Taxing Construction Are you Setting the Stage for Irreparable Consequences? Thomas Mazurek, CPA Principal Tronconi Segarra & Associates Williamsville, NY tmazurek@tsacpa.com Lisa Campbell Senior Tax Analyst Hunter Douglas, Inc. Pearl River, NY lisa.campbell@hunterdouglas.com
Topics Construction Basics Taxable v. Nontaxable Construction Specific State Issues Other Considerations 2
Construction Basics Real property, real estate, realty or immovable property is land and all structures (i.e., improvements and fixtures) integrated with or affixed to the land. Differs from Tangible Personal Property which can be moved or relocated. Sales/use tax treatment generally differs from sale and install of Tangible Personal Property. 3
Construction Basics Construction is the process of constructing something. Buildings Infrastructure Industrial States have specific rules defining construction and the sales/use tax treatment of various construction services new build, remodel, repair/maintenance. 4
Construction Basics A contractor is a person who furnishes labor, materials, equipment and other services to improve real property or incorporate tangible personal property into real property. Contractors are often treated differently than other businesses for sales/use tax. States may treat general (main, prime) contractors differently than subcontractors. 5
Construction Basics How contractors are treated differently: Generally considered the consumer of the materials/supplies they incorporate into real property and their purchases are subject to sales tax. Generally cannot use a resale certificate. Sales of construction services are generally not subject to sales tax. 6
Construction Basics A construction contract is a formal agreement between two parties (i.e., owner and contractor) to improve real property. Different types of contracts: Lump sum or Fixed price Time and Materials Cost Plus The form or type of contract can impact whether and/or how much sales tax should be charged. 7
Construction Basics Lump Sum or Fixed Price Contract Contractor agrees to furnish and install materials for a stated lump sum or fixed price. Sales tax treatment: Contractor usually pays sales tax on the materials at the time of purchase and the cost of the materials (including tax) is incorporated into the lump sum. Sales tax is not typically charged on the lump sum. 8
Construction Basics Time and Materials Contract Contractor agrees to furnish and install materials and provides separate charges for the materials and the installation of these items. Sales tax treatment: Contractor does not pay sales tax on the materials at the time of purchase and bills the customer sales tax on the cost of the materials. The installation labor is not generally subject to sales tax. 9
Taxable v. Nontaxable Construction Improvements to real property are generally not subject to sales tax. However, there are exceptions depending on the nature of the construction services. New construction is subject to tax in: Arizona (on 65% of gross proceeds) Hawaii New Mexico Washington (plus B&O tax) 10
Taxable v. Nontaxable Construction Additionally, construction performed on existing structures (remodel/renovation) is subject to tax in: Arkansas Connecticut Kansas New York (unless Capital Improvement) Texas West Virginia (unless Capital Improvement) 11
Taxable v. Nontaxable Construction Other taxes Mississippi Contractor s Tax of 3.5% of total contract price South Dakota Contractor's 2% excise tax is imposed on all prime contractors engaged in realty improvement contracts Construction and remodeling/renovation services may be taxed differently if the property is for residential v. commercial or industrial use. 12
Taxable v. Nontaxable Construction Contractors also repair real property. Repairs are services needed to restore real property to its original state or condition. Repair services are subject to tax in: Arkansas, Connecticut, District of Columbia, Hawaii, Iowa, Kansas, Mississippi¹, Maine, Nebraska², New Jersey, New Mexico, New York, North Carolina, Texas, Washington, West Virginia. ¹ Services for contracts of $10,000 or less owe the regular retail sales tax. ² Under Option 1, labor charges are nontaxable if separately stated. 13
Taxable v. Nontaxable Construction Contractors may also provide cleaning and maintenance services for buildings and the adjacent land (real property). Building cleaning services include the performance of services which include the removal of dirt, dust, grease or grime on a building or inside of a building and the keeping of the building and its contents in a clean, neat, polished or orderly appearance. The term includes janitorial services, office or building cleaning, window cleaning, floor waxing, or acoustical tile cleaning. 14
