You probably already know that when you become involved in a project outside your home state, you need to be mindful of issues such as licensing, qualification and authorization to do business, and workers' compensation and other insurance requirements. But one area that can be confusing and often overlooked is how a state's sales and use taxes apply to contractors and their material purchases.
For example, will you owe tax on the value of an out-of-state contract? Will you have to pay sales tax on your material purchases? Are exemptions available? Will you have to submit a bond to cover taxes? Does it make a difference whether your contract is stated on a lump sum or time and materials basis?
Because failure to properly pay taxes could result in a job being stopped by state authorities and/or possible monetary penalties, you should know the answers to these questions before negotiating or bidding on a job in another state. And because states have different tax laws and those laws' effects on you can be significant, you should have a basic understanding of what sales taxes may apply before starting or even bidding a job in another state.
The general rules
In all but five states (Arizona, Hawaii, Mississippi, New Mexico and Washington), the general rule is that contractors are treated as end users of materials that are purchased in connection with the performance of a contract. So contractors are, in essence, retail purchasers of materials.
As a result, contractors pay sales tax when they purchase materials and do not charge their customers for the tax or pay the state a tax on the value of their contracts. Of course, there are exceptions, and laws vary from state to state even within this general rule.
For example, some states treat fixed-price, or lump sum, contracts differently from time and materials contracts. In Florida, for instance, a roofing contractor will be taxed as the end user of roofing materials used in the performance of a contract if the contract is stated as a lump sum. The contractor will pay sales tax on the purchase of materials but will not charge for the tax or pay tax on the contract amount.
But contracts on a time and materials basis are treated differently. In those circumstances, a contractor is treated as selling materials to a building owner and then installing those materials. Sales tax is not paid when a contractor purchases the materials, but tax is charged and paid by a contractor on the materials portion set out in the contract.
What difference does this make? That depends on who owns the property. If an entity (such as a housing authority, public hospital or school district) is exempt from paying sales tax on purchases, no sales tax is owed or paid at all on a time and materials contract. The reason is that a contractor does not pay sales tax when materials are purchased and an exempt entity (a school board, for instance) does not pay any sales tax under the contract.
If a contract is in a lump sum form, a contractor pays sales tax on the materials when they are purchased. Consequently, in cases in which a building owner is an exempt entity, the contract's form makes a big difference as to whether the contractor pays sales tax on material purchases.
Contrast the Florida scheme with taxes imposed in Georgia. No distinction is drawn in Georgia between time and materials contracts and lump sum contracts.
If materials are purchased for the purpose of being incorporated into a project pursuant to a contract, a contractor will be required to pay sales tax on the materials purchase but does not charge or remit sales tax on the amount charged under the contract. The type of contract does not matter nor does it matter who owns the property. As a result, even when an owner is tax-exempt, the contractor does not escape sales tax liability.
As mentioned, Arizona, Hawaii, Mississippi, New Mexico and Washington do not follow the majority approach. Instead, out-of-state contractors in these states are taxed on the value of their contracts or receipts and generally are exempt from paying sales tax on material purchases.
Each of these states takes a slightly different approach to imposing the tax, referring to the tax as a "receipts" tax, "contractor's" tax or "privilege" tax. But the end result is the same: Contractors pay tax on money they receive under their contracts and do not pay sales tax on material purchases.
The tax laws in these states also vary in their effects.
In Arizona, tax is assessed against prime contractors and is calculated based only on 65 percent of a contractor's gross income for a job. Subcontractors (provided they meet the statutory definition of a subcontractor) are not subject to the tax. Typically, roofing contractors meet the subcontractor definition and are not taxed.
In contrast, Mississippi imposes a contractor's tax on prime contractors, but if a prime contractor does not pay the tax, each subcontractor is liable for the tax on its portion of the contract. Mississippi requires payment of the tax upfront (or the posting of a special sales tax bond).
Arizona and New Mexico require prime contractors and subcontractors to pay the tax on periodic returns filed during a project's course unless they have complied with the requirements for an exemption or deduction.
