States that impose sales tax generally treat real estate contractors purchasing materials for construction and use on their jobs as the final end user whether it be as a general contractor or a subcontractor. On that note, contractors are subject to sales tax on all their taxable purchases of materials being deployed on their jobs with limited exceptions in certain states.

The Virginia Department of Taxation released a ruling (Ruling), P.D. Ruling 24-123 (Nov. 18, 2023), providing that a retail flooring company (Taxpayer) that sold coverings and installation services to commercial and residential customers was subject to use tax as a “contractor” on the sales tax due on materials erroneously purchased under a resale exemption that were later resold and installed at customer locations. In the process, the Taxpayer had charged sales tax on such purchased and resold flooring materials to customers on their sale and installation at their designated job site. The Ruling declared that the Taxpayer, as a contractor, had improperly charged and collected sales tax from customers, and thus, could not apply such remitted amounts as a credit against the use tax due on the purchases of such resold and installed flooring materials.

In the Ruling, the Taxpayer was found to have improperly operated as “retailer” under state sales tax law. Rather, they were ruled to be a “contractor” due to the installations offered to customers on sold flooring materials and supplies. As a “contractor,” the Taxpayer was required to either pay Virginia sales tax on all material purchases from their vendors or self-accrue and remit use tax on such purchases in which no sales tax was paid to the vendors. The Taxpayer “contractor” was not allowed to charge sales tax on such flooring materials that were resold as a part of an installation at the customer’s location as they were deemed as the final end user of such materials.

Finally, the Ruling noted that the only ability for “contractors” in Virginia to be respected as a dual contractor (i.e., act as both retailer and contractor for sales tax purposes) would be to (1) register as a dealer and (2) be able to separately segregate purchases into inventory that are solely intended for resale availed a resale exemption certificate vs. such purchases to be sold and installed that would be taxable in the hands of the contractor at the time of purchase.

Dual contractors and sales tax complexities

This Ruling illustrates the complexity of sales tax requirements for dual contractors that also intend to operate as retailers purchasing a portion of their materials and inventory held for resale to customers not to be deployed at a construction or installation job site. Some states may apply even stricter limitations on the ability for contractors to purchase materials sales tax free under any sort of resale or other exemption as contractors are generally deemed end user and consumer of such items under most states’ sales tax provisions.

Commingling intended retailing activities with construction, including installations, could result in various unwanted consequences depending on the contractor’s place of business along with all states where they perform construction activities. This elevates the importance in understanding each state’s sales tax reporting and filing requirements, including when such resale or other exemptions would be allowed to avoid any surprises.

Separate affiliated retailer/Wholesale company planning

One planning idea in the case of dual contractors looking to conduct both construction and retailer business to consider would be to establish two separate legal entities to segregate the duties of (1) retailer/wholesaler vs. (2) contractor who would be involved in the construction/installation of building materials.

A retailer/wholesaler, as a separate legal entity from the contractor entity, would generally be able to purchase taxable construction materials sales tax free by issuing the vendor a valid resale exemption certificate. Unlike the contractor entity, the retailer/wholesaler entity can proceed in selling such purchased inventory to their retail customers and either charge sales tax or receive a valid resale sales tax exemption certificate from their wholesaler customer to not charge the tax.

With a separate retailer entity, the retailer entity can then also resell their material purchases to the contractor affiliate and charge them the sales tax on their marked-up price.

What does CohnReznick think?

Navigating sales tax regulations can be complex, and construction companies need comprehensive solutions to manage these challenges effectively. CohnReznick’s State and Local Tax (SALT) team can provide construction industry clients with the sales tax rules in each of their relevant states along with development of processes within their purchasing and sales invoicing systems to help mitigate any sales tax exposures and out-of-pocket costs.

We also can assist in setting up a separate retailer/wholesaler affiliate which will (1) provide cash flow timing savings on such initial materials purchases and (2) provide the retailer affiliate the flexibility to be able to sell directly to customers that merely want to purchase the materials vs. separately sell inventory to their contractor affiliate that would perform the construction/installation services on such materials.

_{Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.}