Sales tax is an important, yet often misunderstood part of managing a construction project’s finances. With so many moving pieces involved, like labor, materials, subcontractors, and specialized services, figuring out what is taxable (and when) can get complicated. To add to the challenge, sales tax rules vary depending on the type of work, location, and even the client. This can make it tough to know when you should be charging sales tax, paying it, or recognizing when an exemption applies.
When most people think of sales tax, they picture a retail business buying products wholesale and collecting sales tax from customers at checkout. But the construction industry operates differently, especially in California. In California, contractors are generally considered the end user of the materials they purchase for a job. This means they are expected to pay sales tax at the time of purchase when buying materials from suppliers. As a result, they do not charge sales tax to customers for those materials they’ve already been taxed when purchasing them.
In most cases, the labor portion of a construction contract is not subject to sales tax if it involves the installation or improvement of real property. The term real property includes new construction, remodels, repairs, electrical, HVAC, and plumbing work. In summary, as long as the labor is tied to the improvement of real property, it’s typically exempt from sales tax.
Sales tax becomes even more complex when the work involves fabricating items off-site, such as custom cabinets, wrought iron gates, or countertops. In these situations, the contractor may be considered a retailer of those items and that means they would be required to collect and report sales tax on the value of the fabricated goods. While installation labor remains non-taxable, fabrication labor may be taxable if it is not clearly separated on the invoice. When it comes to sales tax, accurate invoicing and clear documentation is key.
Another component to consider is fixtures. Fixtures are items attached to a building but are not considered permanent, like light fixtures or appliances. These items can also trigger sales tax, depending on how they are billed and whether they are classified as materials or fixtures under California tax law.
Most projects require subcontractors to help the job move along. When subcontractors are involved, it is important to clearly define whether they are providing labor, materials, or both. It is also important to determine how those costs are reflected in the overall contract pricing. Ensuring there are well-documented agreements in place help prevent double taxation and reduce the chance of red flags during an audit.
Misunderstanding California’s sales tax rules can lead to undercharging or overcharging clients and headaches if there is an audit. At adding technology, we work exclusively with construction businesses and know the ins and outs of California’s sales tax system. We’re here to help you clearly understand when sales tax does and does not apply, prepare for potential audits and avoid costly compliance mistakes.
At adding technology, we know you want to focus on what you do best as a contractor. In order to do that, you need a proactive back office crew who has financial expertise in your industry.
The problem is that managing and understanding key financial compliance details for your business is a distraction when you want to spend your time focused on building your business (and our collective future).
We understand that there is an art to what contractors do, and financial worries can disrupt the creative process and quality of work. We know that many contractors struggle with messy books, lack of realtime financial visibility, and the stress of compliance issues. These challenges can lead to frustration, overwhelm, and fear that distracts from their core business.
That's where we come in. We're not just accountants; we're part of your crew. We renovate your books, implement cutting-edge technology, and provide you with the real-time job costing and financial insights you need to make informed decisions. Our services are designed to give you peace of mind, allowing you to focus on what you do best - creating and building.
Here’s how we do it:
Schedule a conversation today, and in the meantime, download the Contractor’s Blueprint for Financial Success: A Step by-Step Guide to Maximizing Profits in Construction.” So you can stop worrying about accounting, technology, and compliance details and be free to hammer out success in the field.