By Daryl Ohland, Senior Manager – State and Local Taxes

Tax laws and regulations change, new interpretations of existing rules are introduced by the state of Wisconsin, and sales tax audits of contractors continue.  In the day-to-day construction business, it can be hard to balance the need to keep up with the tax rules versus the need to grow and complete existing projects. 

Laws regarding sales and use tax, for instance, can have a big impact your bottom-line business. Whether that impact is negative or positive depends on how much you understand the rules and plan for them.

By recognizing a few tax opportunities and avoiding some common pitfalls, your company can shore up its tax strategy and strengthen its competitive position. Here are some current concerns that can be potential exposure issues for contractors and subcontractors.

Getting a clear line on consumer, retailer roles

The tax treatment of work to be performed by a contractor generally depends on whether a contractor is performing real estate construction activities. If the contractor is performing an improvement to real property, they are acting as a consumer of the materials. If they are installing personal property, they are considered a retailer. But even then, whether to collect or pay taxes on goods and services can be confusing. New interpretations of the impact of the AIA statement by the state, for instance, are currently confusing the issue even more.

Wisconsin requires contractors to pay taxes on materials and supplies purchased for use in constructing real property. But some items within an AIA statement for new building construction are receiving a different interpretation during audits. Cabinets, for instance, may not be treated as part of the building but instead may be viewed as personal property by the state. Therefore, a contractor may be expected to collect tax from its customers on such items. The exposure in this scenario is the difference between the material costs and the contract price.

The Associated General Contractors of Wisconsin is actively working in pursuit of legislation to help clarify this situation. In the meantime, contractors need to evaluate potential remedies. Several contractors have started to adjust the categories of their AIA report to minimize the amount of separately stated items. Other general contractors have asked their subcontractors to document the amount of sales or use tax paid on their portion of the project to ensure that the sales tax has been paid on the various subcontracts. Since this is just an interpretation by the audit staff, many contractors have chosen to follow the current procedures until the regulations have been changed. At a minimum, contractors should verify that they have recourse to bill their customers for additional taxes if they are audited by the Department of Revenue.
 
Three key points when working with exempt entities

When working with nonprofit clients in Wisconsin, there are three tax issues to bear in mind. First, Wisconsin generally does not allow flow-through exemptions. Nonprofits are exempt from the sales tax on their purchases, but contractors are not. Contractors are considered to be the consumers of those building materials, and therefore a material sale to a contractor is a retail sale that’s subject to tax regardless of the tax status of their customer.

Second, a contractor and exempt entity may agree to separate the material sale from the installation portion of the contract. The exempt entity must purchase materials direct from the contractor’s supplier. If the same entity sells the materials and installs the material, the contractor is still liable for use tax on the materials.

Lastly, while some states do allow a flow-through exemption from an exempt entity, a contractor working with a nonprofit customer in a flow-through state may still face tax responsibilities. If any materials used in the project are either stored or fabricated in Wisconsin, the state will still expect its taxes on the material costs.

Service vs. rental: a crucial tax difference

Often contractors hire third parties to provide services during construction. Generally, such services are nontaxable. However, there is confusion in determining whether the third party is providing a service or a rental of equipment with an operator.

For example, crane services are often needed to help with projects. Crane services are nontaxable only if the contractor isn’t directing the crane’s operation, by instructing the operator of the specific placement of materials. If a contractor does direct and control the operator, then those services are viewed as a taxable rental of the crane. Sales tax would be due on the entire charge unless the charge for the operator is separately stated and the customer is customarily offered the crane without an operator.

By the same token, contractors who lease out their company-owned cranes for jobs must collect tax if the activity is deemed a rental of the equipment.

Jurisdiction matters in county and stadium use taxes

Contractors know that most counties impose local taxes and are well aware of various stadium sales and use taxes. But the determination of the proper jurisdiction could be based on either the location of the project or where materials are received. Use tax is due on materials based first upon where the materials are stored and then based upon the location of the project.

Contractors engaged in construction activities in a county with county taxes are responsible for taxes in that jurisdiction if county tax has not been paid to another county. The same rule would apply for the stadium taxes. Keep in mind that contractors can also offset county taxes with county taxes and stadium taxes with stadium taxes, but cannot offset one type against the other.

LC numbers not always exempt

Wisconsin provides a sales tax exemption to for hire carriers that hold an LC number. But the fact that a company has an LC number does not in itself an exemption. The exemption applies only to those units used “exclusively” in common or contract carriage. A contractor who hauls his own materials, for instance, doesn’t qualify for the exemption in that case. The Department of Revenue has begun contacting companies holding LC numbers to validate that they qualify for the exemption.

Sound planning can provide various tax solutions

With forethought and planning, contractors can minimize or eliminate their tax exposure and even create sales tax benefits.

Setting up separate entities is one way to better manage taxes, generate cash savings, or increase cash flow. An example would be establishing a separate transportation entity that hauls goods of others for hire. By utilizing a separate entity, a potential sales tax exemption would apply to the purchase, lease, and repairs and maintenance of qualified vehicles,

Today, with the advent of lean construction, many contractors are fabricating materials prior to delivery to the job site. With the right planning and documentation, these contractors may qualify for several manufacturing exemptions.

To benefit from tax exemption opportunities, businesses need to recognize their current tax situation and develop fact patterns that may create future tax benefits. These tax strategies should be reviewed by an experienced state and local tax professional to ensure that the proper steps have been taken to document the strategy and that nontax considerations have been reviewed, thus reducing the exposure of unfavorable treatment by the taxing authorities.