I will do my best to explain some of the more basic elements of taxes as they pertain to construction projects. I am not a Tax attorney, CPA, or MBA so please consider my work here to be a guideline and confer with qualified professionals whenever a specific problem arises.
State, County, and Cities collect sales taxes within their geographic boundaries according to legally defined guidelines. Any commercial sale within those boundaries would be subject to the total of all applicable sales taxes – as seen on an ordinary sales receipt.
It didn’t take long for Cities to learn that if construction materials are purchased from out-of-town vendors, the City loses a significant revenue source.
Many cities moved towards a “Use tax” system where the sales tax for all permanently installed materials is assessed at permitting. The city then provides a tax certificate to the contractor which exempts the contractor (and their subcontractors) from paying the city tax wherever they actually buy their materials for this job.
From a practical standpoint, the city may elect to assess their sales tax based on 50% of the contract value of the job. This is because it’s uncommon to get a material’s only total from every subcontractor making it very difficult to accurately calculate the actual material value. GC estimators should be very careful when creating their summary spreadsheet. Use taxes will be calculated on project value commensurate with the material value.
Permits and bonds should be calculated AFTER the use taxes. It would be well advised to consult with the permitting authorities as to what constitutes the “total project value”. Permit fees are often priced by calculations on the total project value. Be advised that every permitting agency relating to the project may have a unique take on this
Bonds should be calculated last as they represent the total contract dollar value that the bonding agency will be responsible for. Bonding fee is assessed on the total contract value – be very careful in calculating this as the math is not as simple as it seems. The bonding agent takes the final contract value against their rate. This means that their effective percentage is the sum of a geometric series where it converges .
So the accurate fee to four significant figures is actually
Bonding Fee = (Subtotal * %fee)/(1-%fee)
Add the bonding fee to the Subtotal for your final contract value otherwise the dollar amount of fee carried is less than you’ll be charged. It’s worth mentioning that you’d need to carefully factor any overhead or profit on your bonding costs because they’re not carried anywhere else. Most companies don’t apply markup to bonds but there’s no reason you can’t.
Here lies a fairly big wrinkle. Cities may not have a Tax License which allows them to collect their use taxes autonomously. In such cases, the use taxes are collected by the State which later pays the City. So at permit time – the GC is not required to pay the use taxes.
Adding another layer of complexity is the interplay of counties. Counties are not licensed to collect their use taxes. Most but not all cities that are licensed to collect use taxes are also licensed to collect county use taxes.
So how do I know what to do?
State department of revenue offices generally publish a sales/use tax packet detailing the applicable rates and how the boundaries interact with their guidelines. State taxes can include add-on percentages for special items like Bus/ transit systems, Stadiums, Museums, Housing Authorities, Public safety improvements, the list can be extensive.
From an estimating standpoint the taxes will be either collected at the Permit stage, or they will be collected through individual sales in the supply chain. The conscientious GC estimator publishes the subcontractor tax rate on their invitation to bid to ensure that Subcontractors carry the correct amount. Be very cautious to get this right as bid-day tax corrections can consume a great deal of time.
Who does what?
Summarizing a bit, any taxes due at the permitting stage should be calculated in accordance with the collecting authority. This is the GC estimator’s responsibility. These taxes are paid in advance of material purchases so they must be excluded from subcontractor quotes. The default condition should be to expect Subcontractors to carry any taxes that are not collected at the permitting stage.
Material suppliers that do not install anything may fall into a situation where they are not required to pay use taxes – the stipulations can be very complex. Vendors who are well versed in the local tax law will often cite relevant tax code provisions if asked. Trust but verify.
Sure Bill knows his motor-driven bison well enough but his bookkeeping is awful.
What about tax exempt work?
It would be wonderful to report that all Government, Church, Charity, and Public School work is entirely tax-free. Be very cautious in reviewing the specifications. It’s possible for an entity to be exempt from State taxes without being exempt from City or County taxes. Architects famously use legalese with so many switchbacks of logic it’s incredibly common for there to be RFI’s filed asking what they mean. This is especially common in projects for Public Universities. Get firm answers from the authorities that actually collect the taxes because they could be the agencies conducting audits on your firm later.
Some GC’s are obsessive about tax rates. Merely listing “taxes” in the inclusions is insufficient information for these firms. They will doggedly require every bidder to list the precise percentage on every proposal. Subcontractor’s with any experience in the market are aware that they must include their tax burden on their proposals. Depending on the magnitude of the project they may default to a maximum percentage rather than the exact rate legally required. Be very wary of subcontractor bids that exclude taxes entirely. Unless they are labor only – such proposals should include a breakout of the material pricing for tax calculation purposes. That of course assumes the project is not tax exempt.
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© Anton Takken 2014 all rights reserved