The purchase of materials also is treated differently among these states.
Mississippi allows an exemption from sales taxes for material purchases if a contractor's tax is paid and a certificate is obtained and provided to suppliers.
Arizona law exempts material purchases from sales tax when materials are incorporated into a construction project.
New Mexico issues certain exemption certificates, but a contractor must apply for exemption and the transaction must meet certain requirements, such as the property has to be used for a purpose that is deemed exempt under the statutes.
The states differ in their approaches to receiving refunds or credits if sales tax has been paid but should have been exempt under an applicable certificate.
Note that because these states focus their taxes on contractors' receipts, generally there are no exemptions for income received from hospitals, housing authorities or schools. A contractor's tax or receipts tax is imposed on contractors and attaches to income received by contractors, so a project's purpose or owner's identity is irrelevant.
If you fail to comply with sales tax requirements, the consequences can be severe. Many states have procedures that allow a state's revenue department to issue stop orders against projects that have not complied with tax requirements.
Penalties and interest can be imposed on the amount of the taxes owed, and the penalties can run as high as 50 percent of the tax liability in cases in which the state determines a contractor knowingly was trying to avoid paying the tax. These possible consequences, plus the possibility of being required to pay taxes that could otherwise have been avoided by proper registration, can significantly affect a job's profitability.
As you can see, sales tax laws as applied to contractors are anything but uniform. Consequently, if you are interested in handling jobs in multiple states, be mindful of the requirements and the taxing scheme imposed before bidding a job. In particular, you and your materials suppliers are susceptible to certain traps and unanticipated liabilities imposed by these complicated laws and regulations.
Buy here, use there
When you purchase materials in one state for use on a project located in another state, the complexity of tax laws increases substantially. Many states allow a credit for sales taxes paid to other states, but sometimes these rules only apply if the states treat each other reciprocally.
Even if you have valid exemption certificates that relieve you of paying sales tax on material purchases, a tax still could be imposed on the use of those materials in another state. Suppliers may believe a purchase is properly exempt from sales tax, but the delivery of materials to another state could create a use tax liability.
The primary problem here is the use tax. This is like a mirror image of the sales tax. The theory is as follows: If a person purchases an item in one state without paying tax and uses it in another state, the "using" state will impose a use tax. This tax is calculated based on the item's value and imposed because the item's user would have had to pay a sales tax had the item been purchased in the state where it is being used.
Conceptually, this tax makes sense when the transaction involves the purchase of a television, for example, in one state to bring it into a second state to be used.
When applied to contractors, the analysis becomes more complicated. Generally, in the five states that impose a receipts tax, material purchases are exempt from sales tax and there is no corresponding use tax issue. However, in a majority of states, if you purchase materials in one state and use those materials on a project in another state, you need to know how the use tax will apply.
The tax amount may depend on where the materials are delivered and used if different counties or cities in a state have different tax rates. You may be entitled to a credit against the use tax if a sales tax already was paid in the state where the materials were purchased depending on the law of the state where the materials are used.
In addition, suppliers need to be aware of the applicability of exemption certificates to ensure they do not become exposed to a liability for sales tax that was not charged to a customer.
Suppose you have a project in Mississippi, which imposes a contractor's tax on a contract's value. Assuming the general contractor pays the contractor's tax (or posts the bond accepted by the Mississippi Sales Tax Division), a materials purchase certificate will be issued. You then can use this certificate to purchase materials for the job without paying sales tax on those materials.
If the supplier is in Mississippi or the material purchase takes place in Georgia, no sales tax will be required. (In Mississippi, the purchase is exempt from sales tax under the certificate; in Georgia, no tax would be charged because the materials are being purchased for installation pursuant to the contract).
But if the general contractor had not paid the Mississippi tax and you are unaware of the requirements, you could be exposed to the contractor's tax on the subcontract's value, as well as a sales tax on the material purchase. A Mississippi supplier will be obligated to collect and remit the sales tax unless the materials purchase certificate is presented. If the supplier is in Georgia, sales tax may not be owed on the purchase but Mississippi may impose a use tax on the materials' value when incorporated into the project.
