Sales Tax in Construction: How to Keep Risk Low and Profits High (Part 1)
Do you know if you should be collecting sales tax on the services you provide? The sales tax rate in Texas is high, and improper collection of sales tax in construction or the lack thereof can leave you exposed to large financial liabilities.
To minimize risk, builders should have some understanding of the tax system and its application to the construction industry. Although the tax scheme is complicated, if a builder’s bids, contracts, and accounting system are set up correctly, it can increase profits and hopefully avoid an expensive outcome if audited by the Texas comptroller’s office. Due to the complex nature of these laws, this subject will be covered in two articles. Part 1 will discuss basic concepts of sales tax law, and part 2 will deal with what is and is not taxed.
Key Factors to Understand Sales Tax in Construction
Any time a builder constructs, repairs, remodels, or restores real property, sales taxes might need to be collected, depending on a few factors. To understand how sales taxes are handled in the construction industry, it is important to know how the terms “contractor” and “tangible personal property” are defined in the relevant laws. A contractor is anyone who makes improvements to real property, and, in making those improvements incorporates tangible personal property into the project. As used in the tax statutes, tangible personal property is defined as something that can be seen, weighed, felt, or touched.
Although tangible personal property is generally understood to include materials, supplies, and equipment, under the sales tax laws, it can also include portable buildings, software, computers, and electricity.
Factors that affect the sales tax in construction projects include the following:
1) the type of contract (separated versus lump-sum),
2) whether the work is performed on residential versus nonresidential property, and
3) whether the project involves new construction.
Lump-Sum versus Separated Contract
A lump-sum contract is one in which the agreed contract price is one lump-sum amount and in which the charges for incorporated materials are not separate from the charges for skill and labor. Under a lump-sum contract, the builder is considered the ultimate consumer and owes tax on the purchases of incorporated materials, equipment, consumable items, and taxable services.
While the builder may include anticipated sales tax amounts in the project’s contract price builder does not “collect” sales tax from the customer. For lump-sum contracts, the vendor’s location determines the sales tax rate.
A separated contract (e.g., cost-plus-a-fee contract) is one in which the agreed contract price is divided into a separately stated agreed contract price for incorporated materials and a separately stated agreed contract price for skill and labor. With these contracts, the builder gives the suppliers resale certificates instead of paying tax on materials that are incorporated into the customer’s real property and on “real property services” if the charges for these services are separately identified to the customer.
These “real property services” include surveying, landscaping, final cleanup, and security systems that are incorporated into the customer’s realty. The builder then collects the applicable sales tax from the customer. For separated contracts, the project location determines the sales tax rate.
Residential versus Nonresidential
A residential structure means family dwellings, including apartment complexes, nursing homes, condominiums, and retirement homes. The property does not have to be the residence of the owner to qualify as a residential structure.
Nonresidential structures include hotels, motels, hospitals, rehabilitation centers, prisons, recreational vehicle parks, or residential properties rented for periods of less than 30 days.
If the building contract is to repair, remodel, or restore “multiple-use property” (property used for both residential and commercial purposes), it is wise to receive guidance from the comptroller’s office before entering into such a contract.
New construction includes all new improvements to real property, including initial finish-out work to the interior or exterior of the improvement. An example of new construction is a multiple-story building that has had only its first floor finished and occupied. The initial finish-out of each additional floor before initial occupancy or use is new construction.
New construction also includes the addition of new usable square footage to an existing building (e.g., the addition of a new wing onto an existing building). Reallocation of existing square footage inside a building is remodeling and is not considered new construction.
A builder must understand these concepts to properly collect sales tax in a project. Improper collection creates potentially costly liability and risk.
Be sure to check back here next month as we explore when the builder is liable for sales tax and when they are not. In the meantime, if you have any questions about sales tax in construction or need assistance in your business, contact Joe Tolbert at Brackett & Ellis, P.C. – 817-338-1700.