Understanding tax requirements and exemptions for construction is crucial to ensure your project’s financial health and compliance. But your project’s tax picture can get cloudy, changing depending on the nature of the project, your location, the payment structure and other factors. This guide will help you understand how sales tax applies to construction projects, what exemptions are available and how you can keep your project tax-compliant.
Most states require construction project managers, contractors and companies to pay sales tax when buying construction materials. But since you pay these taxes on the materials up-front, you won’t pay sales tax or use tax when reselling the finished construction. This is often an advantage because you won’t pay sales tax on the markup you charge on materials, labor and supplies. It also means you do not need to charge your customers sales tax on materials, though you should quote a price sufficient to offset what you spend on sales tax.
Several states treat contractors as resellers, granting them exemption from sales tax when buying construction materials. Whether you qualify for this exemption depends on your location and the type of contracts you negotiate with clients. For example, Colorado, District of Columbia, Indiana, Mississippi, and Texas only apply this treatment to itemized — time and materials — contracts. Arizona, Hawaii, Mississippi, Nebraska, and New Mexico apply it both to itemized and lump-sum contracts.
Qualifying for this exemption may require a valid resale certificate and, in most cases, avoiding up-front sales tax means you’ll need to pay sales or use tax based on your gross construction sale after completing the project. To do this, you must charge your customer the sales tax and then remit the amount they pay to your state. It’s vital to clear up your tax obligations before drawing up a contract so you and your customer both know in advance who has to pay the sales tax on materials you purchase for the project.
States that do apply sales tax to contractors upon purchase of materials under both itemized and lump-sum contracts sometimes allow exemptions on other grounds. Some states allow contractors to negotiate contracts with customers that include provisions stating whether the contractor will pay sales tax when purchasing materials or whether the tax will pass through to the customer. If this is the case in your state, ensure you account for the correct sales or use tax rate in your contract pricing.
Oklahoma requires payment of sales tax on construction materials at the time of purchase, not providing exemptions based on the contract type or its provisions. On the positive side, this means the construction company does not have to pay sales tax when reselling the finished construction. Oklahoma does allow sales tax exemptions for materials used in some public projects or when a tax-exempt organization purchases the materials.
In most states, including Oklahoma, sales tax mainly applies to materials and products and only certain services. This means there is typically no sales tax on construction labor or services in construction projects. So, construction companies and contractors don’t charge sales tax on labor or pay it to vendors for services.
Only four states apply sales tax to services by default — Hawaii, New Mexico, South Dakota, and West Virginia. If your project is taking place in one of these states, you likely need to pay sales tax on services to vendors and charge it to your customers for construction labor. However, consulting a tax professional can help you confirm your obligations because these states allow some exemptions, and states that don’t levy sales tax on services by default may have exceptions.
If your customer is a tax-exempt organization like a registered nonprofit company, your state may allow a full tax exemption on construction materials, provided the tax-exempt organization or an agent authorized to act on its behalf makes the purchases. This allows nonprofit companies to benefit from tax-exempt construction projects in Oklahoma, Texas, California, New York and many other states.
Most states don’t allow you to use your customer’s tax exemption for materials you purchase unless you are their authorized agent. If you’re taking a project for a tax-exempt entity, negotiating for your customer to purchase the materials tax-free can help you save money and reduce the overall project’s cost to the customer in many states.
Many states have tax exemptions for sales tax on construction project materials when the customer is a federal, state or local government agency. The extent of this exemption varies depending on your location, the government entity and the nature of your project. Some states apply a sales tax exemption to all construction materials for these projects, while others only apply it to specific materials. In some cases, the exemption only applies if the government entity buys the materials or if the construction company or contractor can act as the government entity’s agent and claim the exemption with the necessary documentation.
In Oklahoma, construction materials you purchase for a government project are exempt from sales tax, provided the government agency gives you a valid exemption certificate to present to vendors.
The default is to pay sales tax to your vendors when purchasing construction materials unless your state regulations treat you as a reseller or your project qualifies for another exemption. Your vendors are responsible for remitting the sales tax you pay them to the state. Consult a tax professional to confirm when you need to pay sales tax on construction materials for your project.
If your state allows a sales tax exemption on construction materials for properties designated for resale, you can buy your materials tax-free and pay sales tax later, after selling the completed property to your customer. If you’ve remembered to bill for sales tax, you’ll have the money from your customer to pay your sales tax rather than having to pay it in advance.
If your state has no such exemption, a tax professional can help you check if you’re eligible for a tax credit and apply for one. This tax credit can help you recover some or all the money you spent on sales tax when purchasing materials to construct a resale property. Understanding what exemptions or credits are available in your state can help you plan your pricing and budget to ensure you have adequate cash flow for a profitable project.
In general, contractors must pay sales tax on construction materials they buy when and where they buy them, even if they intend to use those materials in a different state. Some states may allow you to get a tax exemption certificate to show your local construction material vendors, letting you purchase materials tax-free for an out-of-state project. Others, like Oklahoma, generally require you to pay sales tax upon purchase even if you intend to use the materials in another state. If your state allows this exemption and you take advantage of it, you’ll still have to pay use tax in the state where your project takes place.
States periodically adjust their sales tax rates, and this can sometimes impact the price of materials you’ve already bought for a project before you receive them and pay sales tax. In these scenarios, most states will allow you to pay sales tax at the rate from when you initiated the purchase, as long as you can document the purchase date. A tax professional who serves your state can help you ensure you’re paying at the correct rate.
Your tax obligations also vary depending on whether you have a direct contract with the customer or the prime contractor is subcontracting your services. In most states, including Oklahoma, construction subcontractors must pay sales and use taxes when purchasing supplies and materials for a project and should account for this when negotiating prices with the prime contractor. This keeps construction subcontractor tax liability simple — the subcontractor is liable for sales tax on the materials they buy, while the prime contractor is liable for tax on their own purchases. The states that don’t apply sales tax to prime contractors when they buy materials typically allow the same exemption for subcontractors.
In a few states, like Mississippi, tax liability can pass to subcontractors if the prime contractor fails to pay tax on the portion of the project the subcontractor worked on because of bankruptcy or dissolution. Consult a tax professional to ensure you understand how tax liability works in your state before entering a subcontracting relationship.
Besides sales tax, you may be responsible for other taxes during and after your construction project, including:
Completing a tax-compliant construction project while maximizing your savings can be challenging. Apply these eight tips to find the most cost-efficient way to meet your project’s tax obligations:
Knowing your tax obligations and the most cost-efficient way to fulfill them is crucial to running a profitable construction business. However, tax obligations can vary based on your location, contract type, customers and a shifting regulatory landscape. If you want to clear up your project’s financial picture, maximize tax savings and ensure legal compliance, partner with Polston Tax Resolution & Accounting.
Polston Tax is an Oklahoma-based team of certified public accountants (CPAs) and tax attorneys helping construction businesses nationwide maintain accurate financial records and achieve tax compliance. Our services include:
Schedule a free consultation today to discuss how Polston Tax can help your construction business achieve cost-efficient tax compliance.
