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Sales & Use Tax Tip for May 2007
Making Construction Issues Less Taxing
Is Sales Tax required? Who is responsible? These are common questions in this complicated area of Sales & Use Tax. The answers often depend upon a variety of factors.
In the construction industry, contractors must distinguish if the services they are performing are repairs or capital
improvements. In many states, repairs to real property are taxable services. Services that result in a capital improvement which is an addition or alteration to real property are often not taxable.
The rules for determining whether a service qualifies as a capital improvement vary by state. In many states, a capital improvement must meet three conditions.
A capital improvement must:
- Substantially add value to the real property.
- Become part of the real property or be permanently affixed in a manner that would cause damage to property upon removal.
- Prolong the real property's useful life.
In states that impose Sales Tax on repair service, services to real property will typically be "taxable" if they do not meet the capital improvement conditions.
Once a contractor determines that an installation to a home or building does not meet the capital improvement conditions, it often must collect and remit tax on any installations performed. Many states require the customer to furnish the
contractor with a capital improvement certificate or similar exemption certificate to avoid paying Sales Tax for the labor. If the customer fails to furnish the appropriate certificate and the contractor charges a customer Sales Tax, the customer may be entitled to a refund of any erroneously paid
Sales Tax.
Leased Premises:
Alterations or additions to leased premises may be presumed to be temporary and, accordingly, not qualify as a capital improvement. However, for Sales Tax purposes, alterations or additions to a leased building can typically still qualify as a capital improvement (assuming the other qualifications
are met) if the lease agreement states that any capital improvements will remain with the property and become the property of the landlord upon termination of the lease. Placing such a provision in a lease agreement can save tenants significant amounts of sales tax dollars.
In most states, contractors must pay Sales Tax on all the building materials. If the materials are ultimately used in connection with a taxable repair job, the contractor may be entitled to a credit for Sales Tax paid on materials that
are transferred to the customer in connection with such job. Some states allow contractors to purchase materials exempt from Sales Tax if the materials will be incorporated into a job for the United States government or another exempt organization. In order for the contractor to make any exempt
purchase, it typically must furnish the supplier with a proper exemption certificate. A word of caution, since the contractor is typically considered the end user of the materials, many states do not allow the contractor to claim exemptions that might apply if the materials were purchased directly
by the end customer. Contractors should carefully review the applicable statutes when performing a job for an exempt customer before assuming that they can purchase materials exempt from tax. It may make sense for the exempt customer to purchase the materials directly and hire the contractor to
perform the installation work. While contractors will not typically itemize the Sales Tax on invoices to customers, the Sales Tax on materials is typically embedded in the cost of the job and passed onto the customers.
* This tip is intended to provide general information only and is not to be considered as a substitute for professional advice.
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