Construction Sales Tax: Why "Good Information" Still Gets Contractors Audited

Jason Parr, Danny Wright, and Paul Johnson dig into one of the messiest corners of sales tax compliance... construction and contracting. 

If you think you're safe because you haven't hit economic nexus thresholds, this episode is for you (physical nexus has been the law for 50+ years, and subcontractors or 1099 sales reps working on your behalf can create it without you knowing).

In this episode, the guys cover:
- Why physical nexus still matters even in a post-2018, economic nexus world
- How using subcontractors or independent sales reps can create nexus you didn't see coming
- The real property vs. tangible personal property debate (and why a Tesla charger installation can turn into a legal gray area)
- How Texas, New York, New Jersey, and Arizona each handle contractor taxability differently... and why treating them the same is a costly mistake
- What a capital improvement certificate actually does (and who's responsible for signing it)
- Real audit stories, including a six-figure surprise after a "No Tax Due" audit years earlier with zero changes in the business

The big takeaway: what your competitor does, what your vendor does, or what worked in your home state doesn't tell you what's actually required somewhere else. Every state writes its own rules, and construction is one of the industries where "close enough" gets expensive fast.

If any of this sounds familiar, or you're not sure where your business stands, book a free What's Next call and we'll help you figure out where you actually have exposure.

Transcript

– Introduction & team chemistry

SPEAKER_03 0:00

You're listening to the Sales Tax People Podcast.

SPEAKER_00 0:07

You've never charged sales tax on a construction job in your life, and then you take on a project in Texas or New York or Arizona, and all of a sudden the rules you followed for twenty years don't apply anymore. Is that fixed your real property or is it still tangible personal property? Is that a capital improvement or just a repair? Is your subcontractor creating Nexus for you right now in a state you didn't even know you had a presence in? Today we're talking construction. The assumptions that get contractors in trouble, the states where things get complicated fast, and the six-figure audits that show up years later with nothing having changed except the auditor. If you've ever said none of my competitors charge a tax on this, stick around. This one's for you.

SPEAKER_02 0:46

Just the thing for us. Oh, get it, bro. That is the best intro. It's got all the things. Par with the jingle, Paul laughing. Oh my gracious.

SPEAKER_04 1:05

The perfect intro to our best episode ever.

SPEAKER_01 1:08

You threw me on that one, bro. That was amazing. I mean, he said he had a thing for us. And I can appreciate, you know, having a thing for Paul. I have a thing for Paul. But it's just what came to mind when Danny said, I've got a thing for y'all. And I just appreciate that. That's very kind of you to say that you have a thing for us. And then it just made me think of uh, you know, just the two of us. But it's the three of us and just the thing of us. Anyway.

SPEAKER_04 1:44

Actually, a lot of times it's just the two of you, and I'm just here being entertained, observing, and appreciating it.

SPEAKER_05 1:52

It's true. We have such a long history of just working side by side in the same office and traveling and all the things, right? I mean, we've been doing work together for nearly 18 years now. It's so a lot of inside jokes, a lot of history.

SPEAKER_02 2:07

Yeah.

SPEAKER_01 2:08

Actually just the the thing you actually don't do is tell inside jokes in uh in a public space or in a group setting, which we're in because we're on a podcast right now. But I will say this Paul and I early in our history and relationship together, uh have always hit it off from the beginning. And we can do things that make each other laugh. Now, we actually were reprimanded 15 years ago. 15 years ago by the original founders of the firm. I was in a leadership role, we were in a uh meeting in a boardroom, Paul and I are cutting up a little bit, and um the partners pull me aside and tell me you you need to settle that down. And I thought to myself, business is built on a relationship, and I don't think I'm gonna do that.

– Taking sales tax seriously (without taking ourselves too seriously)

SPEAKER_01 3:08

And I don't think our relationship has been different over these last 18 years.

SPEAKER_02 3:17

So sometimes what you see is legitimately what you get or what everybody else gets when they're around us. So true. Yes, it is the the ideal combination of just real relationships, some good candor, right?

SPEAKER_04 3:37

Some some fun, and then the sales tax piece that we take very seriously, right? What's the par what's the parism? We don't take ourselves too seriously, but we take sales tax seriously.

SPEAKER_01 3:53

Yes, we do. And I'm ready to get serious. This is my serious race, as a matter of fact.

