Can I just pass on the tax?

A reader today posed this scenario. 

Mark is the manufacturer and sells to the retailer

Rhonda is the retailer who sells to the customer

Calvin is the customer

Apparently, Mark is charging Rhonda sales tax. 

Rhonda therefore incurs the cost of the sales tax.

Rhonda would like to pass on this cost to her customer, Calvin.

Can she?

There is an obvious question here

Why can't Rhonda buy from Mark for resale? This would seem to be the obvious and legal solution.  Particularly since Rhonda is required to charge Calvin tax if the sale is taxable and she has nexus in the state.

Two exceptions spring to mind

It's possible that this is a drop shipment and Mark has to charge Rhonda tax but Rhonda doesn't have a way to charge Calvin tax since she has no nexus in the delivery state. 

It's also possible that Rhonda is a contractor.  In most states, she pays tax to her vendors for her building materials but doesn't charge tax when she bills Calvin for the job.

These are the obvious and common exceptions - there are more.

Other than the above exceptions, Rhonda should be buying for resale and charging tax, if the sale is taxable.

However, if she is incurring sales tax for some reason (like the two listed above) and she can't pass it on, or is not allowed to pass it on, then it's a cost of doing business, and she has the ability to fold the tax into the price of her goods.  The only obvious restrictions I can see are:

Rhonda doesn't price herself out of the market and

the customer agrees to the price

Note that these are not sales tax law restrictions...this is just business.  Rhonda can set her price at any point she wishes, as long as the customer agrees.

However...

Rhonda generally can't charge Calvin something called "tax" in a state where she isn't registered.  Rhonda might think this is a way to recover the money from the customer without having to negotiate a new price.  Unfortunately the law generally requires that you must be registered in a state before you charge that state's taxes.  In addition, if she were to be audited, the state would ask her why she has not remitted that "tax" money to the state.  If Rhonda needs to show a charge on the invoice, call it a "we're going to hold you upside down and shake money out of your pockets" surcharge.  But don't put the word "tax" on Rhonda's invoice to Calvin.

And if Rhonda is making a taxable sale to Calvin, then she is required to charge Calvin tax, if she has nexus in the state.  And she should obviously be buying for resale.

Bottom line

If Rhonda is making a sale to Calvin that is taxable and she has nexus in the state, she should be charging Calvin tax.

If the vendor is charging her tax, she should figure out why she can't buy it for resale.

If it's some other situation where she's incurring tax as a cost, she can't pass it on as "tax."  But she can fold that cost, like any other cost, into her price. 

Geez, this stuff is complicated!  If you're reading this and desperately waving your hand because Jim missed something, I know.  But the more holes I fill in, the less understandable this is.  Suffice to say, it's messy.

And don't even get me started on absorption

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The Sales Tax Guy http://salestaxguy.blogspot.com
See the disclaimer on the right.
Don't forget our upcoming seminars and webinars. http://www.salestax-usetax.com and there's more sales tax news and links here http://salestaxnews.blogspot.com

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When Construction Contractors Install Tangible Personal Property

This is part of a series of articles on construction contractors

In virtually every state, contractors pay tax on the equipment and supplies that they use to build a structure.  As with any business, they're using those items.  But what about building materials?  These are the ingredients that become a part of the structure.  They are tangible personal property when purchased by the contractor and, after being affixed to the building, become real property.  Examples would be structural steel, bricks, shingles, millwork, concrete, etc.  That's what contractors do: they turn tangible personal property into real property.

In most states, the contractor pays tax on the building materials as well as equipment and supplies and he (or she) doesn't charge his customers tax - either on the materials or his services*.  The materials transferred as part of the sale aren't taxable for two reasons:

1.  The materials were used by the contractor to provide the construction contracting service.  Therefore they are consumed by the contractor and he pays the sales or use tax.

2.  The materials, when transferred to the buyer, are no longer tangible personal property - they're now real property.  And sales and use taxes generally only apply to sales of tangible personal property.  The contractor is the last person to buy the building materials as TPP and therefore he pays the tax.

Now the customer isn't getting something for nothing here.  She (or he) does pay the tax; it's just buried in the overall price of contract as another cost of the contractor.  Note that there's a danger when the contractor shows the tax separately on his invoice. 

Sometimes a contractor does a job that doesn't involve major construction (eg. new or expanded building, or major remodel).  What if they do a minor remodel or repair, or a smaller project like install flooring, fences, signs, communications equipment, appliances or other machinery and fixtures?

The question then becomes: is the contractor still doing construction contracting, or are they selling tangible personal property, with installation?

