Is it Time for a Sales & Use Tax Check Up?
For many Massachusetts construction contractors, staying compliant with their tax obligations means making quarterly income tax payments and timely filing the annual tax return. They will ensure that there are processes in place to timely process and pay payroll tax liabilities. The tax obligation that often gets overlooked is the sales and use tax requirement. That’s likely due in part to the fact that the state has long operated under the premise that a contractor is considered the consumer of the materials that it purchases for real property contracting jobs. As such, the general rule is that the requirement to pay sales tax occurs at their point of purchase of the materials. No additional sales tax is imposed on the sale of the resulting real property. This is considered the contractor rule and is pretty straightforward to grasp. Unfortunately, nothing is ever as simple as it seems. If any of the following scenarios apply to your business, you may have a requirement that differs from the general contractor rule.
Materials and supplies are purchased out of state (including over the internet) and used in a construction project (or at the home office) in Massachusetts
You have projects in which you merely install a complete unit of standard equipment without any significant fabrication
You have projects in which you significantly fabricate but do not install into real property
You employ out of state contractors on projects in the state of Massachusetts
You perform contracts for organizations or on projects that are exempt from sales tax.
The Use Tax Requirement
Contractors must be cognizant as to whether they have actually paid sales tax when purchasing materials and supplies. And not just to any state. A contractor with a project in Massachusetts must pay sales tax to Massachusetts. It is not uncommon for a contractor to purchase material from an out-of-state supplier and for the supplier to charge their own state’s sales tax. Unfortunately, that’s not sufficient. In addition, depending on an online vendor’s connection to the state (i.e.; their “nexus”), it is entirely possible that they will not be required to impose sales tax on the materials that they sell. That becomes the contractor’s responsibility. Lastly, the contractor may occasionally run into a local vendor that, for whatever reason, doesn’t charge at point of purchase. The contractor needs to be alert to those situations and closely examine invoices because the state certainly won’t forgo their chance to collect and these deficiencies will often show up on exam.
In all of these situations it is incumbent upon the contractor to self-assess their own tax obligation and remit it to the state – except it’s not actually sales tax that they would be paying. Instead, the contractor must pay what’s referred to as “use” tax, which is the counterpart to the state’s sales tax requirement. In those situations where the contractor has already paid another state’s sales tax, they must report the sales on their Use Tax return and then claim a credit for the lesser of the amount they paid or Massachusetts’ 6.25% rate. This is allowed to avoid double taxation. If the other state happens to have a sales and use tax rate less than 6.25%, the difference will have to be paid.
Contractors as a Vendor
There are always exceptions to every rule and the contractor rule is no exception (no pun intended). Contractors will find that they cannot always rely on the general contractor as consumer rule if the project that they are engaged in does not rise to the level of a construction contract. The state’s view of a construction contract is that it is a contractor for the construction, re-construction alteration, improvement, remodeling or repair of real property. Real property is the key term here. There are many instances where the scope of a project entails the contractor’s purchase and installation of a finished piece of tangible personal property, such as an appliance, without any material modification of their own. In this case, the contractor is not considered the consumer but rather a re-seller of tangible personal property. Rather than pay sales tax at point of purchase, the contractor would provide the vendor with a “Resale certificate” (Form ST-4) letting them know that they will be separately charging sales tax to the end customer as any retailer would. The contractor would have to register as a vendor and would be responsible for collecting and remitting the sales tax and filing Form ST-9. Sales tax only needs to be paid on the material component but, in order to not charge sales tax on the full bill, the labor charge must be separately stated.
Furnish Only vs Furnish and Install
Custom millworkers or metal fabricators could find themselves having different sales & use tax obligations depending upon whether they perform the installation services either directly or through a subcontractor. A contractor that fabricates and delivers tangible personal property but does not permanently affix it to real property is generally going to be considered a seller of tangible personal property and would have to charge the customer sales tax on the entire fabricated unit. However, performing the installation function as well would likely result in contractor as the consumer treatment.
Utilizing Out of State Contractors
The issues with other states is not just limited to material purchases but labor as well. A customer or general contractor that utilizes an out of state subcontractor is responsible for ensuring that the subcontractor:
Registers with DOR's Out-of-State Contractors Unit.