SPEAKER_04 4:00

We don't need to be too serious, but we will you you can be focused, right? We are gonna be focused on providing some sales tax information here. And that's uh I mean, I don't even remember, you know, what we were gonna do. No,

– The #1 problem: companies operating on assumptions

SPEAKER_04 4:16

not just kidding. Our our our day consists of lots and lots of phone calls. Okay, and I'm talking specifically phone calls with great companies that we're we've been introduced to through marketing efforts, and a lot, a lot of cases, it's through our trusted partners, just great people, advisors, CPAs, uh CFOs, right, finance and accounting leaders. Um, and then speaking of relationships, oftentimes we're just you know meeting people in the community or having conversations with friends and even family sometimes, uh, that you know, here decades later for you guys, a decade later for me, of like, so what exactly is it that you do, right? So we we have all these conversations and they're coming from all these different uh r sources, you could say. One thing that comes up in almost every phone call is these companies are operating in a certain way and managing sales tax in a certain way based on assumptions. Uh, even you know, sometimes that comes from some amount of sales tax information they've gathered, however that may be. A lot of times they've had people both internally and externally, right? Some sort of contractor advisor that's given them advice and information. It's not that it's uh always wrong. Um, sometimes it's even perfectly correct information, but it's poorly applied to these companies. That's what we're getting at here, right? To the point of that this uh kind of piece, this discussion that we want to have is that so often these companies are operating under, like I said, these assumptions. They're just they have issues because um they just have poor information. Let's put it that way. Okay. What are some one one of the big ones is in construction specifically, right? And and part of the reason why it's such a challenge and why people have good information applied poorly or

– Physical nexus vs. economic nexus—what contractors miss

SPEAKER_04 6:29

just you know, crappy information, sometimes that happens too. That it's often caused by the fact that it is so complex. So if you take like one snippet of information in an area that's super complex, that can lead you down, you know, to terrible places as far as you know, sales tax compliance is concerned. So what what are some of the biggest issues? Um, what are some of the main kind of topics or ideas? Uh, some of the specific rules and even states that come to mind for you guys when we bring up compliance and construction.

SPEAKER_02 7:07

Two two things come to mind specifically.

SPEAKER_01 7:11

You you may not think that this one correlates, but uh construction companies typically are going to establish Nexus um based on their physical presence. Right? Post 2018, most people when they're thinking about Nexus are thinking about economic nexus. They're really not thinking about physical nexus. So one assumption people make is that the only way you establish Nexus is by exceeding the economic thresholds in a particular state. So we can be talking with someone um inside or outside of construction, and um they're talking through the states where they believe they've exceeded economic nexus, but then when we have them complete a survey in preparation for understanding where their nexus footprint might be, it starts asking about different physical activities that they have, right? And then so sometimes what we learn is hey, you you've had actual physical nexus in five states for 10 years. Um, it's had nothing to do with economic nexus. And I think uh contractors, this can really come into play for two for two reasons. Maybe they use subcontractors to do some of their work, maybe they're a GC and subcontractors are doing the work and they don't recognize that when a third party is doing the work on their behalf on their project, that they actually create physical nexus.

SPEAKER_05 8:36

Even if they're 1099?

SPEAKER_01 8:38

Even if they're 1099. Yeah.

– Why your home state rules don't apply everywhere

SPEAKER_01 8:42

They don't have to be employed by you, they can just be contracted by you to do work on your behalf.

SPEAKER_05 8:47

What if I just pay them a uh like a referral fee or a commission?

SPEAKER_01 8:53

Yeah, so like uh an independent sales rep. Independent sales rep physically in the state, selling on your behalf. They might be selling goods on multiple people's behalf, but if they're in there and they have an agreement with you to sell your products or services, then yeah, that pulls you in. So that's one assumption that comes to mind is just this idea that I don't have Nexus because I don't have economic nexus, right? Physical Nexus uh is is still uh the the leading factor on the books. You know, we're going back 50 years that this has been in place. The other assumption that you have, like in construction specifically, is contractors uh typically they're not they're not necessarily going cross-country to necessarily do projects. A lot of contractors are doing projects in their own backyard regionally. They might do it in a few states, but they're not typically doing it in multiple states. So contractors really get into mentality across the U.S. Remember, every state has its own sales and use tax law. And across the U.S., every state has rules associated with imposing sales tax on people who are engaged in contracting services. So typically that's going to be someone doing repair or remodeling or incorporating property into real property.

