Nexus is defined as a substantial connection to a state that allows the state to tax a taxpayer. Although this may seem pretty straightforward, things can get a little complicated for contractors working on out-of-state jobs. It’s important to determine if your construction company is responsible for state sales tax or income tax before bidding on an out-of-state job to ensure an accurate bottom line on the project and to also ensure compliance with state agencies. With advances in technology, states are now able to determine who is filing the correct type of tax and have been increasing their number of audits and notices to confirm companies are compliant with their tax laws.
Each state has its own nexus guidelines, but most agree that having a physical presence in a state (permanent or temporary) usually suggests a substantial connection to a state. This becomes complicated for contractors, when a third party such as a sub-contractor, acts on behalf of the company. The subcontractor working in the state where the job is being performed represents a physical presence for the general contractor and most likely means the general contractor is obligated to file sales and use tax.
When conducting research on a state’s nexus guidelines, construction companies should consider the following methods of taxing construction activities*:
- Contractor as consumer – In some states, all purchases of tangible personal property made by a contractor will be taxable, such as building materials, equipment, and consumable supplies. When sales tax is paid on these materials, most states will not tax the invoice for the actual construction of the building and will allow contractors to include sales tax as a material cost in their bids if the invoice does not separately state a line item for sales tax to the customer.
- Contractor as retailer - Some states treat contractors as retailers of the building materials and labor they sell when constructing a building. In these states, the contractor can purchase building materials tax-free for resale and will be required to charge tax on the material cost to the end consumer. The taxability of the labor will depend on the state.
- Contract type – In general, there are two types of contracts for construction businesses: lump sum, where all materials, supplies, labor and other charges are added together to create one price, or time and materials, where the contract lists separate charges for each item. In some states, the type of contract determines the taxability. If the contract is a lump-sum contract, usually the contractor as a consumer method applies and tax is paid by the contractor when purchasing materials. If the contract separates charges for materials and labor, usually the contractor as a retailer method applies since states view the transactions as selling the materials and selling labor to install the materials.
- Subcontractor relationships – Whether a contractor is the general contractor or subcontractor may also determine how taxes are applied to a transaction. In some states, the contractor and subcontractor are treated separately, and each determines tax liability based on the contract type. In other states, the general contractor determines how to apply tax, and the subcontractor’s services are purchased for resale. It is critical to document the project to match the tax treatment so that all contracts and invoices line up and support the tax position being taken in the event of an audit.
- Flow-through exemptions – Contractors must have a completed exemption certificate on file, which includes all purchaser and seller information complete with dates and signatures, to prevent issues in the event of a state audit. If a completed and accurate exemption certificate is not available, the auditor will most likely assume that all transactions are taxable, and it is up to the contractor to prove the exemption exists.
- Manufacturing – Most states allow exemptions for manufacturing equipment, which may include purchases made by a contractor on behalf of the customer such as electrical materials dedicated to machinery and equipment (not for the general purpose of the building), purchases of the equipment itself in some cases, and pollution control equipment that may be installed during the construction process.
- Governments – States typically provide some type of exemption for construction contracts for state and local governments, and the federal government is almost always exempt from tax. When dealing with government contracts, always obtain an exemption certificate if possible, or keep records to confirm that the contract is with a governmental entity.
- Nonprofits - Everyone assumes that nonprofits are always exempt from tax on purchases, but that is not always the case when dealing with construction contracts. Some states will not allow the exemption to pass through to the contractor.
- Moving equipment – Use tax is often forgotten about when discussing sales tax, but it may affect contractors transporting equipment across state lines. Construction equipment, such as excavators and lift trucks, is subject to sales tax when purchased, but may also be subject to use tax in other states and even cities within the same state. Use tax obligation occurs when the equipment is used in a jurisdiction where sales tax was not paid or paid at a lower rate in the current jurisdiction.
- Bidding issues – Estimators and other personnel involved in the bidding process need to understand tax laws in each state to avoid costly mistakes that cannot be passed on the customer. If a bid separates out all the charges, but the contract is for a lump-sum amount, the bid might not have accounted for tax, and most lump-sum contracts do not allow you to separately state a line item for tax. That means the contractor will most likely pay the tax or negotiate with the customer to increase the lump-sum amount.
Before you bid, make sure you know the answers to these questions:
- Do you need to pay tax on the materials you purchase for the project, or will you be treated as a reseller who charges sales tax to the end customer?
- Are there any exemptions you need to know about?
- Are you in a state that requires you to charge sales tax on construction services as well as materials?
- What other project- or state-specific rules apply?
Contractors may face many obstacles during the course of a project, but not understanding multi-state tax obligations may be a costly one. It’s critical for companies to consider the tax laws of other states when expanding or bidding on out-of-town jobs to prevent underbidding or even losing money on a contract. By being proactive and resolving multi-state tax issues with clarity early in the bidding process, management can confidently focus on the projects at hand.
For questions regarding sales tax nexus in other states, HORNE can help.