When entering a construction contract, there are many considerations contractors must make. One of the most important, and often overlooked, is potential sales and use tax implications related to the contract at hand. We will explore some of the most common types of contracts and their different tax implications below.
There are two major distinctions in construction contracts when it comes to sales and use tax – whether it is a contract for Real Property or “Business Fixtures”. On a contract for real property, contractors do not collect sales tax from customers. The contractor is considered the consumer of the materials installed, and therefore must pay sales or use tax at the time the materials are purchased. If a contractor is installing a Business Fixture, the item never becomes part of real property, even if it ultimately becomes permanently affixed to real property. The items being installed remain as tangible personal property, and as such, the contractor needs to collect sales tax from the customer.
It is vital to make this distinction before a contract is agreed upon, as there could be looming tax implications if the distinction between Real Property vs Business Fixture is not made or incorrectly made. So how do you tell the difference between the two?
Real Property – Includes land, buildings, improvements, fixtures, and structures. Some common examples include doors, windows, walls (inside of a building), restrooms, roofs, etc.
Business Fixtures – Any item of tangible personal property that has become permanently attached or affixed to the land or to a building, structure, or improvement, and that primarily benefits the business conducted by the occupant on the premises and not the realty. Common examples include business signage, office cubicles, data server rooms, fuel storage tanks, etc.
The distinction between Real Property and Business Fixtures is not always apparent and this is an area of much deliberation. So please contact us with any questions about the proper classification of the property.
Mixed Contracts – Best Practices
It is very common that major construction contracts will include both real property and business fixtures, so the different tax treatments can be confusing. However, there are some best practices to follow to ensure proper accounting for these mixed contracts.
It is recommended that a contractor always require the customer to issue a Contractee (Customer) Certification of Property Type form to the contractor, which will specify which portion of the project relates to Real Property vs Business Fixtures. This certification will determine if the contractor is either a consumer of material purchased for a job (Real Property), the reseller of material purchased for a job (Business Fixture), or a combination of the two
For the portion designated as Business Fixtures, the contractor should issue Certificates of Exemption to their suppliers, claiming “resale” as their basis for tax exemption. Contractors should then charge sales tax on the total price of the Business Fixture portion, including the cost of materials, labor, and mark-up, unless the customer provides an exemption certificate.
Sales and Use Tax Exemptions
Depending on the type of entity a contractor is working with, there may be exemptions to these taxes. When entering a Real Property construction contractor with an exempt entity, the contractor can purchase the direct materials incorporated into the contract without the payment of sales tax. To do so, the contractor must obtain a “Sales and Use Tax Construction Contract Exemption Certificate” (Form STEC CC) from the customer. Then, the contractor should provide a “Sales and Use Tax Contractor’s Exemption Certificate” (Form STEC CO) to its suppliers.
The certificate must include the following:
- Contractee (customer’s) name
- Location of project
- Name of project
- Reason for exemption indicated
- Name, signature, address, and date signed by contractor and contractee
However, even if the contract is exempt, the contractor is still liable for taxes on all property not directly incorporated into the project. This commonly includes tools, equipment, and other consumables used in the completion of the project, but that do not get incorporated into the project.
Every state has its own sales and use tax rules regarding completing construction contracts. Building and construction materials sold to a construction contractor for incorporation into Real Property outside the state of Ohio are not subject to Ohio sales or use tax if the materials would be exempt from tax when sold to the contractor in the other state. It is always prudent to research the sales and use tax rules of all states involved in multi-state construction projects. Please contact us with any questions.
*This article was co-authored by Jesse Ferrigno, CPA. Jesse is a Manager in Meaden & Moore’s Assurance Services Group with over six years of experience in public accounting and works with a wide variety of clients in various industries including service, manufacturing, retail and construction.