Audit-Proofing Construction: Tax Mistakes Hiding in Plain Sight

In this episode of Beyond the Ledger, host Shardae Layfield sits down with Adrien Echols to explore why sales and use tax remains one of the most overlooked compliance risks facing construction companies today. The conversation examines common mistakes contractors make, why tax issues often remain hidden until an audit, and the documentation practices that can help businesses build a stronger, more defensible compliance process.

Takeaways

• Sales Tax Complexity Goes Beyond Collection: Construction companies often face filing and use tax obligations even when they are not required to collect sales tax.
• Nexus Creates Hidden Risk: Operating across multiple states and jurisdictions can trigger tax obligations that many contractors fail to identify early.
• Use Tax Is Frequently Overlooked: Contractors often focus on sales tax while missing complementary use tax responsibilities on materials purchased and consumed in projects.
• Audit Exposure Can Remain Hidden for Years: Many compliance issues do not surface until a state audit or major review uncovers gaps in reporting or documentation.
• Assumptions Can Be Costly: Believing taxes were paid somewhere in the process does not always mean the correct amount was paid or remitted.
• Documentation Drives Audit Outcomes: Contracts, invoices, quotes, change orders, and supporting records should remain consistent and clearly define project scope.
• Project Scope Matters: The distinction between new construction, repair, and remodeling work can significantly impact tax treatment in many states.
• Resale Certificates Require Careful Management: Not all states allow contractors to purchase materials tax-free using resale certificates, making compliance requirements highly state-specific.
• A Strong Audit Trail Provides Protection: Maintaining organized records and accurately documenting tax decisions can help reduce audit exposure and support deductions.
• Proactive Planning Reduces Risk: Regular reviews of tax obligations, filing requirements, and internal processes can help construction companies identify issues before an audit occurs.

Chapters

00:00 – Introduction & Episode Overview

00:55 – Why Construction Companies Create Sales Tax Exposure Without Realizing It

02:21 – The Most Common Sales Tax Mistakes Contractors Make

03:49 – Why Tax Problems Stay Hidden Until an Audit

04:40 – Where Construction Tax Issues Usually Begin

05:50 – The Costly Assumption That “Tax Was Paid Somewhere”

06:38 – California and the Growing Focus on Use Tax Enforcement

08:00 – What Auditors Look for First During a Construction Tax Audit

10:11 – Documentation Mistakes That Create Audit Exposure

11:44 – The Importance of Scope, Contracts, and Tax Clauses

12:42 – Resale Certificates and Exemption Pitfalls

14:31 – Building a Strong and Defensible Audit Trail

16:14 – Proactive Steps Contractors Should Take Before an Audit

17:39 – Key Takeaways & Closing Thoughts

🔗 Learn more: btcpa.net | Follow Bennett Thrasher for more conversations that move business forward.

Transcript

SPEAKER_00 0:09

Welcome back to Beyond the Ledger, where we go beyond the numbers to explore the strategies, risks, and opportunities shaping today's business landscape. I'm your host, Shard A Lakefield. In this episode, we're diving into one of the most overlooked but financially impactful areas of the construction industry. Sales and use tax compliance. From mixed tax rules and resale certificate issues to documentation gaps that create audit exposure. Many construction companies unknowingly create risk long before problems surface. Today's conversation explores where contractors most often get sales tax wrong and how businesses can better protect themselves before an audit happens. Joining us today is Adrian Eccles, Senior Manager in Bennett Thrasher's state and local tax practice, who specializes in helping construction companies navigate complex state and local tax issues and reduce compliance risk across complex project environments. Together, we'll explore where construction companies most often get sales tax wrong, why many issues stay hidden until an audit, and what businesses can do to strengthen documentation and build a more defensible compliance process before costly problems arise? Thank you for joining us today. Happy to be here. All the way from Dallas. Thanks for having me. Finally in Atlanta. So let's dive right on in. All right, Adrian. Construction companies deal with a lot of moving pieces across projects, vendors, and jurisdictions. Why is sales and use tax such a common area where businesses unknowingly create exposure?

