State Sales Taxes Create Administrative Challenges for Contractors

As most of us know, taxes are among the few certainties we can expect in life.

And a look at state laws nationwide indicates that sales and use taxes in particular are having a moment, especially laws imposing sales tax on certain types of real property improvements and services. According to a 2015 publication by tax software provider Avalara, at least 18 states impose a sales tax on at least some services that are considered improvements to real property. These states include Connecticut, Florida, Hawaii, Iowa, Maryland, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, New Mexico, New York, North Carolina, Ohio, Pennsylvania, South Dakota, Texas, and Wisconsin. States appear to be trending toward collecting sales taxes from end customers on materials, labor, repairs, and services associated with real property improvements.

The impact is not only an increase in construction costs for consumers, but will also push contractors to overcome administrative challenges and to keep their prices competitive in spite of additional tax costs they must impose on customers. As discussed below, this is especially true for contractors who do both taxable and non-taxable improvements. Anyone unsure of how their state’s law applies to their activities should consult with a CPA, tax attorney, or their state’s department of revenue.

What Services Are Taxable in my State?

Generally, most states have long imposed a sales tax on purchases of goods both on consumers and on businesses. The growing trend appears to be that some states are also imposing sales tax on certain services that may or may not be related to taxable goods. In at least a few states, the distinction between capital improvement projects and repair, installation and/or maintenance work is important. Often, contractors who perform work in both categories — work subject to sales tax and work that isn’t — can submit some type of affidavit or other paperwork in order to be excused from sales tax liability or from the responsibility to pass it to others. However, in many cases, the distinctions between taxable and non-taxable services is highly technical and can depend on the circumstances of the transaction in question.

In Florida, the distinction between “tangible personal property” and “real property” determines when contractors must charge sales tax to the end customer. Under the Florida Department of Revenue Rule 12A-1.006, if contractors furnish parts directly to customers, they must charge sales tax to customers both for the parts and for “adjusting, applying, installing, maintaining, remodeling, or repairing” tangible personal property. Section 192.001(11)(d) of the Florida statutes defines tangible personal property as “goods, chattels, and other articles of value … capable of manual possession and whose chief value is intrinsic to the article itself.” The statute defines “real property” to include “land, buildings, fixtures, and all other improvements to land.” Contractors performing labor to install permanent fixtures that constitute “real property” do not have to charge sales tax to their customers; contractors who will eventually charge their customers sales tax are entitled to purchase the materials as tax-exempt.

A Florida Department of Revenue online guide cites permanent carpeting, roofing, tile, and landscaping as example of “real property” improvements that are not subject to sales tax. However, the same guide states that “carpet” constitutes tangible personal property unless it becomes real property; this provision seems potentially confusing and likely requires flooring contractors to impose sales tax on some of their services but not others. Similarly, the guide states that “stepping stones” constitute tangible personal property; it would therefore seem that landscaping contractors are tasked with taxing some of their services but not others, as the guide generally lists landscaping work as a “real property” improvement.

In Ohio, contractors need to understand the legal distinction between “construction contracts,” which are not subject to customer sales tax, and “tangible personal property” contracts, which are. According to the Ohio Department of Revenue, tangible personal property becomes real property when it is permanently installed or affixed upon the real property pursuant to a construction contract. The Department specifically lists carpet, carpeting materials, and landscaping materials as tangible personal property. The Department advises that for transactions that are not construction contracts and that include the sale of tangible personal property (TPP) for sales tax purposes, contractors should present their vendors with a direct pay permit that will allow them to buy the materials tax free, charge customers sales tax, and then pay the sales tax to the state on a monthly basis.

New York and North Carolina require contractors and other service providers to charge customers sales taxes on the sales price of “repair, installation, and maintenance” work (commonly referred to as RIM), whereas “capital improvements” are not subject to sales tax. The New York Department of Taxation and Finance’s Publication 862 purports to give guidance to contractors and property owners on New York’s sales tax rules. It explains that “repair” and “maintenance” work — work done to keep real property in good working order, safe, or to restore it to a good and safe condition — is subject to sales tax. Publication 862 cites replacing damaged roof shingles, repairing a broken railing, and replacing a faucet as examples of RIM services that, along with the materials, are subject to sales tax. It goes on to discuss taxable installation services and provides that “freestanding appliances” like washing machines, dryers, dishwashers, and refrigerators are among items that, although installed, do not become a permanent part of the real property under New York law.

