The construction industry is no stranger to nuance. State and local tax (SALT) can be particularly complex when taking on projects in different states. As contractors look to expand their outreach and pursue clients in new states, each may present more challenges as they may have unique rules on the treatment of construction contracts.
Thus, it is critical contractors understand their sales and use tax obligations as they enter new states. Doing so will help contractors accurately price their projects and ensure they are compliant with their filing obligations.
Different Contract Types, Different States, & Different Contractor Treatments
For most construction contracts, the contractor is deemed the end-user of any materials, equipment, and consumable items. As such, the contractor will pay sales tax to its vendor or accrue and remit use tax. The revenue from the contract is not subject to sales tax. As further explained below, there are many exceptions to this general treatment.
Contract Type Impact on Sales Tax
The two primary types of construction contracts are lump sum and time and materials. Many states will treat contract types the same for sales tax purposes, but there are several states that will distinguish between the two contract types, such as California, Colorado, and Indiana.
For time and material contracts in these states, the contractor will buy materials for the project for resale (thus not paying tax at time of purchase) and charge sales tax to the customer on the sales price of the material component of the contract.
Unique State Treatment (Regardless of Contract Type)
Some states, such as Arizona and Mississippi, have unique sales tax rules for contractors regardless of the contract type. Arizona uses a transaction privilege tax (TPT) as its form of sales tax. The TPT is a tax on a vendor for the privilege of doing business in the state. Various business activities are subject to the TPT and must be licensed.
With the TPT, most contracts are subject to tax on the overall value of the contract rather than having tax only applied to the materials component or to the cost inputs of the contract. With this, Arizona does apply a discount to the contract value such that the contractor only pays TPT on 65% of the contract value. Additional deductions can also be taken, such as any land costs.
Mississippi applies tax to the value of nonresidential contracts exceeding $10,000, referred to as the Mississippi contractor tax. This is a special rate tax of 3.5% that applies to the entire contract value.
With these two states, as with others that have similar approaches to contracts, there can be many exceptions to the general treatment, so it is important to understand their tax landscape before entering into a contract with clients in these states.
Who Has the Tax Burden?
As mentioned above, depending on the state and/or contract type, both the amount subject to tax and the transaction (purchase versus sale) can be impacted. The latter is very important to understand because it governs who has the responsibility for tax in the eye of a state.
For states that consider the material inputs to be taxable to the contractor, there is no tax obligation for the contractor’s client. Therefore, under audit, a state would typically focus on the transaction between the contractor and their suppliers to confirm the appropriate tax has been remitted.
On the other hand, for states that consider the materials and/or labor components to be taxable on the sales price, the contractor’s material purchase transaction would be less of a focal point other than confirming they are for resale. In these instances, a state would focus on the transaction between the contractor and their customers to confirm the appropriate tax has been remitted.
It is important to understand which transaction holds the potential tax liability in the eyes of the state, as remitting tax on the incorrect transaction may not address the tax obligation from the state’s perspective.
How SALT Explorer Can Help
To help address these considerations, Forvis Mazars developed SALT Explorer™, a streamlined platform designed for estimating sales and use tax for contractors operating in multiple states. SALT Explorer lets contractors plug in the components of their contract, which can then be used as part of an overall bid assessment and pre-contract preparation.
While the platform is primarily helpful for calculations, it is also a useful guide to help contractors map out their tax planning approaches when entering a new state.