SPEAKER_01 1:47

Yeah, it's a great question. So with construction contractors, you often have, you know, the company that sells the contract and then another company that potentially executes the contract. You've got purchases of materials and you've got multi-state considerations when you buy free of tax into inventory and deploy those materials into the state where the project's located. Understanding what states or jurisdictions, both state and local, you have a sales tax obligation or a use tax obligation in is really important. And a simple Googling of I'm a contractor in Atlanta, do I have to collect sales tax would result in a no, you don't have to. And a lot of companies think that that's sufficient. And in reality, uh when you trip Nexus or if you have a relationship with the state such that the state mandates that you uh begin registering, collecting sales tax or remitting use tax, um, that technical obligation isn't covered by just your lack of obligation to collect. So uh understanding where you've got Nexus, uh, where you have a filing obligation, whether or not you have a sales tax obligation or the uh complementary use tax obligation is something that most construction companies don't have a great handle on.

SPEAKER_00 2:54

And do a deeper dive than Google. Google would be a great start, but don't stop there.

unknown 2:59

That's right.

SPEAKER_00 3:00

All right. So when you work with contractors or construction companies, what are some of the most common sales tax mistakes you see businesses make without realizing it?

SPEAKER_01 3:09

Yeah, so right from the start, it's not getting registered in all the different jurisdictions where you've got an obligation. Um just recognizing that you don't have to collect sales tax doesn't mean you don't have to start filing. Uh and then once you do start filing, uh you have to recognize whether or not you have a use tax obligation. So again, a use tax is complementary to the sales tax. If you didn't pay sales tax at the appropriate rate or at all on the materials that you purchase to do a construction job, you have a use tax obligation, uh, typically on the cost basis of materials, but that can be stepped up through improvements to those materials uh that happen uh at your warehouse before you know um you issue those out of inventory. Um there are a number of different potential use tax consequences for contractors, and it's it's a difficult thing to track. Contractors are not often tracking use tax appropriately in their ERP, especially those in the smaller or growing um sort of company size. And then, of course, once you know you get to the point where you start getting scrutinized by a state, it's often too late to go and address that uh without professional assistance.

SPEAKER_00 4:11

Aaron Powell So a lot of these issues seem to stay hidden for years before surfacing. Why do construction tax problems often go unnoticed until an audit or major review happens?

SPEAKER_01 4:22

Yeah, that's a great question. It goes back to the earlier point. Um, a cursory review of you know Google or whatever uh AI options often result in a no, you don't have to collect sales tax. But again, it doesn't mean that you don't have a filing obligation, and it doesn't mean you don't have a use tax obligation. Um often contractors are buying from vendors and they sometimes will issue an exemption certificate because they recognize, you know, at a surface level that they could issue a resale certificate to buy materials free of tax into inventory, but then don't understand their remittance obligation once they issue those out of inventory.

SPEAKER_00 4:56

Are there certain operational areas like purchasing, subcontractor management, or job costing where tax issues tend to originate most frequently?

SPEAKER_01 5:05

Aaron Powell I would say all of the above. Okay. Um with respect to purchasing, respect to are you maintaining tax-free inventory? Uh are your vendors collecting tax? Um the inconsistency there and the assumptions that contractors make when making those purchases from their vendors or suppliers uh often create issues down the road. If they're not appropriately documenting that transaction in an audit scenario, they may end up with a assessment that they otherwise wouldn't have if they simply documented it better. Um then also understanding that you know they've got their vendors may be spread across different states, and those vendors may not be set up to collect sales tax at the contractor's uh warehouse location. In those cases, those suppliers may not collect sales tax, and again, it triggers that you have a use tax obligation where you didn't pay sales tax on items that you consume.

SPEAKER_00 5:57

Aaron Powell Companies assume that if taxes are being paid somewhere in the process, they're compliant. Why can that assumption become so costly later on, though?

