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Construction Contractors as Manufacturers of Fixtures and Materials

author photo of Dan Davis

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.)

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Comments

11 Responses to Construction Contractors as Manufacturers of Fixtures and Materials

  • Posted by ALI on May 6, 2015 10:32am:

    Hi Dan,
    I've done a lot of research regarding this topic,mainly utilizing EDU 29 Kansas' guidelines for contractor-manufactures. In any other circumstance, I think the material would be very helpful but it's not quite answering my question in our unique situation. We are a concrete place and finish company in Kansas, who are in the process of building a ready-mix facility that will be treated as a division of the long-standing company we currently operate. Unlike most ready-mix's however, we will only produce concrete as turn-key, for use on projects that we will also do all of the labor for. We will not sell the manufactured material to other contractors or individuals for their use, it will only be used as a necessary part of the building/project completion process on contracts held by the place-finish division. Because the ready-mix is a division of it's sole buyer(the same entity), we will not be required to charge sales tax on the material to ourselves. However, We will pay sales tax on the raw material used to manufacture the finished product (concrete). My question is, when we bill our customer something such as the tear out and replace of a driveway for a residence, the price will be a flat all inclusive number that includes labor and the material (like we do now, buying from a non-associated ready-mix). Because residential work in Kansas is not taxable, and technically we were the final user of the material, being the concrete which is essentially an integral part of performing the contract, are we required to charge sales tax to our customers on the concrete portion of the bill? The material is not broken out into a separate line item, we do not sell the material we manufacture to anyone even the GC we are working for (it is part of the contract just like the concrete we buy elsewhere is now), we will have paid sales tax on the raw materials or "ingredients" that produced the final product, we will have to review blue-prints or visit the site to determine how much will need to be produced, we will only batch after a contract has been obtained and only for the amount needed on that contract, our employees will install the product as a part of the overall contract, and we will not maintain an inventory of this material. Doesn't this technically characterize us still as a contractor and not a retailer like most other ready-mix facilities?
    I just cannot seem to figure it out or find any publications that touch on such a situation.
    I would be most grateful for your wisdom on the subject!
    Thank you so much!

    • Posted by Author photo of Dan DavisDan Davis on May 7, 2015 8:34am:

      Hi Ali,
      You've raised an interesting question, and the available guidance is not entirely clear. (For one thing, Kansas' Publication EDU 29 was rescinded by the Department of Revenue on August 26, 2014.) The most specific guidance I've found is a policy letter (P-2005-017, dated June 23, 2005, but still shown as currently applicable) which states that when contractors use portable mixers to make concrete at the job site, they are treated as contractors rather than retailers and thus only pay tax on their costs of the materials used to make the concrete. The letter implies that the same would be true for concrete manufactured by the contractor off-site (as long as its only purpose was to be used by the manufacturer in its performance of construction contracts), but the off-site example does not specifically address concrete.
      Since (a) your contracts are lump-sum (i.e., you don't make separate charges for the concrete), (b) your company only uses the concrete it manufactures to perform its own construction contracts, and (c) your company does not maintain an inventory of the product, I believe you're correct in assuming the company should be treated as a contractor rather than a retailer, and you're only obligated to pay sales tax on your purchases of raw materials. However, I strongly recommend that you request an opinion letter from the Department of Revenue to solidify your position. You would do this by laying out all the specifics (as you did in your email to me) in a letter and requesting their opinion. Your request should go to: Office of Policy and Research, Kansas Department of Revenue, 915 SW Harrison Street, Topeka, KS 66625-0001.

  • Posted by Gabriele on September 15, 2014 3:18am:

    I fogot to mention: we are in Florida.
    Thanks a lot.

    • Posted by Author photo of Dan DavisDan Davis on December 16, 2014 5:36am:

      Gabriele,
      Sorry it has taken me so long to respond - somehow your question didn't reach me.
      It appears that the cabinet contractor's billing to you is incorrect. In most cases, Florida contractors are regarded as consumers, not sellers, which means they owe tax on the materials they install but should not be billing the tax to their customers. The only time a contractor should be billing you tax is when he's holding himself out as a "contractor-retailer." In that case, he'd have to itemize every individual item of tangible personal property that he was going to provide, and he'd have had to do so in the original contract, before doing the actual installation. Even then, he should not be billing tax on the installation labor.
      Whether or not you would have to pay him the tax is a separate issue that would depend on the wording in the contract. I suspect that if you disputed the tax and told him you would settle the matter by requesting a decision from the Florida Department of Revenue, he'd probably be willing to negotiate.
      Again, sorry this response is late.
      Dan

  • Posted by Gabriele on September 15, 2014 3:17am:

    Hello -
    we are currently refinishing our kitchen. While the countertop and installation is not subject to tax (different company), the cabinet company is charging us full sales tax on material and labor. From some basic research is sounds as he should not charge us tax as considered a real property improvement contract.
    Do we have to pay the tax or should we withhold? What if the contractor doesnt agree?
    Any guidance is appreciate. Thanks, Gabriele

  • Posted by Kristie on July 19, 2014 2:21pm:

