Tax Considerations for the Construction Industry

Sales and Use Tax

With the passing of economic nexus laws in almost every state, it can be complicated for any business to stay sales tax compliant. Contractors are no exception to this, and even have their own set of rules that vary by state. McKonly & Asbury’s State and Local Tax group is available to assist in making taxability determinations for contractors, and can assist with sales tax audits or provide resources such as taxability flow charts.

There are several methods that states use to determine who is liable for sales tax on materials used in a contract. Generally, either the purchaser (contractor) pays the tax and does not charge tax to the final customer or the purchaser uses a resale certificate and then charges tax to the final consumer.

Contractor vs. Retailer/Repairperson

The definition of a contractor is different for almost every state, so I use that term very loosely here. Many states treat contractors as the end user of property and require them to pay tax on all materials, equipment, components, and supplies which they furnish and install in the performance of construction activities (also defined differently in almost every state). If the determination is made that the purchaser is a retailer as opposed to a contractor, the tax would be paid by the final consumer. In many states it is even possible for a business to be acting as both a contractor and a retailer. Some states also have other categories, such as repairmen or subcontractor which may differ in taxability.

Real Property vs. Tangible Personal Property

Real property includes land and anything attached directly to it, whereas tangible personal property (TPP) includes items which can be physically relocated, such as furniture or laptops. Often the determination of whether someone is acting as a contractor is defined by whether they are performing work on real property or TPP.

Type of Service & Type of Billing

Taxability of service can also depend on the type of service – i.e. whether the contractor is performing an installation, a repair, or selling a maintenance contract. Oddly enough, taxability can also depend on whether a service is billed as a lump sum amount or if materials incorporated into the service are separately stated from the labor.

Exempt Entities

If the state normally taxes the contractor, some states allow the customer’s exemption to pass through to the contractor, so they may purchase materials tax free. This can include nonprofits and government entities, or even manufacturing exemptions.

Income Tax

The construction industry has a specific income tax adjustment related to long-term contracts. Whether a contractor must make this adjustment is determined by whether they are considered a small contractor or a large contractor. A large contractor is one that has average annual gross receipts for the prior 3 years over $10 million. Large contractors are required to follow Section 460, and must use the percentage of completion method to account for their non-exempt contracts. I mention non-exempt contracts because there are two exceptions to the required PCM method related to home contracts and residential contracts. The tax adjustment for these large contractors involves deferring revenue on contracts that are less than 10% complete, as well as allocating indirect costs to contracts.

Small contractors on the other hand may use any method they want to account for their contracts, as long as the other requirements for those methods are met. There are several different methods to choose from, which means it may be worth looking over your current method to determine if you are using the best possible one to account for your contracts.

Another point of interest in the construction industry is the impact of tax reform that became effective for the 2018 tax year – specifically 3 provisions for the construction industry previously discussed by Kelly Koman, Tax Manager here at McKonly & Asbury, in the following article: https://macpas.com/the-impact-of-tax-reform-on-your-construction-business/.

For more information on this article, or to learn more about State and Local Taxes and the construction industry, please contact Lindsey Waltemyer, McKonly & Asbury Tax Manager and State and Local Tax expert, at lwaltemyer@macpas.com.

 

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