If they're still performing a construction contract, they they don't charge tax to the customer - they pay tax on the building materials, as described above.

But if they're selling TPP with installation, they should be charging their customers tax and buying the building materials for resale.

Easy, right?  But how do you tell?  When, for example, does a minor remodel become a major project? 

In the absence of any specific rules, here's the general idea. If the contractor is installing something that is permanently affixed to the structure and integrated into the value or use of the structure, then the contractor has done construction contracting.  In that case, he pays tax on the building materials and doesn't charge tax to his customers.  But if he hasn't done all of those things, then it is considered a sale of TPP with installation and he buys the materials for resale and charges the customer tax.

Examples:

1.  A telecommunications rack is installed in the wiring closet.  The installation is not permanent - everyone knows that it'll be replaced in a few years.  It's not affixed since permanent damage wouldn't occur if it was removed (it's just bolted to the floor).  And it doesn't have any affect on the value or purpose of the building.

One way of telling if an item has any affect on the value or purpose of the building is to ask, "if the building were sold, would the new owner care about the addition?" Other examples of this kind of thing would be signs, satellite dishes, draperies and blinds.

2.  A landscaping contractor plants a nice tree in the front of the building.  In this case, it is intended to be permanent, and damage would be caused if it was removed after a few months.  And the value of the building is enhanced by the landscaping.  So it's construction contracting and the contractor would pay tax on the tree when he purchased it and would not charge the customer tax.

Except it doesn't always work that way.

Many states will override the logic, or help it along, by simply declaring that certain types of contracting are sales of TPP with installation, and are taxable to the customer and purchased for resale for the contractor.  A typical project that is handled this way is carpeting and sometimes other flooring.  Why?

Well, the cynical Sales Tax Guy notes that the state gets more money.  Remember, if the contractor pays tax on his purchase of building materials (as a construction contractor) the state will get less money because the tax is based on his cost.  But if the state can figure out a way to call it the sale of TPP with installation, then the tax is on what the contractor sells it for, which would typically be higher - more money for the state.

The other reason is that, with certain purchases, the true object of the customer is to buy a specific type of TPP, paying attention to things like the brand, model, features, capabilities, and price.  They are really buying the TPP and the contractor is merely the installer.  So it would be appropriate to treat as the sale of TPP with installation.

In a normal construction contract, the customer is more concerned about the capabilities and service of the contractor than the materials they use.  I'm guessing that most customers don't really care about the brand of furnace (as long as it's a name brand) or the manufacturer of the bricks or shingles.  Color and appearance?  Yeah.  But they'll let the contractor worry about the details.

Here's a stumper.  What about window installation?  In this case, appearance, features, brand and other attributes are very important to the buyer, probably as much as the ability of the contractor.  So wouldn't it be the sale of TPP with installation?  I'd say no, it would probably be construction contracting.  Why?  Because the windows are permanently affixed to the structure and integrated into the value or use of the structure.

So, when you're trying to figure out if it's a sale of TPP with installation; as opposed to a contruction contract, you can use logic, as I've described above.  But check to make sure that the state doesn't have their own ideas.  These are usually shown in the regulations, and sometimes, if you're lucky, in a publication on the state web site.

There are other ways that some states will determine if the sale is treated as the sale of TPP with installation.  One is if the deal is billed as a time and materials contract where the labor is separated from the materials.  Another is if the customer takes title and possession of the materials before the actual work is done (eg. a roll of carpet delivered a week before the installers arrive).

To summarize:

When contractors do construction contracting (eg. new or expanded building or major remodeling) they typically pay tax on the building materials and do not charge their customers tax. 

But when the contractor does a job that is more of a sale of tangible personal property with installation, then it's likely that the materials will be taxable to the customer and the contractor will be able to buy for resale.

*Remember, the rules are different in your state.  Probably.

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The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only.  Research these issues thoroughly before making decisions.  Remember: there are details that haven't been discussed, and every state is different.  Here's more information

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Golden Rule: Three Different Types of Property

[This is an overhaul of an article originally written in February of 2009]

While there are variations for what constitutes real and tangible personal property, these are pretty good definitions in most states.

Real Property

Real property is generally property that has been:

1. permanently
2. affixed to other real property (like land and buildings) and
3. is integrated into the value or use of that real property.

Permanent usually means there are no plans or expectations to remove the item - it will last as long as the building or at least 10 to 20 years.

Affixed means that you'd cause significant damage if you removed the addition.  

"Integrated" means that the additional property extends the life or increases the value of the existing real property. In addition, it would be something that would be expected in the building or that facilitates the purpose of the building (like a roof).

