Contractors are at risk in three general areas:
In this article, we focus on the second area: what firms need to know about invoicing customers.
Before creating a customer invoice, you must establish how to itemize the invoice, and determine if the job is taxable. Whether or not its a requirement to charge your customers tax depends on the answers to a few questions: Are you a retailer/installer or a contractor? What are the differences between these designations?
It’s not as cut-and-dry as you might think. In some states there may even be a hybrid version of retailer/installer and contractor designations. For the most part, 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 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? All of these can be taxable in certain states at any point. Additionally, all three areas of cost should be broken out appropriately, in accordance to the 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 task at hand 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 includes 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 negotiations based on a percentage-of-completion accounting model can be another murky area of sales tax. Again, depending on your business classification and the nature of the contract, it may be a requirement to charge tax only upon project completion. In most cases, jurisdictions will require you to tax each progress payment upon submission to the customer for payment. Contract holdback amounts create more variables and requirements and you ought to be researching on a case-by-case basis.
Within the contracting world, it truly boils down to this: sales tax is an extremely complicated area. Some companies decide to pay the sales tax as retailers charge, secure exemptions where possible and be through with it. We understand the temptation to opt out of jurisdictional registration procedures. How can you truly be compliant in every jurisdiction? However, 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 may not anticipate.
If you have questions about the best course for your company, Smith and Howard can help. Since 1971, we’ve been providing value by assessing the entire landscape of the transaction. In addition, we help contractors understand the true taxability of utilization of materials and the service performance. We help our clients reach clarity on their tax liabilities and support them in strategies for minimizing risk and cost.
If you have any questions and would like to connect with a team member please call 404-874-6244 or contact an advisor below.CONTACT AN ADVISOR