– Real property vs. tangible personal property: the gray area

SPEAKER_01 10:18

And you get real used to the way that it works in the state or the few states that you operate in. And so contractors can get used to the idea that they're the consumer of all materials, tools, and supplies that are used and or incorporated into the property that they're working on. They're considered the consumer of that and they don't charge any tax ever on their services. That's probably, I don't know, Paul, that's probably 35 or more out of the states that impose sales tax. Might be even more. I'm I mean, that might be 40 states that operate that way.

SPEAKER_05 10:56

Yeah, I would say a majority of the states, contractors performing the work, I mean, they're they're they're considered the end user, the final consumers of the TPP, right? So yeah, they're they're effectively responsible for that. And I explained this to a client just the other day, actually. They were confused by that. And I said, Well, they could think about it this way the tangible personal property that you're purchasing, it effectively just disappears because it because it's incorporated into real property. You take the two before is the nails, everything that you're building this building, and now it becomes real property. And therefore, you can't sell it to the customer for resale necessarily by default. Now, obviously, there's a lot of exemptions which we'll get to, but yeah.

unknown 11:44

Yeah.

SPEAKER_01 11:44

Then all of a sudden, yeah, go ahead.

SPEAKER_04 11:47

There's some interesting complexity in that too, where you even talk about it becoming real property. Because there's certain types of construction and even certain products that are used that are in that gray area of like, does this remain personal property versus becoming real property? And I that's there's a a current client right now that we're working with that you know, we just brought on board, and they they they were operating under the assumption that um that as they are built, they actually have a big franchise network, so a bunch of franchisees, and they they build out these facilities for their franchisee, and they're just certain products and and certain kind of materials, just the way that they build out these facilities, they're products that's like, yeah, normally if that you know particular thing was in my backyard and I was just using it and my kids are using it, yeah, it's personal property. But when it's being bolted down and it's you know, it's like there's that question at what point does it cross the threshold of going from personal property to you know real property? And it's it's really one of the massive problems that companies run into that you know they don't address it and dive into it, and thus you know, they have some significant exposure. And this particular company with that model uh ran into some issues even in a state where you know they ended up with some liability and of course penalties and interests because the tax wasn't handled correctly.

SPEAKER_01 13:29

Aaron Powell Yeah, even if it's well defined. I mean, most of these statutes in every state have all of these items defined, right? It's it could be temporary, it could be permanent, it could be considered a fixture. Is a fixture real property or is a fixture tangible personal property? Have you built real property with a fixture or have you attached it to real property and it retains its classification as TPP? So do you switch from contractor following construction rules to an installer who has to follow different rules because installation services might be taxable and construction services aren't? Or those items might be separately stated. And if you're an installer, you would charge no tax on your labor in one state, but you would still charge tax on the item that you're installing. So when you start talking about appliances that are connected to plumbing and electricity, um, when you start thinking about you're buying a Tesla and you're installing a supercharger, is that real property? Is that a fixture? Is it tangible property? Well, it depends on the state. Depends on the state how they define it. But even with really good definitions,

– State-specific complexity: Texas, New York, Arizona, New Jersey

SPEAKER_01 14:40

uh, some of these uh issues go to court because of how it's defined and what's determined. Some definitions say it's real property if the removal would create uh material damage. Well, what's material damage? Sometimes the state may say real property, like you could have a large uh storage tank on on your property. Well, if it's over a certain size of storage tank, it's real property. If it's under a certain size, it's tangible personal properties.

SPEAKER_04 15:17

The the definition of the dig a big hole and put the storage tank in there and then you know bury it and cover it.