One test that I've seen is: if the building were purchased, would the new owner retain the addition, or would they probably tear it out?  In other words, is the addition something that is fundamental to the purpose and value of the building?  For example, if someone buys a house, would they keep the old draperies?  Probably not.  They might keep the Venetian blinds, but the drapes?  Blech.  Out they go!

Effect on construction contractors

If a construction contractor permanently affixes TPP to real property, and it becomes integrated into that real property, she has converted that TPP into real property.  In most states, the contractor's sale wouldn't be taxable and she would pay tax on the TPP when purchased by her.

TPP - Tangible Personal Property

Tangible personal property is property that is perceptible to the human senses (tangible), and is not real property. See above.

A simpler way to describe at TPP that is not as accurate, but easier to grasp, is: tangible personal property can be moved without causing damage to the property or to any property it is attached to.


Note that sales of real property are not generally taxable, but that sales of tangible personal property are, by default,taxable.  There are lots of exceptions and variations.

Intangible Personal Property

And then there's a third type of property: intangible personal property.

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The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only. Research these issues thoroughly before making decisions. Remember: there are details we haven't discussed, and every state is different. Here's more information

Get these articles in your inbox - subscribe at http://salestaxguy.blogspot.com

Don't forget our upcoming seminars and webinars.
http://www.salestax-usetax.com/

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Parables and Illustrations: Do you sell equipment?

If you sell old equipment, you may be making taxable sales.  Have you taken a look at this problem?

One particular construction company that I'm familiar with (heavy/highway) is constantly buying new equipment.  Constantly.  The owner really likes new equipment (he must have been a big fan of Tonka toys as a child). 

In the old days, as he bought new equipment, the owner would need to sell the odd piece of used equipment.  This happened a couple of times a year and the transactions were concluded over a beer at the local tavern.  These were "occasional sales" and wouldn't be taxable. 

But, as the years went by, and the company grew, they found themselves getting rid of more and more used equipment.  They added "selling equipment" to the job description of one of the purchasing guys and started paying him a commission.  They parked the equipment in front of the building, put a sign up, and installed lights so that the equipment could be seen at night.  The deals were now closed at the office, not over a beer.  The company had become a used equipment dealer.  But they did not realize that.  Until the audit.

The state came in and noticed the amount of cash being thrown off by the equipment sales.  They also noticed the lights, signs, etc.  The auditor said, "you know, you should be charging tax on all of those sales."  The company talked to a lawyer, who referred them to a sales and use tax lawyer, who told them they were screwed.  The assessment was over $300,000 with the interest and penalties.  The lawyer helped get that reduced, but it still hurt.

Another situation was similar, but not as painful. 

A hospital found themselves selling lots of used medical equipment.  They could afford to be spendthrift because of the patient mix in their service area (lots of private insurance).  They sold the used equipment to other, poorer hospitals, clinics, and physicians offices.

Yes, the hospital was a non-profit organization.  But sales by non-profits are usually taxable, other than fund-raising events.  So this hospital should have been charging tax.

"But wait! Weren't they selling the equipment to other exempt hospitals?  So the sales would still be exempt, right?"

Yep.  But remember that not all hospitals are government or non-profit operations.  There are for-profit hospitals too.  And they sold equipment to physicians and clinics who are generally taxable.

Luckily, unlike the construction company, this organization realized what they were doing and began collecting taxes before they got caught.

Not such a horror story, but illustrative anyway.

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There are three major points to be made here:

1.  You may be selling so much equipment that you become an equipment dealer.  If you're doing more than selling the odd item over a beer, you should take a hard look at the situation.

2.  Your core business may not be your only source of taxable sales.  Other sales may be taxable without you realizing it.  Until the audit.

2.  Your company changes.  If you make a judgment about the taxability of something today, will the same set of circumstances and laws exist in five or ten years?  You need to frequently re-analyze what you are doing.  Don't just rely on the decision that was made in the good old days.

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The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only.  Research these issues thoroughly before making decisions.  Remember: there are details we haven't discussed, and every state is different.  Here's more information

Get these articles in your inbox - subscribe at http://salestaxguy.blogspot.com

Don't forget our upcoming seminars and webinars.
http://www.salestax-usetax.com/
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Be Careful with your Assumptions

I was talking with a friend the other day. As I like to do, I figured out a way to introduce sales tax into the conversation. I knew that his customers were usually wholesalers and dealers. Here's the way the conversation went:

Me: So, Bob, do you guys charge sales tax?

Bob: Nah. Everyone who buys our stuff is buying for resale. We never sell to the end user.

Me: Not even off your website?

