Sales and Use Taxes: An Ongoing Challenge

We’re fast approaching the fourth anniversary of the U.S. Supreme Court’s landmark decision in South Dakota v. Wayfair. That makes now a good time for construction business owners to review their sales and use tax obligations.

Wayfair explained

In Wayfair, the Court ruled that a state may require out-of-state sellers to collect and remit sales tax if they have an “economic nexus” with the state. Previously, states were limited to imposing sales tax collection obligations on sellers that had a physical presence in the state.

At first glance, one might think Wayfair has little impact on contractors. After all, construction companies typically have a physical presence — that is, at least one job site — in the states where they do business.

But the ruling could substantially affect your out-of-state suppliers, who may now be required to collect sales tax on the materials and equipment they sell. So, you need to manage these transactions carefully to avoid double taxation.

Nexus in a nutshell

Economic nexus laws impose sales tax collection obligations on businesses that exceed certain sales thresholds in a state, regardless of whether the seller has a physical presence. The South Dakota law upheld in Wayfair applied to businesses with more than $100,000 in annual sales or more than 200 separate annual transactions in the state.

Today, nearly every state with a sales tax has followed suit, though the annual sales and number-of-transaction thresholds for establishing economic nexus vary dramatically from state to state. For example, some states require sales as high as $500,000; others base nexus only on sales, regardless of the number of transactions. Still others require businesses to meet both sales and number-of-transaction thresholds.

Construction specifics

For construction businesses, managing sales and use tax can be challenging. Generally, you’re treated as the consumer of materials that you use on your jobs. Thus, you either pay sales tax to your vendors or, for out-of-state vendors that don’t collect sales tax, you self-assess use tax and remit it to the state. You probably don’t typically collect sales tax from the owners you contract with.

As with most general rules, however, there are exceptions. For instance, some states treat contractors as retailers of certain materials. In such cases, you buy the materials tax-free under a resale exemption and collect sales tax from the owner. Examples might include:

  • Appliances,
  • Window treatments,
  • Window air conditioning units,
  • Carpeting, and
  • Some business fixtures treated as personal rather than real property.

A few states impose sales tax on specified construction services, requiring contractors to pay sales tax on their materials and collect sales tax from customers.

In some states, the sales tax treatment depends on the type of contract. With a lump-sum contract, for example, the state treats the construction company as the consumer of materials incorporated into the real estate.

However, with time and materials contracts, in which material charges are itemized separately from labor and other charges, the state views the construction business as a retailer. This allows the builder to buy materials tax-free for resale but requires it to collect sales tax from the owner.

Another complexity involves sales tax exemptions. In many states, certain types of entities — such as schools, hospitals and nonprofits — are exempt from sales tax. In some of these states, the exemption “flows through” to the construction business. That means the contractor can buy materials tax-free under an exemption certificate for use on a project involving an eligible entity. However, in other states, the exemption is available only if the entity itself buys the materials.

Impact of Wayfair

Before Wayfair, out-of-state suppliers without a physical presence in the state in which a construction company does business typically wouldn’t collect sales tax. But that’s no longer the case now that most states have enacted economic nexus laws.

Therefore, it’s critical for you, as a construction business owner, to understand the sales and use tax rules in the states where your company operates. You also need to provide resale or exemption certificates to your vendors — or have exempt owners buy materials directly, if necessary — to take advantage of the sales tax exemptions available.

Finally, look closely into how the contract types that your business usually operates under affect your sales and use tax obligations. Consider those obligations when developing bids.

Prevalent and complex

Given the nationwide prevalence of economic nexus laws, and the complexity of sales and use tax, regularly review your business activities to ensure that you’re in compliance.

Also, consider a reverse sales-and-use tax audit to ensure you’re not paying taxes that you really don’t owe. (See “Should you conduct a reverse sales-and-use tax audit?” on page X.) Your CPA can be an invaluable resource when it comes to these matters.

Should you conduct a reverse sales-and-use tax audit?

If your construction business buys building materials, supplies, equipment and other items in several states, consider conducting a reverse sales-and-use tax audit.

You might be familiar with sales and use tax audits conducted by state or local authorities. The purpose of these audits is to uncover purchases for which sales or use tax was improperly collected and remitted to the state. A reverse audit, as the name suggests, does the opposite: It examines the sales and use tax your company has paid and identifies overpayments for which you can claim a refund.

Often, these overpayments involve taxes paid on purchases that were eligible for an exemption. Generally, it’s the purchaser’s obligation to claim an exemption, so mistakes are common. A reverse audit can help you spot and correct these mistakes — sometimes leading to substantial refunds.

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