SPEAKER_01 15:25

Yeah. Uh when I when I put a parking lot down, that seems pretty permanent. But when I lay carpet down in a building, is that permanent? Or is that got a life short enough to determine its tangible personal property? It's kind of easy when you think about drapes or things that you attach to the wall with a screw and you can remove those things. But what if you start installing cabinets or start installing carpet or other types of flooring? Um it's it can get real confusing real quick. So contractors are usually very familiar with the rules in their state. They're trying to operate properly, they don't want to be audited, they don't want to have exposure. But then you walk into states like Texas or Arizona or New Jersey or New York, and you're a contractor who's never collected tax on your uh contracts. Now, all of a sudden, in Texas, you might need to. In New York, you might need to. In New Jersey, you might need to. In uh Arizona, you might need to uh collect tax on a portion of the contract based on the way their their rules are done. So uh Texas gets super complicated real quick because they differentiate between residential and non-residential and the rules that apply. They differentiate between whether it's a lump sum contract or a separated contract and rules for taxation on the services and the materials based on the type of contract. And so, real quick, you can be very confused very quick when you're a contractor having worked in, let's say, Oklahoma, um, for the last 20 years, and now you're doing some projects in Texas, you didn't know you were supposed to tax it, you didn't know when you were supposed to pay tax on materials or not pay tax on materials, um, or in New York, um, you know, maintenance, real property services, repairs, um, all of that is taxable when performed on real property. But if you can claim that it's a capital improvement project, CIP, and you can get a certificate from your customer stating, I mean, they're the ones that have to decide if this is a capital improvement project, because they have to sign a certificate to give to you to not charge them tax, then you become the consumer of all the materials that are incorporated into that job. Otherwise, materials incorporated into that job may not be taxable to you, and you're supposed to collect it from your customer uh when you do that work. So

– "But my competitors don't charge tax…"

SPEAKER_01 18:10

what what what we're falling back on here, what we're talking about, is the fact that regardless of industry, construction is just one that exposes a lot of uh complexity, whatever industry you're in, uh you can't make the assumption that what you're used to in one or a few states, the way that something is taxed, that it's taxed that way in all the other states. You really do need to dig into taxability of your goods and services state by state so that you don't get stuck in a situation where you're paying tax out of your own pocket with penalty and interest.

SPEAKER_04 18:48

Yeah, and don't do it a certain way just because another company in your industry does it that way. Right. And and and don't do it that way just because you know the prior owners of a company did it that way. Right. Because even you you mentioned this par, even in certain industries that are more complex than others when it comes to taxability, you can still find clear, you know, black and white answers, oftentimes in these you know industries and and call it even like tax treatment for you know specific instances of what you just described of you know, time and materials contracts versus lump sum, and then like commercial versus residential construction. You can find clear answers, but the added layer,

– Why following your competitors' tax practices is a terrible idea

SPEAKER_04 19:34

added piece of information that is always worth discovering and diving into is how those rules apply to your business.

SPEAKER_01 19:42

Yeah. Yep. How many times, how many times are y'all on calls where someone says to you, uh, yeah, but none of my competitors charge text? Oh well I can't I can't speak for what your competitors are doing, but I'm just telling you that this is what the state law says, and this is what you should think about, because I don't know if you're gonna be the first in line or your competitors gonna be the first in line that the state's gonna come to and say, Oh, you're you're not handling this correctly.

– Understanding your risk tolerance and worst-case audit scenarios

SPEAKER_01 20:17

Yeah. That's what I guess.

SPEAKER_04 20:19

The other one that comes to mind in that same kind of vein is well, we're working with this vendor or that vendor, or you know, this is our customer, and they're a big company, they know what they're doing. Like they might, but also like they might have you know John McGee over there that's just doing things a certain way because he learned how to do it a certain way, and again, it might not be the most correct way.

SPEAKER_01 20:45

Did Danny just call out John McGee?

SPEAKER_04 20:48

Yeah, John.

SPEAKER_01 20:49

John McGee, if you're listening to us right now, it's okay. It's okay.

SPEAKER_05 20:55

I was gonna mention that usually in those instances, you you I tend to focus a little bit more on the tax liability and their risk tolerance. I mean, if uh if if audited, maybe that business has enough in reserves that could pay the tax with penalty and interest out of their own pocket and they're operating at a much higher margin or what have you. But you ought to consider, worst case scenario, if you get audited and you didn't charge the tax to the customer, and it should have been, you know, on a m on a very large deal, maybe a hundred thousand dollars in tax. Well, if your profit, right, if your margins don't account for that and you have to pay that out of your own pocket with pilling and interest, it's game over. And nobody wants game over. We're just trying to make a living, you know? Yeah.