Files a bond or pays a deposit to DOR for projects valued at $20,000 or higher (that includes material)
Pays sales and or use tax on purchases of project materials.
Registers with DOR to file and pay applicable taxes via MassTaxConnect.
Presents a DOR Certificate of Compliance to the hirer before completion of a project.
If the out of state subcontractor does not comply with these requirements, it becomes the responsibility of the customer or general contractor to withhold 6.25% of all amounts payable to the out of state contractor and remit to the Department of Revenue. It is important that the general contractor identify the non-compliance prior to paying their subcontractors in full so that they can holdback the amount needed to satisfy the state’s requirement. Otherwise, it could end up coming out of their own pocket.
Sales Tax Exemptions
Not every exception in the sale and use tax realm results in bad news to the contractor. There are instances where a contractor may be exempt from paying sales tax.
One exemption applies when material, tools, fuels, machinery, or replacement parts are consumed and used directly and exclusively in certain manufacturing or research and development functions. When purchasing such materials, a contractor must provide an Exempt Use certificate (Form ST-12) to the vendor. Care should be taken to ensure that these Exempt Use certificates are fully completed by the customer as the state will expect the details if they were to ever examine.
Another exemption applies if a contractor is hired to provide services to an exempt organization which would consist of: the US Government, the Commonwealth of Massachusetts, a Massachusetts state agency or a 501(c)(3) organization. In doing their due diligence, the contractor will want to make sure that the organization has a current Exemption Certificate (Form ST-2) in their files. When purchasing materials for these construction projects, the contractor must provide the vendor with a copy of (Form ST-5C) which is a Contractor’s Sales Tax Exempt Purchase Certificate.
Got all that? It seems the state has started to realize how complicated the sales & use tax regime is for contractors as, in recent months, has started to release industry specific sales & use tax guide. Currently, these three are available, likely with more to follow.
Sales Tax Guide for Electricians
Sales Tax Guide for Landscapers
They have also previously issued Directives and/or Rulings related to specific constructed items
Application of Sales Tax to Cabinet Makers
Application of Sales and Use Tax to the Construction of Storage Sheds
Keep in mind that everything discussed to this point is Massachusetts specific. While many states have similar guidelines, there are several that operate with their own unique requirements. Some will impose sales tax on labor, some have separate sets of guidelines for new construction vs renovations, and some have restrictions to the credits that they allow for out of state purchases. Construction is a very unique industry when it comes to accounting and tax and it’s very easy for a business to end up out of compliance, especially when not working with advisors that specialize in the industry. All of this said, is it time for sales and use tax check up?
About the Author:
Jeffrey T. Rogers, CPA, MST
Jeff has over 16 years of experience specializing in tax planning, tax research & compliance, IRS & State Exam Representation, Mergers & Acquisitions, and Business succession & ownership transitions with a focus in the construction, real estate, non-profit, restaurant, manufacturing & distribution industries. He helps businesses adopt the most tax efficient accounting methods available to them and identifies all tax credit and incentives to which they may be entitled. In recent years, Jeff has developed a deep understanding of the Employee Retention Credit program and has presented on the topic for multiple trade associations, Chambers of Commerce, and at other business events. He was published in the Boston Business Journal and the Cape and Plymouth Times on the subject matter.
Prior to joining E.J. Callahan & Associates, Jeff has served as both a Partner and Director at regional and national CPA firms. He holds a Bachelor of Science Degree in Accounting from Merrimack College and a Master of Science degree in Taxation from Bentley University. Jeff is an active member of the American Institute of Certified Public Accountants (AICPA), the Massachusetts Society of Certified Public Accountants (MSCPA), and the CFMA. Jeff is also on the MSCPA Taxation Committee, a Board Member for the Danvers American Little League and a volunteer coach in several youth sports programs.
Check out Jeff's work:
"Year End Tax Planning for Contractors"
E.J. Callahan & Associates Blog - December 8, 2022
"Employee Retention Credit Benefits for Contractors"
Boston Business Journal - July 1, 2021
"Don't Leave Bread on the Table: How Restaurants Can Benefit From The Employee Retention Credit"
Cape & Plymouth Business Media - December 2021 Issue, pg. 19