Figuring out how the Texas sales tax applies to construction contracts can be tricky. This is because the sales tax treatment of construction contracts varies based on: (1) the specific type of services that the contractor is providing; and (2) whether the contract in question separately states charges for labor and incorporated materials.
What Is Generally Subject To Sales Tax?
Generally, tax is imposed on every sale of tangible personal property and taxable services in the state of Texas. The Texas Tax Code provides detailed definitions for both “tangible personal property” and “taxable services.” But for our purposes, it’s enough to say that “tangible personal property” means any personal property that can be sensed in any way (e.g., seen, heard, touched, etc.), and “taxable services” means those items specifically identified as such by the code.
How Does Sales Tax Apply To A Contractor’s Sales To Customers?
The repair and remodeling of nonresidential real property is normally a taxable service. This means that contractors who repair or remodel nonresidential real property should collect tax from their customers based on the total sales price less separately-stated charges for certain unrelated services. The Texas Administrative Code states that the drawing up of architectural designs or engineering plans, new construction, increasing manufacturing capacity, and real property maintenance may be examples of unrelated services (although most of these examples are fairly strictly defined under the law).
On the other hand, new construction – whether residential or nonresidential – and the repair and remodeling of residential real property are not taxable services. The sales tax treatment of a contract involving new construction and residential repair and remodeling depends on whether the agreed price in the contract separately states charges for labor and incorporated materials. If a contract for new construction or residential repair and remodeling contains only a lump-sum price (in other words, the contract doesn’t separately state charges for labor and incorporated materials), then the contractor should not collect sales tax from the customer on any portion of the price.
However, if a contract for new construction or residential repair and remodeling separately states charges for labor and incorporated materials, then the contractor should collect sales tax from the customer based on charges for incorporated materials as well as, under certain circumstances, separately-stated charges for consumable items and taxable services.
This is where it really gets complicated. It’s also possible for contracts to be in part for new construction, residential repair and remodeling, and other nontaxable services; and in part for nonresidential repair and remodeling, and other taxable services. The Texas Administrative Code provides the example of a contract for the remodeling of a restaurant’s kitchen (nonresidential repair and remodeling, a taxable service) and the construction of a new dining area (new construction, a nontaxable service). Another example may be the repair and remodeling of a structure that has units leased for both commercial and residential use.
The total charge under a contract for any combination of the services mentioned above may be presumed to be for nonresidential repair and remodeling and, therefore, taxable if:
- That portion of the charge attributable to nonresidential repair and remodeling and other taxable services exceeds 5 percent of the total charge; and
- The parties do not separately identify the charges attributable to taxable labor (including nonresidential repair and remodeling) and nontaxable labor (including new construction and residential repair and remodeling).
This presumption may be overcome by appropriate documentation establishing the percentages of the total charge attributable to taxable and nontaxable services. Contracts detailing scope of work, bid sheets, tally sheets, schedules of values, and blueprints are examples of the kind of documentation that would be necessary to rebut the presumption. Such documentation also may need to show that the charge for each service under the contract approximates what would be charged if the service had been performed independently.
Minor repair and remodeling performed in connection with new construction may not be subject to sales tax if the portion of a lump-sum charge attributable to repair and remodeling is less than 5 percent of the total lump-sum charge. But you’ll probably still need documentation detailing what percentages of the lump sum charge are attributable to what services. And if charges for nonresidential repair and remodeling and other taxable services are separately stated, then all such charges could be subject to tax.
(As a side note, the administrative rules dealing with the sales tax implications of mixed service construction contracts are often poorly written and confusing. You may want to consult an attorney if you think you’re in this sort of situation.)
Are There Any Sales Tax Exemptions For A Contractor’s Sales To Customers?
All of this assumes that an exemption from sales tax doesn’t apply. However, there are a number of exemptions from sales tax. Three such exemptions may warrant a closer look in this context:
Sale-for-resale exemption. This exemption generally applies if (1) a customer purchases tangible personal property or taxable services from the contractor (2) for the purpose of reselling such property or services in the normal course of the customer’s business (3) in the form or condition in which the property was purchased or as integral part of other tangible personal property or taxable services.
Exempt customers. This exemption involves the sale of tangible personal property or taxable services to a customer that has been granted an exemption from sales tax. Think schools, churches, charitable organizations, governmental entities, and so on. But it’s essential to get confirmation from the Texas Comptroller that a particular customer really is exempt from sales tax. A good place to start is here.
Disaster Relief. Also exempt from sales tax are separately-stated charges for labor involved in the repair and remodeling of nonresidential real property in certain officially-designated disaster areas if the property was damaged by the disaster that caused the area to be so designated.
If any of these, or any other, sales tax exemption applies, the contractor should make sure that the customer claiming the exemption provides the contractor with a fully-completed resale or exemption certificate at the time of sale. These certificates can be found here.
How Does Sales Tax Apply To A Contractor’s Purchases?
In addition, it’s important to bear in mind that a contractor’s purchase of tangible personal property or taxable services in connection with a construction contract also typically will be subject to sales tax. Exceptions similar to those outlined above may apply, however.
For instance, a contractor may not have to pay sales tax on the purchase of materials that will be incorporated into the customer’s real property under a contract for nonresidential repair and remodeling, a separately-stated contract for new construction, or a separately-stated contract for residential repair and remodeling if the contractor issues the vendor a resale certificate for these materials. When performing new construction or residential repair and remodeling, a contractor may also be able to issue a resale certificate for the purchase of certain taxable services and consumable items that are resold to customers.
Furthermore, a contractor also may not have to pay sales tax on the purchase of certain items in connection with construction contracts involving customers that are exempt from sales tax.
As the above non-exhaustive overview hopefully shows, the application of Texas sales tax to a construction contract can be difficult to determine. If you have any specific questions about the application of the Texas sales tax or any other related issues, feel free to contact us.