Key details: Sales and use tax compliance is critical for construction businesses, especially those operating in multiple states and localities. Varying tax laws, definitions of taxable activities, and evolving nexus standards create a complex environment. Non-compliance may result in substantial tax assessments, penalties, and interest. This article provides essential background and steps for sales and use tax compliance. This article is for informational purposes only and is not comprehensive tax advice. Sales and Use Tax rules vary widely. Always consult a qualified accountant or attorney before making tax decisions. Noncompliance can result in significant penalties.
State and Local Tax (SALT) compliance requires following state and local tax laws. Construction companies must manage sales, use, income, payroll, and property taxes.
For construction companies operating in multiple states and localities, SALT compliance is especially challenging due to complex and variable tax rules. Proper compliance reduces the risk of costly tax assessments and helps companies bid for and complete projects without unexpected liabilities.
Sales tax is an indirect tax imposed by state and local governments on certain goods and services. Sellers collect sales tax at the point of sale and remit it to the tax authority.
Use tax applies when you purchase items without paying sales tax, often from out-of-state vendors, and use them in the taxing area. Both taxes ensure states and localities receive revenue from taxable sales, regardless of where the sale occurs. Processes and Tools for SALT Compliance.
Managing sales and use tax obligations across jurisdictions requires structured processes and advanced tools. Construction firms should use automated tax calculation software integrated with their accounting systems to ensure accurate tax calculations. These tools help apply correct rates, manage exemption certificates, and prepare audit documentation. Establish formal procedures for contract review, monitor nexus thresholds, and maintain thorough records. Conduct regular internal audits and use state compliance portals to support compliance. Investing in technology and disciplined workflows is essential to meet regulatory requirements and minimize errors.
Tax rules, rates, and requirements vary significantly by state and location, adding complexity for businesses operating in multiple areas. Understanding sales and use tax fundamentals is essential for compliance and effective operations, especially in construction, where projects often cross state lines.
A core concept in construction tax compliance is distinguishing real property improvement projects from retail sales of tangible personal property. Typically, a contractor enhancing real property, such as constructing buildings, undertaking major renovations, or installing permanent systems, is considered the consumer of the materials and is responsible for applicable sales or use taxes at the time of purchase. As a result, no sales tax is collected from the client on the completed improvement.
If a contractor sells goods not incorporated into real property, such as appliances, window treatments, or equipment, the contractor is considered a retailer. The contractor must collect and remit sales tax on these items.
Tax rules governing whether a contractor is treated as a consumer or retailer, and how sales and use tax applies, vary significantly by state and local jurisdiction. The examples here provide general guidelines and do not constitute comprehensive tax advice. Always consult a qualified tax advisor or attorney, as state-specific regulations and exemptions can impact obligations. Consumer Versus Retailer
Contractor tax obligations depend on both the state and the type of contract. The two most common contract types include:
Some states allow contractors to charge and remit sales tax on contract proceeds or use special tax rates.
Previously, contractors collected sales tax in a state only if they had a physical presence, such as an office or employees. After South Dakota v. Wayfair, Inc., states may now require tax collection based on economic activity, such as sales revenue or transaction volume, even in the absence of a physical presence.
For example, Virginia requires remote sellers to collect sales tax if their sales in Virginia exceed $100,000 or if they have 200 or more transactions in a year. Many other states have similar thresholds, typically $100,000 in sales or 200 transactions annually.
Construction companies must systematically track business activities in each jurisdiction, including sales, deliveries, and the physical presence of personnel or subcontractors, to accurately assess nexus thresholds and manage tax registrations, collections, and remittances.
These risks are not exhaustive. State and local tax laws vary widely, and additional issues may arise depending on your business. Always consult a tax advisor for guidance tailored to your situation.
A common risk is misclassifying a project as a capital improvement, which is often not taxed, rather than as repair or maintenance, which is often taxable. For example, painting a new building during initial construction is typically a capital improvement, while painting an existing structure is generally considered a repair and is usually taxable.
If contracts combine taxable and nontaxable items or services, states may apply a “true object” test. If the primary purpose is selling taxable goods, the entire contract may be taxed unless charges are clearly itemized. When charges are listed separately, each component is taxed under its own rules.
When working for tax-exempt entities such as governments, contractors can often purchase materials tax-free if billed directly to the exempt entity or acting as their agent. Obtain and retain exemption certificates for audit purposes.
For resale transactions, contractors must obtain and retain resale certificates from customers. Maintain detailed, itemized invoices that clearly distinguish taxable and non-taxable items, separate sales tax charges, and provide comprehensive descriptions of work performed. Incomplete or ambiguous invoices may increase audit scrutiny and result in additional assessments.
Non-compliance with sales and use tax laws could result in:
State and local tax authorities are increasingly using artificial intelligence, machine learning, and advanced data analytics to identify non-compliance. These technologies enable governments to cross-reference invoices, exemption certificates, and purchasing data with third-party sources, making it easier to detect discrepancies and initiate audits. Automated systems can flag issues such as missing resale certificates, inconsistent tax reporting across jurisdictions, or unusual purchasing patterns. For construction companies, manual processes and incomplete documentation are no longer sufficient. Robust compliance tools and proactive monitoring are essential to avoid penalties and reputational damage.
Failure to comply with state and local sales and use tax requirements can place your business at significant financial risk. Penalties, interest, and back taxes can accumulate quickly, potentially resulting in license loss, cash flow problems, or even business closure. Do not take unnecessary risks. Consult a qualified tax advisor and attorney promptly to protect your company. For guidance and support, contact us today. Compliance for construction companies is complex due to diverse state and local rules, evolving nexus standards, and the unique nature of construction contracts. By understanding the differences between real property improvements and retail sales, monitoring nexus, maintaining proper documentation, and proactively managing compliance, construction companies can reduce tax risk and avoid unexpected costs.
Today’s Thought Leaders
About Jason Dudas
Partner & CPA
Jason is a Partner in our Vienna, VA office. Since joining the firm in 2009, he has worked closely with clients on tax, audit and accounting issues. Jason has become an expert in construction accounting and is a member of the Real Estate and Construction CPA’s. He also has experience with research and development credits, and tangible property regulations.
About Salem Soin-Voshell
Finance Consultant
Salem Soin-Voshell is a Finance Consultant at Ryan & Wetmore. He focuses on implementing and building technology at the firm as well as providing clients with data-backed insights through tax research and financial modeling. Salem earned Dual Degrees in Computer Science and Economics at University of Maryland, Baltimore County.
A contractor is someone who improves real property by affixing materials to it and is treated as the end user of those materials, incurring sales tax on their cost. A retailer sells tangible personal property to customers without affixing it to real property and must collect sales tax from the customer at the full sales price. Some businesses act as both, depending on the transaction.
Exemptions for government or nonprofit entities do not extend to contractors. Contractors are usually still required to pay sales or use tax on materials, even if the project owner is exempt. Some exceptions exist for direct purchases by exempt entities for specific types of contracts, but these are state-specific.
If you buy materials in one state and pay sales tax, and then use them in another state, you may owe use tax in the state of use if its rate is higher, but you can usually claim a credit for tax paid to the first state. If you buy materials tax-free and use them in a state with a sales or use tax, you must self-assess and pay use tax in the state of use.