In either case, you could be subject to a tax on the contract's value and a sales (or use) tax on the materials' value. And if the tax totals 7 to 10 percent, your profit margin can evaporate unexpectedly.
When you take on a project in a different state, there are several areas of compliance that require attention. Depending on the state's taxing scheme, you may be required to post a bond, file a registration for the project or complete paperwork for the issuance of exemption certificates. Usually these registration requirements need to be satisfied before a job is bid. Sometimes these requirements are imposed even if you will not be responsible for the payment of any sales tax in connection with the particular project.
For instance, in the 1992 New York case Felix Industries v. State of New York Tax Tribunal, a contractor was assessed substantial penalties and interest for failing to register as an entity authorized to collect and remit sales tax.
The contractor argued he did not owe any sales taxes because the contract was exempt (there were three possible exemptions), but the court held "the mere fact that it ultimately may have no sales tax liability does not obviate a petitioner's need to comply with the registration and reporting requirements" of the New York law.
The contractor argued further that penalties should not be imposed because he relied in good faith on the advice of an accounting firm, but the court ruled that "reliance upon advice from a professional does not, per se, insulate a taxpayer from penalties" and that the contractor had a duty to inquire as to what requirements existed for registration and obtaining a certificate of authority.
Similarly, if you act as a subcontractor, be especially aware of prime contractors' compliance with state law.
For instance, if you have a job in Mississippi and are unaware the prime contractor failed to satisfy the tax payment and registration requirements, you could unwittingly become exposed to substantial additional taxes and, potentially, penalties and interest. Doing jobs in any state with a registration requirement presents the same exposure risk.
Relying on exemption
As a general matter of public policy, entities such as hospitals, housing authorities and government agencies (such as school systems) are exempt from paying sales tax. Some states allow contractors to use this exemption and avoid paying sales tax on material purchases for projects owned by these entities.
For instance, if you are part of a contract written on a time and materials basis in Florida, you will not pay sales tax when you purchase materials and will not charge sales tax to the owner because of the exemption.
In the Missouri case Becker Electric Co. Inc. v. Director of Revenue (which was later written into law as a statute), a contractor ordered materials for a project; the housing authority paid for those materials; and no sales tax was owed. The contractor was entitled to use the exemption.
Not so in Georgia. In ESI Companies Inc. v. Fulton County, the contractor was liable for sales taxes on material purchases even when the project owner (the county) specifically instructed all contractors to exclude sales tax from their bids.
In Resourcing Services Atlanta v. Georgia Department of Revenue, the court held that a private company, even while acting as the agent of a tax-exempt hospital authority, was responsible for paying sales tax.
In a private ruling, the Georgia Department of Revenue took the position that even in cases where a hospital or school actually purchases materials used in the performance of a contract (using its valid sales tax exemption), the contractor is responsible for paying the sales tax on those materials. In Georgia, the most important fact is that if a contractor is using the materials in performing services, he or she is responsible for the tax.
As a result, if you operate in a state such as Missouri that allows the use of an exempt entity's certificate of exemption, you will be unpleasantly surprised by the sales tax law if you take on a job for a tax-exempt entity in a state such as Georgia.
Know the rules
Sales tax laws are complicated and vary among states. Transactions in which materials are purchased in one state and used in another state require careful attention to ensure compliance with applicable state laws.
In addition, each state has registration and certificate requirements that need to be followed closely, and you cannot necessarily rely on general contractors to handle all the issues.
Finally, be aware that similar transactions are treated differently in different states—even in neighboring states with similar public policy approaches. Sales tax issues can be just as important as licensing and registration issues when you take on business in a different state.
Take some time to understand these issues upfront, even before you negotiate or bid a job, so you can avoid much expense and aggravation later.
Scott D. Calhoun is an attorney with the Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.