North Carolina law similarly sets forth particular activities that constitute RIM services — like “floor refinishing and the installation of carpet, flooring, floor coverings, windows, doors, cabinets, countertops, and other installations where the item being installed may replace a similar existing item … .” The repair or replacement of roofing, gutters, and flashing appears to fall squarely within North Carolina’s definition of RIM services for which contractors must charge their customers sales tax. North Carolina’s law — N.C. Gen. Stat. § 105-164.3(33l) — goes on to say that RIM services that are part of a real property contracts for capital improvements are exempt from the sales tax.

“Capital improvements,” on the other hand, are not subject to sales tax in New York and North Carolina. In New York, whether a project constitutes capital improvement work appears to depend heavily on the particular circumstances; even the method of installation can affect how the work is taxed. For example, some projects that ordinarily would qualify as capital improvements are not considered capital improvements if a commercial tenant installs items as trade fixtures. Whether they are taxable depends on whether the intent is for the improvements to remain permanent. In North Carolina, capital improvements include new construction; work that requires a permit (with some exceptions); installation of equipment or fixtures that is “capitalized and depreciated”; paint or wallpaper not incidental to RIM services; landscaping; and HVAC unit or system installation or replacement.

How Is the Industry Being Impacted?

For many contractors performing RIM or other sales taxable work in one or more of these states, distinguishing which services are and aren’t subject to sales tax is only the first step. Contractors also need to comply with the requirements and, when applicable, take the administrative measures needed in order to avoid what is effectively double payment. When contractors buy goods and materials from wholesalers, they are generally responsible for paying sales tax at that time. Typically, though, the states that impose sales tax on RIM or other similar services don’t require contractors to pay sales tax on materials that will be used in transactions where the end customer will have to pay sales tax. In many states, including North Carolina and Ohio, contractors can submit a form E-595E and potentially be exempt from paying sales tax on goods they will eventually resell and assess taxes upon. But for those contractors who buy goods and materials to be used both for RIM and capital improvements — for example, roofers who perform both new construction and repair work in North Carolina — the logistics of keeping the purchases separate (and keeping two sets of books, essentially) might be too administratively costly to justify the tax savings.

Mike Tenoever is the president and owner of The Century Slate Company, a roofing construction company in Durham, North Carolina, and he also is a member of the Roofing Editorial Board. Tenoever stated that even though the new sales and use tax laws took effect in North Carolina in 2016, some general contractors don’t seem familiar with North Carolina’s affidavit of capital improvement form when he submits it — something that indicates that not everyone is complying with or aware of the new law yet. If that’s the case, then it would appear that contractors who aren’t complying with the law and charging sales tax to end customers would be gaining a competitive edge over contractors who are following the law and charging sales tax on projects that constitute RIM under N.C. Gen. Stat. § 105-164.3(33l).

Furthermore, requiring contractors to determine what materials and supplies for which they should pay sales tax versus for which ones to tax customers is burdensome and, at least in Tenoever’s case, has effectively resulted in double tax payment because purchasing capital-improvement materials and RIM materials separately from the same vendors has been too administratively burdensome for his company.

About the author: Caroline Trautman is an attorney with Oak City Law, LLP, based in Durham, North Carolina. Questions about this article can be directed to her at caroline@oakcitylaw.com.

Author’s note: This article does not constitute, and should not be construed as, legal advice on any particular scenario. For specific advice, consult with an attorney licensed in your state.

About Caroline Trautman

Caroline Trautman is an attorney with Anderson Jones PLLC, Raleigh, N.C. She assists clients with construction litigation, contractual drafting and disputes, collections, lien and bond claims, licensing issues and other matters affecting businesses.

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