Taxable v. Nontaxable Construction Building maintenance services include the performance of routine and periodic services upon a building which keeps a building in a satisfactory operating condition. Cleaning and Maintenance services are subject to tax in: Arkansas, Arizona, Connecticut, District of Columbia, Florida, Hawaii, Iowa, Kansas, Minnesota, Mississippi, Maine, Nebraska, New Jersey, New Mexico, New York, Ohio, Pennsylvania, South Dakota, Texas, Washington, West Virginia. 15
Specific State Issues Arizona Prime Contracting Law Change Effective January 1, 2015, the gross income derived from maintenance, repair, replacement or alteration ( MRRA ) activities affecting real property are not subject to transaction privilege tax under the Prime Contracting classification when the activities are performed directly for the property owner or authorized party. 16
Specific State Issues What are maintenance, repair, replacement and alteration activities? Maintenance is the upkeep of property or equipment. Repair is an activity that returns real property to a usable state from a partial or total state of inoperability or non-functionality. Replacement is the removal of one component or system of existing property and the installation of a new component or system. Alteration is an activity or action that causes a direct physical change to existing property. 17
Specific State Issues A TPT-licensed contractor who purchases tangible personal property and who uses that property in performing an MRRA project is subject to TPT on the purchase price of the tangible personal property. Materials purchased by a TPT-licensed contractor for incorporation into a taxable modification project (that is not an MRRA project) are stil not subject to retail TPT at the time of purchase, because such projects are subject to prime contracting TPT. 18
Specific State Issues New Mexico Gross Receipts Tax Gross Receipts Tax is imposed on construction services and all construction materials that will become part of the construction project. Construction Deductions Receipts from the sale of tangible personal property, subcontracting services, construction-related services and leasing construction equipment. Nontaxable Transaction Certificate (NTTC) Type 6 19
Specific State Issues New York Capital Improvement Whether or not a contractor collects sales tax from a customer depends on if the work being performed is considered a capital improvement to real property, or is installation, repair, or maintenance work (subject to sales tax). Publication 862, Sales and Use Tax Classifications of Capital Improvements and Repairs to Real Property, provides detailed information on various types of work that do and do not qualify as capital improvements. 20
Specific State Issues A capital improvement* is any addition or alteration to real property that meets all three of the following conditions: 1. it substantially adds to the value of the real property; 2. It becomes part of the real property or is permanently affixed to the real property so that removal would cause material damage to the property or article itself; 3. It is intended to become a permanent installation. * Should collect ST-124, Certificate of Capital Improvement 21
Specific State Issues North Carolina Repairs & Maintenance Effective January, 2017: Repair, maintenance and installation services are expanded to real property. A property owner who hires a person to perform repair, maintenance and installation services where the person purchases tangible personal property for the service and performs the labor (installation), shall pay sales tax to the person on the total sales price of the repair, maintenance and installation service. 22
Specific State Issues Any property that becomes a part of or is applied to property in the performance of taxable repair, maintenance and installation services should be purchased exempt from tax. (Form E-595E) For real property contracts, sales/use tax is still due on the purchase price of any tangible personal property used to provide the nontaxable service. 23
Specific State Issues Mixed Transactions A contract that includes both a capital improvement to real property and a repair, maintenance, and installation service. If the taxable services are less than 10%, then the services and property used are taxable as a real property contract. If the taxable services are equal to or greater than 10%, tax applies to the taxable service portion. The person must determine an allocated price for each taxable service in the contract based on a reasonable allocation. 24
Specific State Issues Ohio Business Fixture Tangible personal property that is permanently affixed to real property, but that primarily benefits the business conducted on the premises by the occupant, is a "business fixture" and retains its status as personal property after such affixation is made. An agreement to transfer and install a business fixture is a taxable sale and not a construction contract. 25