SPEAKER_01 21:41

Paul, I want to express some gratitude to you today. Um, yeah. Your voice is uh unusually calming today. Typically, your voice is very calming, but today it's it's extremely calming. And the reason I'm expressing gratitude, uh you're as Me, why your voice is so calming. I I guess you are very, very calm. But you're bringing a calm uh expression to a very complicated and complex uh world. So that's why I'm expressing gratitude to you today. Appreciate that. I was gonna ask you have you been to a spa within the last couple of hours? Because you you definitely yeah, you definitely appear this I will say, aside from being relaxed and calm, especially about these subjects. Um I like your fresh cut. Let me just say that.

SPEAKER_05 22:41

Well, thank you. Now last week I did go get a massage. Regular massage, it goes a long way. But I just have a a tender spot, quite honestly, in my heart, for construction companies in general, especially as of late, because we've been working with a couple in particular in Utah and Texas and in Arizona who just got absolutely mauled by the state uh for tax that they didn't owe. And it's just not right. The state believes it's one way, the contractor believes it's another way, they can't see eye to eye, the state issues a large assessment, or the state

– When auditors interpret the law differently—and what to do about it

SPEAKER_05 23:19

issues an unruly ruling in the state's favor and not in the taxpayers' taxpayers' favor. And it's just it's sad. And so for me, when it comes to contractors in in particular, understanding the legislation, understanding your state law, and then as you go next door to the neighboring state, yeah, now you're in a whole different ballpark playing a whole different game. It may be somewhat similar in some aspects, but to take the same legislation in Utah, for example, and applying that in Arizona, I mean, yeah, right. You're amen to that. So yeah.

SPEAKER_04 23:58

Yeah, that's a that's a great point to bring up, even for companies that actually have a good handle on sales tax, and they either go to a new state or they just face, you know, a new audit, you could say. They face an audit in their home state or a certain state where they're operating, you know, five, six years ago, a new audit comes along, and I I see this not like all the time, but there's one that comes to mind specifically in Washington where this company, uh, we were introduced to them uh by their CPA and they were already in this audit, and it was at the you know near the end. And we were able to go in there and look at it, the facts, and look at taxability and just say, like, look, the state has this wrong. And it was something where they just kind of were resigned to you know whatever the state told them, right? There wasn't really any battle. There was some level of resistance, uh, but there was the combination of like adding extra resistance there from you know the information that we were you know sharing with them and that we were collaborating on. And you know, there was some money there that they could, you know, not necessarily claw back because they hadn't paid it yet, but it's like, look, let's push back on this. And actually, they they still ended up in a situation to where there was enough there and they'd like kind of dragged it on long enough and they were just done with it to where they even at that point said, Yeah, let's just kind of come to the table with the state and agree to disagree on some points. No doubt.

SPEAKER_01 25:35

No doubt. Yeah. If you run into a situation that that you don't agree with, we we really want to be involved in that conversation. We'd love to just hear about it and talk through it because one of the things we do run into fairly consistently is a company has uh no tax due audit uh eight years ago. And they've really not changed management, they've not changed operations, maybe there hasn't been any vast changes in legislation uh as it relates to

– The sniff test: no tax due one audit, seven figures the next

SPEAKER_01 26:05

their industry or their company. Um, but they get audited four, five, six years later, and all of a sudden they have a six-figure, seven-figure audit liability. It's like, wait a minute, nothing has changed. We're not aware of any law changes. Uh, the only thing that's changed here is the auditor that conducted the audit, and we go from a no-tax due to a six and seven-figure audit assessment. So uh if the if the sniff test doesn't work, you you should definitely we should have a conversation just to make sure that um you're not getting exposed just to an interpretation that this auditor has in relation to your industry than the previous auditor had.

SPEAKER_02 26:48

The old-fashioned SNF test. No, I don't like seven figures.

SPEAKER_01 26:54

Some don't seem right about that one. Indeed.

SPEAKER_05 27:02

Ain't nobody got time for that? No. You definitely want us as your first second opinion. Nobody got time for an an appropriate application of the law to what we do or how we do it.

SPEAKER_01 27:16

Can we trademark that? That was beautifully said.

SPEAKER_03 27:28

Thanks for hanging out with us on the Sales Tax People podcast. If you want to talk about sales tax, or maybe you have an experience that goes along with something we talked about today, or maybe you just want to hear about how Paul's day is going, make sure you send us an email to podcast at sales dot tax, or you can text us at nine four nine three five five five zero nine eight. See y'all again soon.