There are thousands of state and local tax (SALT) laws in the United States. They vary greatly by state and change often. If contractors aren’t tracking them, they risk underbidding or overbidding their next construction project, putting margins and financial performance at risk. Adding to this complexity, if contractors are performing construction services for exempt entities, the rules become less clear, and even the exempt entities may not have a full understanding of how their exempt status may or may not impact their contracts. This article explores a few key questions about tax exemptions in the construction industry.
Why Do Exemptions Matter?
Many assume there would be uniformity in sales tax exemptions across all states and municipalities. However, each state has its own set of rules. Most states offer tax exemptions for certain categories of nonprofits, but the specific qualifications vary widely from state to state. In the construction space, there are several important considerations that should be contemplated when performing a contract for an entity that qualifies as exempt in a state:
- How does the exemption flow through in the state, if it even can?
- Is the contractor buying the materials?
- Who is considered the consumer of those goods if they are going toward the production of a building on an exempt entity’s property?
- For example, do the materials have to remain attached to the property at the end of the project to qualify for exemption?
- What is the mechanism to allow the contractor to buy items tax exempt from their suppliers?
It is important for contractors to know the rules because of the complexity in the exemption space and the multijurisdictional differences. Understanding exemptions before making a bid can help contractors reduce risk and improve efficiency.
When Do the Cracks Start to Show?
Contractors may not immediately know if they have underpaid sales tax. If the project owner said material costs were exempt and the contractor moved forward with the bid and project with that information, unless suppliers push back, the contractor may not realize there may be an issue until there is a state audit. What was thought to be a pass-through exemption is now an instance of being required to pay back sales tax. Questions to consider include:
- When was the last time the contractor bid in this jurisdiction? Jurisdictional tax laws and rules can also change over time. A tax exemption from five years ago may no longer apply.
- Is the contractor a multistate contractor? Maybe they have a good grasp of the rules in the two states they work in, but are they prepared enough to make bids in a third state?
What Is the State of Each State?
State exemption rules vary significantly. Some states offer exemptions to certain components of a project. The labor, materials, equipment rentals, and the use of subcontractors are just a few factors that can have varying exemptions. Some states offer no exemptions for contractors. Other states offer exemptions for contractors working for certain types of federal, state, local governments, or religious organizations. Others have differing qualifying measures. The map below is just a cursory overview of states where exempt entities most often have limited or no pass-through tax exemptions to construction contractors.
Which States Allow Pass-Through Exemptions for Contractors?
Need More Support?
SALT Explorer™ can give contractors a powerful edge when bidding across multiple states, especially on exempt entity projects. Get project-specific estimates for sales and use tax, gross receipts tax, and exemption scenarios, helping you understand how exemption rules may affect your tax liability. Whether working with schools, governments, or other exempt entities, SALT Explorer helps you bid confidently and protect your margins. The product is embedded with deep insights from our experienced SALT team and allows requests for personalized guidance from a tax advisor directly on the platform.
What Are Common Pitfalls Contractors Face When Working With Exempt Entities?
Contractors should watch for the following common pitfalls when bidding on work for exempt entities:
- Thinking all states are the same. Remember that each state has its own process. Learn what is needed to have on hand to take full advantage of possible tax exemptions. The question to ask is: Do I have the guidance available?
- Avoid assuming the customer is exempt just because they say they are. Customers may often misunderstand how their tax-exempt status applies to construction contracts. Verify what the exemption actually covers to avoid unexpected sales tax liabilities during an audit.
- Misunderstanding the valid exemptions. If some purchases are exempt, what are the specifics? Is rented equipment used to build on the property eligible for exemption? Or is it just the materials that create the final product on the property that are exempt? If exemptions are over-applied, it is most likely the contractor who may be held liable. Some states use more broadly defined tax exemptions. But one must understand where the changes/differences are. Be aware of related-party rentals, as exemptions may not cover these.
How Can Proactive Communication Strengthen a Bid?
As a contractor, it is best to be proactive and understand all aspects that may impact a bid, including sales and use tax estimates and exemptions that may impact these estimates. If contractors have done their due diligence and identified exemptions that may not apply, they may be positioned with greater clarity than others bidding on the same project. The bid may reflect greater transparency, reducing the likelihood of unexpected costs. Proactive communication with the customer may help contractors secure the bid and develop a continuing relationship. Proactive communication is key to making sure the entity knows that the contractors know the rules.
How Is Technology Impacting Tax Estimation?
Technology is allowing contractors to have better real-time information at their fingertips. While some are still using outdated guidance, there are more advanced tools and platforms to help sort through materials costs, rules, etc. Artificial intelligence (AI) can do much in this space, but it can only take one so far. An estimator or contractor must verify the information because AI pulls from unknown content. Big projects should not be banked on invalid, unverified information. Human intervention is still needed in many cases to help solve some of these problems.
How Does SALT Explorer Help Estimators & Pre-Construction Teams in Real Time?
- Knowing the costs and being transparent about those costs are essential when bidding on a contract.
- Understanding where you can potentially reduce costs can be an advantage to the bottom line. SALT Explorer™ helps contractors identify tax exemptions and estimate sales, use, and gross receipts taxes before engaging with project owners, helping save time, improve accuracy, and reduce risk. With just a click, contractors can uncover what’s driving tax costs or spot exempt items in their bid.
- Combining real-time insights from seasoned SALT professionals with access to advisors helps eliminate guesswork and outdated guidance. With SALT Explorer, get clarity and confidence, without slowing down your workflow.
In addition, SALT Explorer Essentials™ offers complimentary access to current state and local tax rates, licensing requirements, and employment tax information. It’s a fast, reliable resource for researching compliance matters, currently available to CFMA general members.
How Forvis Mazars Can Help
If you have questions about SALT or state tax exemptions, please reach out to one of our professionals to assist you.