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Construction – Common Sales Tax Issues

October 2, 2014

Accounting for Texas sales tax in the construction industry is treacherous at best. In order to effectively administer sales tax, contractors need to stay aware of changes in the law. Tax professionals should also stay aware of state tax issues in order to better serve their clients. Below are some common errors that, in an audit, can cost significant time and money.

Definitions – Often times what contractors call ‘new construction’ or ‘remodeling’ may not be the same as the state’s definition. The definition also varies depending on the type of construction – residential or commercial. New construction is defined as ‘all new improvements to real property including initial finish out work to the interior or exterior of the improvement.’ Finishing out existing office space that was previously used as storage or occupied by a tenant is not considered new construction. Texas defines remodeling as ‘to rebuild, replace, alter, modify, or upgrade existing real property.’ Adding a new floor (an additional story) to an existing building would be considered new construction, while relocating a wall to create new square footage is remodeling. Lifting a ceiling is only new construction if it creates new, usable square footage. Texas does not tax new commercial construction labor (only incorporated materials) but does tax remodeling materials and labor for commercial buildings. In order to effectively administer sales tax a contractor should know how their project will be classified by the state.

No Written Contract – While it seems like common sense to put it in writing, all too often construction contracts are handled on the ‘good old boy’ system, with just a handshake and a promise. If a conflict ever arises (and a contract does not exist) an invoice will take precedence, even if on its face it doesn’t support what the parties agreed upon. It is important to always have a written contract that details the terms agreed to by both parties.

Resale Certificate – On the job site it is often necessary to send an employee to a local hardware store to make a purchase. Depending on the setup of the contract you may want the employee to issue a resale certificate. If so, it is important that employees with access to this certificate understand when it should and should not be used. Proper review of these purchases will ensure that tax is being administered according to the structure of the contract and is not underpaid or overpaid.

Lump-Sum vs. Separated – Different jobs have different contracts. The difference centers around who is deemed the end user (contractor, sub-contractor, customer). If a resale certificate is utilized for purchases it is imperative that the contract or invoice be structured according to the guidelines set forth by the state. Texas does not tax labor on new commercial or residential construction but does tax the materials incorporated. If the contractor chooses to issue a resale certificate at the time materials are purchased, it is necessary that the contract be separately stated for materials and labor. If the contractor pays tax at the time materials are purchased, a lump-sum contract can be used in both commercial and residential construction and no tax will be charged to the customer (the contractor is deemed the end user of the materials). Sales tax must be collected on materials and labor for commercial repair and remodeling.

Different Contracts For Same Job – Often times contractors and sub-contractors are not using the same contract structure (lump-sum or separated). When the general contractor is working under a lump-sum contract and the sub-contractor is using a separated contract, the sub-contractor will collect tax from the general contractor on incorporated materials. The general contractor will not collect any tax from the customer. In cases where the general contractor is using a separated contract and the sub-contractor is using a lump-sum contract, it is the duty of the sub-contractor to pay tax on the materials used in jobs he performs. The general contractor should list the amount billed by the sub-contractor separately on the invoice to the customer and should not collect tax. It is very important for the general contractor and the sub-contractor to agree on what type of job is being performed (new construction or remodeling) and the type of contracts used.

The scenarios listed above are just a few of the many details that a construction company should closely monitor. It is always easier to start something off on the right foot rather than try to fix it in the end, when it will only be more difficult to sort through and more costly to resolve. A strong understanding of applicable state law combined with clear communication can help ensure that sales tax is properly administered.

Brad Gross, CPA, Lane Gorman Trubitt, PLLC, provides tax and management consulting services to contractors. Contact: 214-871-7500 or bgross@lgt-cpa.com.

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