    We have a custom cabinet shop in California.
    We are currently paying sales tax on all materials. We do a lump sum contract.
    We do not charge the homeowners sales tax on the
    cabinet job.
    We pay sales tax on cabinets that are picked up by a customer and are not installed by us. But we only charge the tax on the labor for building those cabinets.
    Can we not prepay sales tax on materials and charge the customer tax on the cabinets?
    Thanks so munch

    • Posted by Author photo of Dan DavisDan Davis on July 21, 2014 9:31am:

      Kristie,
      In California, cabinet contractors are considered consumers of the materials they use in constructing and affixing the cabinets, IF less than 90 percent of the total direct cost of the labor and materials is incurred before the actual attachment of the cabinet to realty begins. (Stated another way, more than 10 percent of the direct costs of labor and materials would have to be incurred in the course of actually attaching the cabinet and its components to realty.)
      This requirement applies on a cabinet-by-cabinet basis. Generally custom cabinet shops meet the requirement, and my answer is based on the assumption that it applies to your operation.
      As consumers of the cabinet materials, it sounds like you're handling your tax obligations correctly with respect to the cabinets you furnish and install. Tax is due on the entire selling price of cabinets you sell without installation, but you're entitled to take credit for any tax already paid on your materials purchases.
      If you don't pay tax on materials to your vendors, you should report and pay use tax on your costs of all materials allocated to construction contracts (furnish and install jobs) directly to the Board of Equalization when you file your sales and use tax returns. As a lump-sum contractor, you should not bill your customers for this tax on cabinets you install. (Of course you can build the cost of the tax into your lump-sum price - you just shouldn't separately state it.) On the cabinets you sell without installation, you'd bill your customers for the tax on the whole selling price, without taking a credit or offset.
      Either method is allowable, although it sounds like it might be simpler to continue paying tax on materials to your vendors.
      Regards,
      Dan Davis

  • Posted by Lissete on June 5, 2014 10:16am:

    Hello,
    We have a fabrication company in California. The bases of the company is windows displays for retail stores, I was hoping you can clear up the rules for when lobar becomes taxable. As of now we been charging all labor as non-taxable, but recently I was told that this might be incorrect. Our invoices are divided in 3 selection; selection 1: Installation – Includes Install Kits, selection 2: Services – Include line items such as Patch/ prime and paint wall and floor panels, Wall and Floor panels wall paper with contact cement, Receive and deliver props to store, Deliver/ Install new panels and pick up old ones, Uninstall display and dispose of it properly, Storage for all panels, selection 3: Materials/Taxable Items – include all materials. From this information would you be able to let me know if we are doing it correctly or if any of this labor is taxable?
    Thanks so much!
    Lissete

    • Posted by Author photo of Dan DavisDan Davis on June 5, 2014 11:24am:

      Lissete,
      Most labor is exempt from sales tax in California. The exemption includes installation, repair labor, and maintenance. Fabrication (labor to create a new item of tangible personal property) is taxable, as is labor to assemble a new item. Thus, any labor expended in making your displays would be a taxable component of your charge to the customer. This would include labor to assemble a display at the jobsite prior to installation.
      The following would be exempt: attaching the display to the underlying real estate, moving the display around, or taking it down and disposing of it. Charges for patching, priming, and painting wall and floor panels (as well as for applying wallpaper to panels) are exempt as long as the panels are already attached to the walls and floors or you're going to attach the panels as part of the contract. If the panels aren't already attached, and a separate company (or the customer) will attach them, your labor will be regarded as taxable fabrication.
      Storage charges are not taxable. Charges for common carrier deliveries are also exempt, unless the sale is for a delivered price or the contract stipulates that title will pass at destination. Charges for delivery in your own vehicles of items that you're selling at retail are generally taxable unless your contract specifies that title passes prior to delivery (the term "F.O.B. shipping point" will serve this purpose), the delivery charges are separately stated, and the delivery charges are reasonable.
      As you can see, this can get a little complicated. Hope this is helpful.
      Best regards,
      Dan

  • Posted by steve on April 9, 2014 7:49am:

    I have a cabinet company in California. I'm trying to confirm a sales tax rule that I was told long ago. We manufacture custom cabinets from raw material, pay sales tax on all of this material and attach the cabinets to the real property. The installation costs are 10-15% of our total contract.Do we need to charge the customer sales tax?

    • Posted by Author photo of Dan DavisDan Davis on April 9, 2014 9:05am:

      Steve,
      In most cases, custom cabinet manufacturer/installers are considered consumers of all tangible personal property that they attach to realty in California. As a consumer, you would only be liable for tax on your costs of such property unless you actually billed a higher amount of tax to your customers. The applicable rule is this: the cabinet contractor is treated as a consumer when less than 90% of the total direct costs of labor and materials are incurred before the cabinet is affixed to realty. Custom cabinet installers usually meet this criterion, although occasionally they may not on an unusual individual job. (The test is applied on a cabinet by cabinet basis.) For jobs where 90% or more of the direct costs of labor and materials are incurred before the cabinets are affixed to realty, the contractor is considered a retailer of the cabinet rather than a consumer of the component materials. In such a case, if a price for the fixture is stated in the contract (e.g., a time and materials contract), tax would be due on that amount. If the price is not stated, tax would be due on the amount that the cabinet would be sold for to another contractor, or on the amount stated in your price lists, bid sheets, etc.
      Hope this helps.
      Regards,
      Dan Davis

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