Construction Sales Tax Liabilities: Invoicing Customers
December 25, 2014
Contractors are at risk in three general areas: managing the contract, invoicing customers, and purchasing items for use in the contract.
In this article, we focus on the second area: what firms need to know about invoicing customers. (Click here to read the first article in this series, on managing the contract.)
Determining If a Service Is Taxable
Before you even create an invoice for a customer, some basic facts need to be obtained and understood about how you should itemize the invoice, and if tax will be charged. Whether or not you’re required to charge your customers tax depends on the answers to a few questions: Are you considered a retailer/installer or a contractor? What are the differences between these designations?
It’s not as cut-and-dried as you might think. In some states there may be even a hybrid version of retailer/installer and contractor designations. Mostly it will depend on the type of service that you’re performing, the inventory you typically maintain, and how your business operates and interacts with its customers.
The Risk of Presenting Invoices Incorrectly
The basic questions for tax on construction invoices always come down to this: Do you charge tax on materials, labor or both? Should these items be separately stated? Any one or all of these can be taxable in certain states at any given point, and all three areas of cost should be broken out appropriately, based on contract terms. Time and materials contract invoices could look different than cost-plus contract invoices, which could look different than fixed-bid invoices. It all depends on the nature of the job being completed and the rules of the jurisdiction you are operating in.
Absorption and shifting of tax are additional considerations. For example, let’s say you’re providing janitorial services. You have an agreement with your customer to serve them at a fixed cost of $6,000 per year, billed in monthly increments. Depending on the state, that monthly invoice should include sales tax. So, assuming 7% tax, your $500 invoice each month should become $535, with the $35 itemized as a separately stated sales tax line. If it’s not, your company is absorbing the tax – paying it for the customer, i.e., you are not “shifting” the tax burden to your customer. This is usually illegal (few states have rules around this), and it definitely is not the best business decision. If you are not shifting the tax and effectively absorbing it into your bid price, you have reduced your overall profit margin by an average of 7%. Who would want to accept that as a normal operating procedure?
Progress payments and holdback negotiated based on a percentage-of-completion accounting model or some other acceptable method within a contract can be another murky area of sales tax. Again, depending on your business classification and the nature of the contract being performed, you may be required to charge tax only when the project has been completed. In most cases, jurisdictions will require you to tax each progress payment as it has been submitted to the customer for payment. Contract holdback amounts create more variables and requirements and should be researched on a case-by-case basis.
What Business Risk Are You Willing to Assume?
Within the contracting world, it truly boils down to this: sales tax is an extremely complicated area. Some companies may decide they’d rather just pay the sales tax as it is charged by retailers, secure exemptions where possible and be done with it. We understand the temptation to opt out of jurisdictional registration procedures, complying with invoicing requirements and subscribing to sales tax reporting requirements. How can you truly be compliant in every jurisdiction? We recommend that our clients consider this a leadership decision, to truly weigh the risks of non-compliance, and know the potential cost to the business if non-compliance is uncovered. But remember this – your activities in a jurisdiction may not place you on the audit radar of a jurisdiction, but your customers’ activities could pull you into audit activity that you would have never anticipated.
If you have questions about the best course for your company, Smith & Howard can help. Since 1971, we’ve been providing value by assessing the entire landscape of the transaction and helping contractors understand the true taxability of the materials being used and the services being performed. We help our clients reach clarity on their tax liabilities and support them in strategies for minimizing risk and cost.
Please call Timothy Howe at 404-874-6244 to discuss your situation and to learn how Smith & Howard can assist you.
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