converted raw lumber into a fence or cut, sanded, painted, and installed the lumber as part of a kitchen counter, tax would only be due on the purchase cost of the lumber (plus the costs of any nails, screws, or paint applied in the process).
This general rule applies in Arkansas, Connecticut, Illinois, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Minnesota, Missouri, Nevada, North Carolina, North Dakota, Oklahoma, Pennsylvania, Rhode Island, Utah, and Wyoming. Colorado, the District of Columbia, and Indiana take a similar approach but make an exception for time and materials contracts, where the tax on materials and fixtures becomes due on the prices stated in the contracts.
A few states tax the fabricated costs of self-manufactured materials and fixtures. Fabricated costs include component materials, labor expended in making the property, and indirect manufacturing costs computed according to generally accepted cost accounting principles. States that tax fabricated costs include Florida, Georgia, Iowa, and Michigan.
In West Virginia, tax on installed self-manufactured property applies to the price at which similar completed units would have been sold to another contractor. However, if the project will result in a capital improvement, and if the contractor fabricates the items on the job site, tax will only be due on the cost of the component materials. (If the project does not result in a capital improvement, tax will be due on the total amount billed to the customer in any case.)
The following states make distinctions for contractors who manufacture items that they both sell separately (without installation) and install:
- Alabama taxes materials on their fair market value if they are fabricated into standard items at the contractor’s shop. If the fabricated items are unique to a particular job, however, or if they’re manufactured at the job site while the job is in progress, tax will only apply to the costs of their physical components.
- If a New York contractor sells self-manufactured materials to others and also installs them under construction contracts, the tax will be due on the retail selling price of the fabricated and installed materials. However, if the contractor installs such items as part of a capital improvement, the tax will apply to the wholesale price, i.e., the normal price at which the manufactured items would be sold to other contractors. If the contractor doesn’t normally sell the fabricated units to others, tax will only be due on the cost of the component materials. New Jersey has a similar rule.
- Tennessee, Vermont, and South Carolina tax contractors’ self-manufactured materials and fixtures on their fair market values if the same items are also sold by the contractors without installation. For contractors that don’t normally sell such items without also installing them, the tax applies only to the costs of the component materials.
- Idaho and Virginia generally tax property made and installed by contractors on the costs of the component materials. However, if a contractor makes fixtures and materials primarily for sale but sometimes withdraws the manufactured units from inventory for installation under a construction contract, tax will be due on the fabricated costs (materials, manufacturing labor, and overhead) of the installed property.
Although Kansas’ general policy is to tax the costs of installed materials and fixtures, the assessed “costs” may include any value added by internal fabrication. The guidelines are provided in Department of Revenue publication EDU-29, which is available at the DOR’s website.
In Ohio, contractors must make an election to be taxed either as contractors or manufacturers on materials and fixtures that they fabricate. If “contractor” status is elected, tax will be due on the costs of all physical components of manufactured items, regardless of whether the items are sold or installed. If any such items are sold without installation, no credit will be allowed for the tax previously paid on their component costs. Conversely, if “manufacturer” status is elected, no tax will be due on the costs of manufactured units, but tax will apply to their full retail selling prices whether or not they are installed.
If physical components of self-manufactured items are bought tax-paid in South Dakota, no further tax will be due when the items are affixed to realty. However, if they’re bought without tax, use tax will be due on the greater of their cost or fair market value at the time of installation.
Finally we have California, where contractors are consumers of installed materials but retailers of installed fixtures. When contractors make and install their own materials (e.g., heating/air conditioning ducts), tax is due only on the costs of the component parts, whether the tax is paid to the vendors or reported on the appropriate sales and use tax return. However, when contractors manufacture and install fixtures (e.g., temperature control devices), tax applies to the amounts they would have to pay outside vendors for similar (fabricated) fixtures. Of course, if a contractor itemizes a retail selling price for a fixture within a contract, the tax will apply to the stated price.
When California contractors manufacture and install fixtures that aren’t normally available from outside vendors, other formulas apply for determining the tax due. See the State Board of Equalization’s Sales and Use Tax Regulation section 1521(b)(2)(B).
As always – your questions and comments are not only welcomed – but greatly appreciated.
In the next installment, we’ll look at the state sales and use tax exemptions and exclusions available to contractors. (BTW - Let us know if there are any particular issues you'd like us to address in that post.)
Other recent “Construction / Contractor Tax” posts by Dan Davis:
- Arizona's New Contractor Tax Rules: Watch for Misleading Terminology!
- Contractors: Watch Out for Arizona Tax Changes
- Construction Contracts with Exempt Entities (State Breakdown)
- Supporting Your Exemptions: Acceptable Documentation
- Common Construction Exclusions and Exemptions