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SALT TALK: Sales Tax Planning Allows Building Boxes More Efficiently

Posted by Wayne Berkowitz CPA, J.D., LL.M. on Apr 4, 2016 7:00:00 AM
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Ask any accountant and they will tell you how tired they are of the stereotype that we are math geniuses. You don’t need to be a geometry expert to help a client make his/her idea a reality.   You do need the ability to listen carefully to the plan and use your knowledge and experience to implement it in the most efficient way.

Case in point: a client came to us looking to achieve the maximum benefit from the sales tax exemption that virtually all states grant to the construction of a capital improvement.

While most are aware that capital improvement projects are generally “exempt” from sales tax, most don’t understand that in virtually all circumstances, someone still pays the tax on the materials incorporated into the project. Contractors should almost never buy materials for resale. They pay tax on their purchases and build it into the price they charge the customer.

The exemption lies in the labor component of the improvement. For example, a contractor is hired to build you a house.  He pays sales tax on materials (wood, nails, shingles, etc.) but doesn’t charge you sales tax on the price of the house. The contractor buys the $50,000 of materials used in the project for $54,000 (assume 8% tax) and bills you $500,000 for the house, with no tax. The tax savings come from the labor component and the contractor’s markup being exempt from the tax.

Sometimes the lines between a contractor and a retailer of materials blur, especially when the raw materials are fabricated into something else to be used as part of a construction project

Take Carrie Contractor, for example, who has been constructing custom homes for years. In the past, she purchased lumber and sent carpenters on-site to assemble permanently installed custom bookcases. Carrie would pay tax on the materials but the labor component would not be subject to tax.

Carrie realizes she is spending too much time building these bookcases, while her competitors order prefabricated units from a third party and install on-site. However, when her competitors buy the units, they pay tax on the total charge from their vendor, which includes the labor component and markup.

Were Carrie to follow the crowd, she would either make less money on each home or have to raise the selling price. While saving time and money at the construction site (less labor for the carpenters), some or all of that is being given back in sales tax. Instead of paying sales tax on $500 of lumber to build the cabinets, Carrie is now paying sales tax on the $5,000 purchase price.

With careful planning and shifting Carrie’s cabinet “supplier” into the role of a subcontractor, we helped Carrie achieve both savings. Contracts must be structured carefully to achieve these savings, but a little outside the box thinking allowed us to build the boxes more efficiently.

If you are a contractor looking to see what sales tax savings might be in store for you, contact me at wberkowitz@berdonllp.com or your Berdon Advisor.

Wayne Berkowitz, a tax partner and head of the State and Local Tax Group at Berdon LLP, advises on the unique requirements of governments and municipalities across the nation.

Topics: SALT TALK

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