California Sales Tax for Construction and Real Property Contractors
As a real property contractor, your construction business is subject to California’s complex system of sales and use tax reporting for the property and services you provide. Different sales and use tax obligations occur when you purchase supplies, consume products, and charge clients under the terms of a contractor agreement. The rules become even more complex depending on the specific type of construction work you do and your method of contracting. It’s important to understand the rules in this highly audited industry to avoid audits and tax penalty and to take advantage of available tax exemptions or deductions on your returns. Our California sales tax guide for real property and construction contractors provides detailed explanations for further developing your sales tax reporting practices.
How California Determines Sales and Use Tax for Construction Contractors
Two primary factors will determine the sales or use tax consequences of the transactions you make as a construction contractor. The first factor is the classification of the property you buy, use, or sell in your contracting business. The second factor is the payment structure used in your contractor agreements that determine if you are a consumer or retailer of the property. California’s sales tax regulation 1521 classifies the property used in your construction business into three different categories: materials, fixtures, or machinery and equipment.
Be Aware of California District and Local Sales Tax that May Apply to Your Contractor Jobs
Your contractor work likely involves traveling to a variety of jobsites throughout California. As a result, you will need to be aware of the district and local taxes that may apply to each of your jobsites, regardless of where your principal place of business is. You are responsible for collecting any excess district tax you may owe and for reporting the allocation of district and local tax on your sales and use tax return.
Registering for a California Seller’s Permit or Consumer Use Tax Account
Depending on how you operate your construction contracting business, you will need to either register for a seller’s permit with the CDTFA or register for a consumer use tax account. A seller’s permit is necessary if you make any retail sales of materials, fixtures or machinery and is what allows you to issue resale certificates to suppliers. If you don’t need a seller’s permit but have gross receipts of $100k or more then you will need a consumer use tax account.
PDF embed: https://www.cdtfa.ca.gov/formspubs/pub9.pdf
The Different Property Classifications for Construction Contractors
Materials refer to the items you use in the construction process that become a part of the real property once you complete the project (i.e., that lose their individual identity in the process). Examples of common materials include lumber, stone, brick, drywall, windows, hardware, etc. You can find a detailed list of construction items California labels as materials in Appendix A of Sales and Use Tax Regulation 1521. Real property contractors are generally the consumers of the materials they use for projects in California. As a result, you will usually pay sales tax at the time of purchase or pay use tax when you consume the materials in your work. Additionally, builders and real property contractors should be aware of California’s lumber product assessment when you purchase certain lumber and engineered wood products.
Fixtures are the accessories that you may install as part of a construction contract but do not lose their individual identity in the process (e.g., a/c units, cabinetry, furnaces, refrigerators, etc.). Appendix B of Regulation 1521 has a more detailed list of common fixtures. In most cases, you are the retailer of the fixtures you provide to customers and will collect sales tax from your customer based on the price you charge for the fixture in your contract. If you don’t state the fixture’s price in your contract, then you will base the sales tax on your price to acquire it. The exception to this rule is if you build or manufacture your own fixtures, in which case sales tax calculation is a result of several factors. For contractors that handle fixtures, the key is using resale certificates correctly when buying from suppliers and charging the right amount of sales tax to your customer or end-user.
Machinery and Equipment
The final category of items you might sell in your contracting business is machinery and equipment. When outfitting a building or other real property, you may provide for things like drill presses, lathes, kilns, etc. as part of the contract. You can distinguish machinery and equipment from fixtures based on whether the item is essential to the structure and whether you can attach or remove the item without losing its identity. Real property contractors should be mindful of the special calculations for determining sales tax when you manufacture your own fixtures or machinery for customers.
How Your Construction Contract Affects California Sales Tax
The type of construction contract method that you use will then determine how sales and use tax applies to the materials, fixtures, and machinery or equipment that you handle. The CDTFA primarily relies on your existing written contracts when assessing sales tax after an audit (regardless of what your billing documents or other records may say). California recognizes several major types of contractor agreements that will impact when and how you report and pay your sales tax. Some contracts and projects may also qualify for discounts, exemptions, or exclusions of California sales and use tax.
Lump Sum or Cost-Plus-A-Fee Construction Contracts
Lump sum contracts are those where a single price is given for the total amount of materials, fixtures, or machinery sold. Cost-plus-a-fee contracts are those that itemize costs for materials (including related overhead) in addition to charging a fee or percentage that represents nontaxable installation labor. Both types offer the most straightforward sales tax approach because you act as the consumer of purchased materials.
As the consumer, you pay sales tax at the time of purchase. If not, use tax is due as soon as the material becomes part of the real property. This rule is critical for contractors who would otherwise attempt to improperly pass that sales tax cost to their customer. Charging the sales tax on a lump sum or cost-plus-a-fee contract leads to excess sales tax reimbursement that will cost you in administrative headache and penalty. Rather, contractors must consider their paid sales tax for materials as a business expense incorporated into their contract quotes. In contrast, you are responsible for collecting and reporting the sales tax from your customer as the retailer of the fixtures or machinery you provide under these types of contracts.
