The United States government and its agencies are the only entities that are universally exempt from sales and use tax. This exemption proceeds from the U.S. Constitution, which prohibits states and their subdivisions from taxing the federal government. The great majority of states also exempt sales to themselves and their political subdivisions, apparently recognizing that shifting money back and forth from one hand to the other would not be particularly productive. (California, which does tax sales to itself and its subdivisions, is a notable exception.) A smaller majority of states exempts sales to nonprofit and public benefit agencies, although the agencies exempted are by no means consistent from state to state.
Since in most states contractors are considered consumers of the materials they install, the tax burden usually falls on the contractors rather than their customers. In such cases, the exempt status of a customer will not flow through to the contractor. States that tax contractors as consumers of materials used to fulfill contracts with exempt entities include: Arizona, Arkansas, California, Florida, Georgia, Idaho, Kentucky, Louisiana (except for a few specific charities), Maryland (except for designated nonprofit agencies), Michigan, Mississippi, Nevada, North Carolina, North Dakota, Pennsylvania (with limited exceptions for certain building machinery and equipment), South Carolina (with a limited exclusion for property transferred to the federal government), South Dakota, Tennessee, Virginia, Washington, West Virginia (capital projects only), Wisconsin (except for materials specifically designated as tangible personal property after installation), and Wyoming.
Hawaii’s general excise tax is considered the contractor’s obligation and therefore, with a couple of very limited exceptions, applies to materials installed on behalf of all entities regardless of the nature of the customer. The same is true of New Mexico’s gross receipts tax. (Hawaii’s general excise tax and New Mexico’s gross receipts tax are the sales tax equivalents in those particular states.)
Several states do allow contractors to buy materials without tax when they intend to incorporate those materials into realty owned by exempt agencies. Generally the agency claiming exemption must give the contractor either an exemption certificate or a copy of a state-issued form confirming the entity’s exempt status. The contractor must then provide copies of the document to its vendors. (In a few states, the contractor self-issues the applicable exemption certificates to its vendors.)
States with exemptions for materials installed under contracts with exempt entities include: Colorado, Connecticut, District of Columbia, Iowa, Kansas, Maine, Massachusetts, Missouri, New Jersey, New York, Ohio, Oklahoma, Rhode Island, Texas, Utah (primarily for nonprofit agencies), and Vermont.
In Alabama, Arizona (for federal contracts only), Minnesota, and Nebraska, exemptions for materials installed on realty owned by exempt entities are permitted through the use of state-specified agency agreements. Under such an agreement, the contractor is permitted to buy materials as the agent of its exempt customer, causing title to the materials to pass to the customer at the time of purchase. The vendor is then regarded as selling directly to the exempt agency (rather than to the contractor) and accordingly is relieved of responsibility for collecting the tax.
The form required for an agency agreement varies among the applicable states and, of course, most states don’t recognize such agreements at all. A few states not only refuse to recognize agency agreements but also hold installing contractors responsible for tax on construction materials even if their exempt customers have purchased them directly.
In states that tax construction services (such as installation and repairs to realty), the providing contractor is considered the retailer of such services rather than the consumer. Thus, unlike materials regarded as consumed by the contractor, the services component of a construction contract usually will be eligible for the customer’s exemption. (Arizona, Hawaii, and New Mexico are exceptions, since their taxes apply to gross construction proceeds without distinguishing between materials and services.)
Caveat: the individual details of each state’s exempt entity provisions are myriad and beyond the scope of this article. When such exemptions appear applicable, the relevant statutes, regulations, and state pronouncements should be thoroughly reviewed.
BTW - In my next post, I'll look at the sales and use tax effects of prime contractor/ subcontractor relationships. Let me know if you have any particular issues that you'd like me to consider regarding that topic.
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