Bob: Nope. The quantities are just too small. We're set up to ship skid-loads of material. We just refer consumers to a list of dealers on the website

Me: What about contractors. You do sell directly to big contractors, don't you?

Bob: Yeah. But they're buying for resale too.

Me: Bob, I'll bet you didn't know this, but contractors are, in most states including the one we're in, considered the end users of the building materials they buy. Therefore you should be charging them tax. As far as the law is concerned, they are NOT wholesalers or retailers. They're the consumers.

Bob: [long pause]

Me: And I bet you're not getting resale certificates from your wholesale customers either. When you get audited, you'll need those certificates, even if it's your business model to only sell wholesale.

Bob: Can I use your phone. I left mine in the car.

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Folks, you must be careful with your assumptions. Make absolutely sure of the taxability of every sale you make. The safest way is to assume everything is taxable until you can confirm that it isn't.

Here is the golden rule of taxability, which states the defaults for sales of services and sales of TPP. And here are the exceptions. And here are the situations where you'll need certificates.

Note that, if Bob had asked his contractors for resale certificates like he did for the rest of his customers (ahem), he would have discovered his mistake. Most contractors would be nervous about providing a resale certificate. Bob would then have presumably realized he should be charging them tax.

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The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only. Research these issues thoroughly before making decisions. Remember: there are details we haven't discussed, and every state is different.

Here's information on our upcoming seminars and webinars.
http://www.salestax-usetax.com/

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Watch Out, Construction Contractors!

There was a case recently in Minnesota. You can read the opinion here, if you dare. Section I is what I'm going to talk about.

Remember the typical way that contractors are handled in most states: they pay sales or use tax on their building materials but do not charge their customers tax. What they sell (construction contracts) isn't taxable.

The intention of the law is that the contractor, when preparing his bid, factors in his material costs, which include the sales tax. So the contractor really looses no money. The tax gets passed on to the customer, buried in the material costs.

But in the above situation, the contractor got busted. He didn't bury the tax in the material cost. Instead, he showed it separately on his billings and apparently in a pretty obvious way. It was so obvious, (and I'm reading between the lines a little) that his customers (and the auditor) could easily assume that he was billing for the sales tax.

Minnesota law states that, if you bill someone for sales tax, you owe that money to the state, even if the billing was incorrect or illegal. Similar laws exist in many of the states.

This guy had billed his customers sales tax by showing it on the invoice. Minnesota held out their hand and said, "pay up." He argued that he had already paid the tax to his building materials vendors. They said, "Don't care. You collected sales tax. Pay it to us." He lost.

I'm often asked about this by contractors. "My customer wants to see my costs broken out separately on the invoice. Can I show the sales tax I paid?"

The answer is be very, very careful. You don't want it to look, in any way, like you're charging them sales tax. Frankly, the best way is just to show the material cost, with the tax as part of the number. Heck it's calculated for you - it's at the bottom of your materials invoices. But if you show the tax on the invoice, even if you're careful to say that it's merely one of all the costs you've paid for the materials, you might get an over-zealous auditor. Like me.

Check the law in your state to see how much flexibility you have. And write your contracts so that you don't have to break out the sales tax on the your invoices.

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The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only. Research these issues thoroughly before making decisions.

Here's information on our upcoming seminars and webinars. Don't forget, we just announced our February to April schedule!
http://www.salestax-usetax.com/

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The Standard Contractor's Rule

First of all, a definition: in this discussion, "contractor" means a construction contractor - someone taking tangible personal property and turning it into real property.

In most states the standard way these situations are taxed is that the contractor pays tax on his building materials - the stuff that goes into the building. He does not charge his customer tax. The logic is that the contractor is actually using those materials to perform the non-taxable service of building real property.

The other view is that the contractor is the last person to buy the building materials as taxable tangible personal property. Therefore, he pays the tax. Either way, states have gravitated towards the treatment of the contractor's purchases as being taxable.

Of course, the cost isn't eaten by the contractor. She will pass it on to her customer as part of her materials cost. But the sale to the customer is not a taxable sale and therefore there should be no tax on it, as such.

This same treatment is usually used for contractors that repair or improve real property as well.

Maybe half of the states have an exemption that allows the contractor to purchase their building materials tax free if the project is for an exempt organization, like a church or a school. But it is not universal.

Finally, there are states that do not do it this way. They either consider the entire sale from the contractor to the buyer to be taxable, the services to be taxable, or some combination thereof.

And then there are a couple of states that have a contractor's occupation tax. Sigh.

Sales Tax Guy
See disclaimer and make sure you check the rules in YOUR STATE.