SPEAKER_01 6:06

Yeah, it's a good question. Um, some contractors by paying tax on their purchases into inventory or paying tax on the materials that are going to be consumed in the job feel like their bases are covered. In some cases that may be true, especially when they're paying sales tax to a vendor who's charging at a higher rate than is ultimately due or at the same rate that's ultimately due. But with state and local tax, and or sales tax in particular, the rates vary across different cities, uh, counties, and then of course across states. And so a difference in the rate that you paid, even though you get reciprocal credit on the tax paid in the jurisdiction that you're going into, generally speaking, um, you may still have some rate play there that results in a use tax obligation. Additionally, uh when materials are bought into inventory and if they're improved in inventory, once those move across state lines, the basis for use tax could be stepped up. We see this in California very often. Um you buy structural steel, you bend it, you machine it, you code it. It all of a sudden has a higher market value when it goes into like a state like California and is consumed at the job site, and you have a use tax consequence on that stepped up value.

SPEAKER_00 7:21

And I've got like a side question. Why do you see that most frequently in California?

SPEAKER_01 7:27

Um You know, it's not just California, it's a number of different states, but California is one that um from a macro perspective, uh the as in the sales tax landscape, as our uh as the economy is sort of shifted into more services and SaaS, California is a state that doesn't tax SaaS. And so they have to make up that revenue by in their enforcement process in other industries. So construction is one that we see because of the complexity and because of the nuance that they are aggressively targeting with respect to uh identifying use tax under remittances.

SPEAKER_00 8:02

Got it. Okay, so let's shift into audit specifically. When auditors review construction companies, what are they actually looking for first?

SPEAKER_01 8:11

So in an audit scenario, uh an auditor is looking at both your sales population and your purchase population. Uh the sales population is obviously gonna be bigger. That's, you know, it's got your your cogs and your profit and your labor all all baked into the total job price. Um they're gonna look at your sales population. At the same time, they're gonna look at the purchases that you made of materials that could be consumed in those jobs. So in effect, you're looking at the same transaction on both the sales tax and the purchase side for all the cogs. But big picture, an auditor's looking at your gross receipts, are you reporting those correctly? And then they're looking at your taxable sales, are you reporting those correctly? The difference, the delta between those is your deductions. And you've got to have that supported. So all of those non-taxed elements in a job, if those aren't supportable, it's gonna result in an assessment.

SPEAKER_00 9:01

Okay. Documentation tends to make or break an audit outcome. What are some of the biggest documentation gaps that create unnecessary exposure for contractors?

SPEAKER_01 9:11

It's a great question. And frankly, it varies across jobs. So what we see is inconsistent treatment from small jobs to large jobs, for example. Small jobs might be billed on just a simple invoice, whereas large jobs have an overarching contract, they had a you know a quote, um, they might bill on an AIA schedule for progressive payments uh with change orders. Um the complexity there is that you want your documents to be consistent across the quote, the contract, then the invoices that relieve that all the way through. And in addition to that consistency, you want the scope to be uh easily demonstrable. So whether it's new construction or repair and remodel, it matters. And if your documentation uh isn't consistent, you might have a quote that makes it look like a new construction job, and then invoices that make it look like a repair remodel job. And that's very consequential in a state like my home state in Texas. So consistency is key. Uh ensuring that there's a contract with a defined scope is really important, and then we always recommend a tax a strong tax clause that addresses sales and use tax considerations for that job.

SPEAKER_00 10:12

Is there any part of that process where you see inconsistencies more often?

SPEAKER_01 10:19

Um yeah, I think you know scope is is the key one. Um if you don't have a defined scope that both parties have kind of agreed on and uh uh and signed off on, then you leave it somewhat to the to an external party's interpretation. And of course, a state who's looking for revenue is going to assume that when you, you know uh demoed a wall or something that it was partial and that's gonna be taxable as uh in my home state anyway, as uh repair and remodel. Whereas a complete demo down to the grade would result in a non-tax consequence on the labor. So that distinction is really important. You want to make sure you capture scope, all the various terms. You want a tax clause that identifies like what your tax treatment is uh or who takes responsibility if necessary so that you have some um recourse in the event of an audit.

SPEAKER_00 11:10

Okay. Resale certificates and exemptions are often misunderstood in construction. What are some of the biggest pitfalls companies run into when managing exemption documentation?

