As a contractor, your priority is getting the job done right—on time, within budget, and with a satisfied client. However, a responsibility can often be overlooked alongside customer satisfaction: New York sales and use tax compliance.
Whether you're working on a new build, a renovation, or a repair project, understanding New York's sales and use tax laws will help avoid costly mistakes. The tax regulations for contractors are filled with nuances that can catch even experienced professionals off guard. There's a lot to know, from how you handle material purchases to what counts as a capital improvement.
Understanding Key Concepts for Contractors
New York broadly applies sales tax to the sale of tangible personal property. When you purchase materials, you'll typically pay sales tax on those items (N.Y. Tax Law § 1105[a]). On the other hand, the sale of services is more limited; a service is taxable only if specifically listed in the law (N.Y. Tax Law § 1105[c]). For example, services like architectural design aren’t taxed, but others, such as interior decorating, are (N.Y. Tax Law § 1105[c][7]).
Understanding the treatment of tangible personal property (TPP) and real property (RP) under New York law is not just a matter of compliance; it's a matter of significant tax implications. The lines between these categories may blur, but for contractors, the impact of these decisions is crystal clear.
If you sell TPP—movable items like appliances, equipment, or materials—these sales are subject to sales tax. This taxation extends to any services related to the installation of TPP (N.Y. Tax Law § 1105[c][3]). For example, if you sell and install a refrigerator or office equipment for a client, the sale and the installation service are taxable.
In contrast, contracts that involve construction work on RP are generally not subject to sales tax charged to the customer. This includes services that result in a capital improvement to the property, including significant renovations like remodeling or adding an addition. (N.Y. Tax Law § 1105[c][3][iii]). While the customer is exempt from paying sales tax on these construction services, the contractor must pay sales tax on materials and supplies used in the project.
The challenging aspect lies in distinguishing between TPP and RP. Determining whether an item remains TPP after installation or becomes part of the real property significantly impacts tax obligations.
Distinguishing Tangible Personal Property from Real Property
The distinction between tangible personal property and capital improvements lies in a three-pronged test used by the DTF. A capital improvement is any addition or alteration to real property that: 1) substantially adds to the property value or appreciably prolongs the useful life of the real property; 2) becomes part of the real property or is permanently affixed to the real property so that removal would cause material damage to the property or article itself; and 3) is intended to become a permanent installation. See (TB-ST-104). For example:
- Installing a freestanding appliance like a washing machine is considered a sale of TPP. Both the appliance and the installation service are taxable.
- Installing built-in fixtures like cabinetry or plumbing systems is considered a capital improvement to RP. The customer is not charged sales tax on the installation service, but the contractor pays sales tax on the materials.
Properly identifying whether a service involves the sale of tangible personal property or qualifies as a capital improvement affects pricing, how contracts are structured, and how invoices are prepared.
Navigating Sales Tax Obligations as a Contractor
Whether you're performing repairs, maintenance, or installations, understanding the tax rules that apply to your work is essential. Here’s what you need to know according to Tax Bulletin ST-129.
When You Need to Charge Sales Tax
If your work involves repairing, maintaining, or installing items that does not rise to the level of a capital improvement, you must typically charge sales tax for such work. These services are necessary to keep the property functional, safe, or in good repair. For instance, replacing damaged siding, repairing a broken step, or installing weather stripping are all examples of taxable services. Similarly, tasks like installing above-ground pools or freestanding appliances are taxable, as these items do not become part of the property.
However, the service becomes tax-exempt when your work rises to the level of a capital improvement—such as building an extension or adding new plumbing to a home. This distinction is crucial because it determines whether you must collect sales tax on the project. To clarify classifying your work, refer to Publication 862, which details the tax treatment of various construction projects our reach out to one of our team members, so that we can better assist you with the digesting the information and classification status.
Purchasing Materials and Passing Costs to Customers
As a contractor, you must generally pay sales tax when purchasing project materials. If you transfer these materials to your client as part of a taxable service, that being, one that does not qualify as a capital improvement job or one that does not qualify as a real property installation job, the total cost of the materials and labor will be subject to sales tax when billed to the customer. However, if you pay sales tax upfront when purchasing materials, you may be entitled to claim a credit or a refund for that tax when you file your return, avoiding the concept of double-taxation.
Consider an example: You purchase materials for a repair project and charge the client for labor and materials. If you paid sales tax at the time of purchase, you may be eligible to claim a credit or submit a refund request with the New York Department of Tax and Finance. This ensures you’re not paying double on those material costs.
