Managing Sales Tax in the Construction Industry
Sales tax compliance in the construction industry is surprisingly complex. Contractors must navigate the intersection of labor, materials, subcontracting, and varying state tax rules. Unlike retailers, who typically collect tax at the point of sale, contractors often absorb those sales tax costs themselves—especially on materials—depending on the type of job and jurisdiction. Understanding how sales tax applies can make a significant difference in job costing, pricing, and risk management.
In most states, contractors are treated as the final consumers of the materials they purchase. This means they usually pay sales tax on materials at the time of purchase and do not charge sales tax on the completed construction project. For example, when a contractor installs roofing, they pay tax on the shingles when they buy them, and then typically bill the customer without charging sales tax. However, this treatment can be dependent on several different factors and should not be applied across the board, as that can result in a tax bill for amounts that would have otherwise been paid by the customer.
State-Specific Rules
In Pennsylvania, contractors generally must pay sales tax on materials purchased for capital improvement projects to real property (e.g., building an addition, installing HVAC). These projects are non-taxable to the customer, and the contractor eats the tax cost on materials. Work on tangible personal property (property that isn’t permanently affixed to a building) is taxable to the customer. In this case the contractor may use a resale certificate to purchase materials exempt from tax and then charge tax to the customer to remit to the state. Work on real property is also taxable to the customer if it is for maintenance or a minor repair that is not considered an improvement.
Other states handle sales tax in their own ways. For instance, in Texas, new construction labor is non-taxable, but remodeling can be taxable depending on whether the property is residential or nonresidential. California taxes certain fabrication labor, while New York exempts capital improvements but taxes repairs. New Jersey also exempts capital improvements but has very specific guidelines on what type of work qualifies. Contractors working across state lines must understand these differences or risk non-compliance.
Other Considerations
Contract Type
The way a construction project is contracted can play a key role in sales tax treatment. With a lump sum contract, the contractor is often treated as a consumer – responsible for paying sales tax on materials and does not charge the customer sales tax. In a time and materials contract, the contractor may be treated as a retailer and need to charge sales tax on the materials—and sometimes the labor—depending on the jurisdiction.
Subcontractors
Subcontractors must also understand their tax obligations, which are often similar to the contractor but have nuances depending on the type of work and overall project. Communication between general contractor and subcontractor can be crucial in ensuring proper tax compliance.
Tax-Exempt Customers
When dealing with tax-exempt customers, such as schools, churches, or government agencies, states vary on whether that exemption extends to the contractor. In Pennsylvania, there is a Building Machinery and Equipment (BME) exemption for contracts with exempt entities that can apply if various requirements are met. The state provides a 54-page Taxability of Contractor’s Purchases for Exempt Entities List which details items eligible for this exemption. There are also exemptions for construction in specific industries, such as manufacturing, but proper paperwork must be maintained to ensure the exemption is honored by the state.
Best Practices for Managing Sales Tax
To manage sales tax effectively, contractors should maintain accurate records, understand project classifications (capital improvement vs. repair), and invest in technology or systems that track taxable and non-taxable purchases. Working closely with a tax-advisory firm familiar with the construction industry, such as McKonly & Asbury, can avoid compliance issues and provide peace of mind.
For more information about McKonly & Asbury’s Architecture, Engineering, and Construction (AEC) experience, visit the AEC Industry Page and don’t hesitate to contact a member of the AEC team.
About the Author
Lindsey joined McKonly & Asbury in 2014 and is currently a Director with the firm. Serving as the leader of the firm’s State and Local Tax Group, she assists companies with sales tax issues and state tax compliance as well as negotiating… Read more