SPEAKER_01 11:20

Yeah, it's a great question. So there's a there are a number of different types of exemption certificates that will show up uh in the course of my work. So you mentioned resale, so a typical contractor can opt to issue a resale certificate to their vendors, suppliers, so that they can purchase all their materials into inventory free of tax. Um not all states allow contractors to issue a resale certificate for materials because the contractor is deemed the end user or consumer. And so you're actually um breaking the rules in effect if you issue a resale certificate as a contractor. There are other types of exemption certificates too. So there are some that would follow the uh the project owner, so their status, a nonprofit, a government agency. Um we see this often when companies are doing jobs for a municipality. Um and the key thing there is understanding in the particular state that you're operating in whether or not that exempt project status uh for the end project owner can be cascaded all the way down through the GC and then the subs and subs of subs. In some cases they can, in some cases they can't. And so you want to either read the rules, uh check the code, or consult with your attorney, CPA, or friendly sales tax consultant.

SPEAKER_00 12:37

Would it also be great just to also do the all three, but still and like make sure they're yes, yes, that's right. So at least they have a basis of understanding when they're going through the process with you all. Okay. So for companies trying to strengthen their compliance posture today, what does a strong and defensible audit trail actually look like in practice?

SPEAKER_01 12:57

Yep. So the foundation there is understanding your nexus, like when did you have the obligation to get registered? Are you filing? All right, that's first and foremost. Umce you're filing and and you're compliant um with your basic technical obligation, at least you get statute limitations protection. So we always start with that. How far back did you have to register? Did you do so? And have you been filing? Now, of course, if you're wildly inconsistent and misrepresenting, you know, your gross receipts and your deductions, we could run into an issue where you don't get that protection. But generally speaking, we want to make sure you're filing and you're compliant so you get statute limitations protection. That's first and foremost. Um after that, I would say ensuring that your ERP or bookkeeping software has the requisite information needed to make a determination uh of taxability. And so whether that's you know including the contract structure, right, lump sum versus time materials, or if it's including uh residential versus non-residential as part of the scope, having those kind of key elements tracked in your ERP are great. Um you obviously want the contract if there's a governing contract, uh you want change orders, and you want to make sure uh you can document how sales tax was handled on all of your purchases of materials used for those jobs.

SPEAKER_00 14:14

And looking ahead, what proactive steps should construction companies take now to better protect themselves before an audit ever happens?

SPEAKER_01 14:23

Yeah, I think if you're doing something internal, it it starts with the documentation and making sure you have all those elements that we talked about earlier. Um you don't have an in-house person who's adept at sales tax, I'd say go ahead and consult with either your attorney, CPA, sales tax consultant, all three, and start thinking about putting uh some procedures in place to make sure you're capturing all of the uh requisite information that would come up that could impact your taxability. Um you want to make sure that someone with knowledge of the sales and use tax compliance process has sort of vetted what you're doing on your returns and that you can speak to those deductions because ultimately the tax authority isn't as concerned about all the tax you're remitting. They're more concerned about what you're not remitting. And so the deductions that show up on your return need to be substantiated.

SPEAKER_00 15:14

Okay. Well, thank you, Adrian. This was a great conversation. I'm sure a lot of people took away a lot of your gems you had today. The insights were very valuable, especially someone wanting to make sure that they don't run into problems or what to do if they already are in a little situation. So thank you so much and hope to see you back soon.

SPEAKER_01 15:34

Thank you, Sardane.

SPEAKER_00 15:36

That wraps up today's conversation with Adrian Eccles. Construction sales and use tax is far more than a back office compliance issue. From overlooked tax rules and exemption documentation to audit readiness and defensible record keeping, the gaps companies ignore today can quickly turn into costly exposure years later during an audit. Thanks for tuning in to Beyond the Ledger. For more insights and expert perspectives, visit BTCPA.net and explore our latest resources. And don't forget to like, follow, and subscribe. And until next time, I'm Sardane Layfield, and we'll see you for the next conversation.