Tax-Exempt Clients
Working with tax-exempt customers—such as non-profits, schools, or government entities—requires a different approach to consider. If your client qualifies for this type of designated tax exemption, you may not need to collect sales tax as long as they provide a valid exemption certificate. Additionally, you may be able to purchase materials for tax-exempt projects without paying sales tax upfront, using Form ST-120.1, Contractor Exempt Purchase Certificate.
Repair, Maintenance, and Installation Services
While capital improvements are exempt from sales tax, repair and maintenance services are typically taxable. Repair and maintenance work involves keeping the property in good working order and safety or restoring it to that condition. For example, replacing a damaged faucet or repairing a broken step would be considered taxable repair services.
In the case of a taxable repair or maintenance job, the tax treatment depends on how the project is billed:
● If the property owner buys the materials and performs their labor, they only pay tax on the sale of the materials.
● If the owner hires a contractor, and the contractor buys the material, the property owner will be responsible for paying sales tax on the material charge and installation charge.
Even though contractors may pay tax on materials purchased, they are often required to collect sales tax from their customers for the total job. However, it is important to note that the contractor can likely claim a refund or credit for the tax already paid on materials transferred to the customer as part of the job. See Tax Bulletin ST-129.
Installation services are also subject to sales tax if the installed items do not become part of the real property. For example, installing freestanding appliances like washing machines or refrigerators is taxable. The charge for both the installation and the appliance itself would be subject to sales tax.
Understanding the Relationship Between Contractors, Subcontractors, and Sales Tax
In construction projects, understanding how sales and use tax apply as materials and services move from supplier to general contractor (GC), subcontractor, and finally, to the end customer is crucial. The general rule in New York is that sales tax applies to selling tangible personal property (TPP) and specific services. However, real property (RP) is not considered TPP, and knowing the distinction between TPP and RP can significantly impact tax treatment.
The Role of General Contractors and Subcontractors
In many projects, the client (X) hires a general contractor (GC) to manage the overall construction process. The GC provides a quote to X, who agrees to the terms. From there, the GC may hire subcontractors to perform specialized parts of the project. For example, one subcontractor may be an expert in kitchen installations, whereas another subcontractor may be an expert for vanity and bathroom installations.
● When the GC purchases materials: In some cases, the GC buys the materials and passes them to the subcontractor for installation. Here, the GC pays sales tax on the materials at the time of purchase, but the labor provided by the subcontractor is generally not taxable. This, of course, is the case when the contract as a whole qualifies as a real property contract or a contract that is for a capital improvement. This would not be the case if the contracts is solely for the purposes of repair, maintenance and installation services of tangible personal property.
● When the subcontractor purchases materials: Alternatively, the subcontractor may purchase their materials for the job. In this scenario, the subcontractor will pay sales tax on the materials, and their labor may be non-taxable depending on the type of work (such as capital improvements).
In projects involving capital improvements, GCs, and subcontractors must apply the appropriate tax treatment to materials and labor. Misclassifying taxable services as capital improvements—or vice versa—can lead to compliance issues. It is important to get this right from the start; a GC or subcontractor that does not consider sales and use tax obligations in its inception tends to do business without proper procedures in place, throughout its lifespan.
If you're a general contractor hiring subcontractors, it's essential to understand how sales tax applies to their services. In many cases, subcontractors' services can be purchased for resale. You won’t need to pay sales tax when hiring a subcontractor for taxable work if you use Form ST-120.1 to document the resale transaction. This rule applies to general contractors and subcontractors when one hires another. Ensuring you have the proper paperwork is essential to staying compliant and avoiding unnecessary tax payments.
Leasehold Improvements
When it comes to leasehold improvements, determining whether an alteration qualifies as a capital improvement depends on the intent to make it permanent. For example, If a tenant adds a structure or installation to a leased property and the lease specifies that the alteration will remain after the lease ends, it may be considered a capital improvement. However, if the installation is intended to be temporary, it does not qualify for tax exemption as a capital improvement. See TSB-M83(17)S.
Conclusion
The complex web of sales tax regulations for New York contractors can be daunting. With constantly evolving rules and numerous exceptions, even the most diligent professionals may need to be more compliant. This complexity significantly increases the likelihood of a Department of Taxation and Finance (DTF) audit for contractors.
Given the intricacy of tax regulations, contractors must prioritize compliance with sales and use tax laws. The potential consequences of non-compliance—including hefty fines, penalties, and damage to your business reputation—far outweigh the effort required to ensure adherence to these rules.