Time and Material Contracts
A time and material contract is one where you separately charge for the sale of materials or fixtures and for the related installation or fabrication. You will be a retailer of materials under a time and material contract under two scenarios:
- If you charge the customer for sales tax based on a marked-up billing of the materials (i.e., a time and material plus tax contract); or
- If you explicitly transfer title of materials to the customer before installation and separate the charges for materials and installation.
The amount of sales tax you must report and collect will depend on if you paid sales tax or not when you initially purchased the material, fixture, or piece of machinery. From a practical perspective, time and material contracts are difficult to use for sales tax compliance with the CDTFA because you would have to account for every nail and lightbulb used on a construction project. The larger the construction project, the more cumbersome this becomes, which is why lump sum contracts are easier to use as a taxpayer.
Other Types of Construction Contracts
California also has special sales and use tax rules for a variety of contractor activities that may apply to your business. Some of these rules offer reductions in sales tax or additional guidance on how to classify particular property (e.g., cabinets, countertops, etc.).
- Fixture Repair Contracts: Sales tax reporting will depend on if you replace the fixture entirely or if you separately bill for parts instead of furnishing them through a lump sum contract.
- Subcontractor Agreements: The CDTFA considers prime contractors as consumers of materials and fixtures offered by subcontractors. Therefore, subcontractors cannot generally accept resale certificates in lieu of sales tax for these transactions.
- Sales of Prefabricated Buildings: Sales tax applies to the entire purchase price.
- Factory-built School Buildings: Partial sales tax of 40% of the purchase price (excluding any charges for placing the building onsite).
- Restaurant Equipment Contractors: The CDTFA offers special guidance with the Restaurant Equipment Contractors Association on the classification of property and sales tax disposition of items you may normally use in this context.
- Cabinet Contractors: Classification of your property sold in cabinetry work as either materials or a prefabricated fixture will depend on application of the 90% rule. If you incur at least 90% of the material and labor cost prior to installation, then the cabinetry will be a prefabricated fixture.
- Countertop Installation: Generally viewed as materials unless it involves a built-in sink or installing a sink prior to final installation, in which case it becomes a fixture.
- On-premises Electric Signs: California views these as fixtures and sales tax applies to the purchase price or 33% of the contract price when the electric sign’s sale price is not specified.
- Solar Energy Installations: Solar panels and other property can be either materials or fixtures depending on how they attach to or function with a structure. Contractors should consider partial tax exemptions for solar energy installations that may be used as farming equipment.
- CAEATFA Exclusions: Some of your construction contracts may be for a “participating party” under CAEATFA, which offers exclusions from sales tax for eligible renewable energy projects (Form CDTFA-192).
- Modular Furniture: Furnishing and installing modular systems furniture is usually a retail sale of property and not a construction contract, but you may be able to claim 10% of the contract price as nontaxable installation labor.
- Landscape Contractors: Be aware of the property classifications for different greenery used in these types of construction contracts (e.g., sod as material vs. trees being fixtures).
- Exemption for Military and Veteran Medical Facilities: Through 2024, California has an exemption (Form CDTFA-230-C-2) for the sales and use tax of property necessary for the construction of qualified facilities by qualified persons (nonprofits or contractors working for a qualified nonprofit).
California Sales and Use Tax for Your U.S. Government Contracts
If you provide contractor services to real property that belongs to the U.S. government, then a more simplified set of sales and use tax rules will apply. You are generally the consumer of the materials and fixtures you furnish in completing a contract, which means you can either pay sales tax at the time of purchase or use tax at the time of consumption. You are the retailer, however, of the machinery and equipment you provide in performance of a contract, which means you can use a resale certificate on the initial purchase. Depending on the work you provide, you could also be the consumer of machinery if you use it prior to passing title to the U.S. government, which can create additional use tax reporting obligations.
PDF embed: https://www.cdtfa.ca.gov/taxes-and-fees/manuals/am-12.pdf
Final Remarks on Sales and Use Tax for California Contractors
The construction industry is a fast-paced environment due to contract deadlines and coordinating with inspectors, subcontractors, and other parties. It can be very easy to overlook the sales and use tax consequences of the property you use or furnish as a contractor. You have some flexibility in how you pay and report your sales or use tax based on how you contract and other business considerations. This flexibility can also lead to pitfalls from an audit if you are not consistent or lack records sufficient to support your tax reporting. It’s important to always think about if you are the consumer or retailer of the involved property involved so you can either pay or collect tax, issue a resale certificate, or file for an applicable exemption on your return.
Schedule a free consultation for your questions about sales tax for California construction contractors and related CDTFA audits.