Specific State Issues A business fixture includes, but is not limited to, machinery, equipment, signs, storage bins and tanks, whether above or below ground, whether above or below ground. A business fixture also means those portions of buildings, structures, and improvements that are specially designed, constructed, and used for the business conducted in the building, structure, or improvement. Does not include fixtures that are common to buildings, that primarily benefit the realty and not the business conducted on the premises. 26
Specific State Issues Pennsylvania Attaches or Affixes Construction and repairs to realty are not taxable. An activity resulting from an agreement or contract under which a contractor attaches or affixes tangible personal property to real estate so as to become a permanent part thereof. Hook, bolt, screw, nail or other similar method; Inserting equipment through a building wall or floor, or mounting it upon a foundation; Wire which is integrated into an electrical system. 27
Specific State Issues Examples include: Alarm systems Chalkboard Coolers, freezers (central cooling system) Financial institution security equipment Garage door opener Outdoor advertising signs 28
Specific State Issues Washington B&O Tax Prime Contractors (subject to 0.00471 Retailing B&O) Collect retail sales tax from the landowner on the gross contract price (without deduction of costs incurred) Purchases of materials by contractors that will become part of the completed project are purchases for resale. Rentals of equipment are subject to retail sales tax as the contractor is the consumer of the rented item. 29
Specific State Issues Subcontractors (subject to 0.00484 Wholesaling B&O) Do not need to charge retail sales tax if they secure a reseller permit from the prime contractor. Purchases of materials are for resale. Rentals of equipment are subject to retail sales tax Contracts that include a combination of services are taxable in accordance with the predominant activity of the contract. 30
Other Considerations Installation of Machinery & Equipment that Results in Improvement to Real Property Need to determine whether exemption applies to contractor s purchases of materials and supplies. Production M&E furnace, freezer, conveyor belt, process piping, foundations Pollution Control Equipment smokestack, bag house, wastewater treatment plant Environmental remediation 31
Other Considerations Nonresident Contractors States may have special rules/requirements for nonresident contractors. Registration for state/local taxes, licenses, permits Taxability of construction services Use tax due on materials, supplies, equipment (reciprocal credits?) 32
Other Considerations Nonresident bonding requirements Prepayment of sales tax or percentage of contract amount (i.e., surety bond) often required depending on contractor and dollar amount of contract. Most states require bonds to ensure sales tax due on tangible personal property and/or services is paid to the state. Connecticut, Georgia, Massachusetts, Mississippi, West Virginia, Wisconsin, among others. 33
Other Considerations Contractors-Retailers A business that contracts to improve real property and also makes retail sales of building materials, supplies or fixtures. Do not know whether the materials will be used or sold when you purchase them. Can you purchase materials for resale or pay sales tax then take credit on your return? Need to keep detailed records and receipts. 34
Other Considerations Government Contracts Different set of rules for contractors Contractors may be able to purchase materials/supplies for contract w/o sales tax. When does title to materials/supplies pass? Provide exemption certificate, government purchase order or other documentation. Subcontractors may be treated differently. Differences for Federal/State/Local exemptions. 35
Other Considerations Contractor Purchases What is the sales/use tax treatment of: Machinery, equipment, supplies, tools, rentals, other purchases not incorporated into real property. Waste removal services Temporary facilities including: scaffolding, hoisting systems, protective pedestrian walkways, temporary electrical and plumbing facilities. 36
Other Considerations Special Circumstances When can a business be treated as a contractor? Assuming the role of a construction manager or prime contractor. Architect, Developer, Engineer who typically provides nontaxable services may be liable as a contractor depending on contract and scope of services. Need to follow specific sales/use tax rules for contractors. 37
Closing Thoughts Sales/use tax treatment of construction services and contractors varies from state-tostate; it is critical to determine the specific rules and regulations that apply in each jurisdiction. Don t assume the contractor understands sales/use tax. Consult state tax website/publications for information on construction services. 38