Construction contracts: multistate sales and use tax implications.

• Author: Sowa-Holmes, Marcella

There are many different state laws and regulations that apply to contractors that perform construction contracts in various states, and the sales and use tax rules applicable to such contracts. Because of the variations among the states, it is necessary to consult the rules of the particular state in which the contractor is operating to determine the proper treatment.

Contractors are generally subject to either a sales or use tax on purchases of tangible personal property affixed to real estate in the process of constructing, altering, repairing or improving such property. Construction firms, home improvement companies, brick, roofing, plumbing and electrical contractors and even wallpaperers are examples of taxpayers considered to be contractors in most states.

For each construction contract, several key issues arise: * The taxability of the particular transaction. * The cost base or "price" of the property subject to tax. * Whether the contract is exempt from tax under a special rule. * When does the transaction become taxable. * How is the contract taxed if construction takes place outside the state in which the contract originates.

Types of contracts

The general rule in most states is that a contractor is treated as the consumer of all the materials and supplies used in the performance of a construction contract. As a result, sales tax is generally due on the purchase of materials and supplies by the contractor. If the supplies are purchased without tax (e.g., outside the state of use or consumption), a use tax will generally be imposed at a subsequent date. In order to accurately determine how the contract is taxed, it is necessary to determine the nature of the contract being entered into.

There are generally three classes of contracts and five operational categories. The classes of contracts are lump-sum, time and materials, and cost-plus. Within these general classes, five categories exist: (1) Erecting and installing a building on land; (2) repairing and/or remodeling existing buildings; (3) selling buildings without installation (i.e., prefabricated buildings); (4) erecting, installing and leasing buildings; and (5) installing machinery and equipment. In some instances, the taxpayer does not in fact act as a contractor but instead is a servicer, a different set of rules (not addressed in this article) applies.

Price subject to tax

A construction contractor is generally treated either as a reseller or a consumer of tangible personal property, dictated by how the property is used to fulfill a construction contract. When entering into a contract to construct or improve real property, the contractor is generally regarded as the ultimate user of the property and must either pay a tax on materials used to fulfill the contract at the time of purchase or remit use tax to the taxing state at the time the materials are committed to the contract. The contractor generally cannot charge sales tax because the customer is purchasing real estate or an improvement to real estate, which is not a taxable purchase. The contractor may, however, pass the cost of the...