As the New York State Department of Taxation and Finance increases its scrutiny of sales tax activity, construction contractors have become prime targets for audits. While regulations make it difficult to navigate sales tax compliance for every industry, the rules for New York contractors in particular are quite burdensome and very often confusing. This can add an additional layer of stress on contractors, as getting it wrong can result in substantial negative consequences with potential penalties and/ or loss of profits.
New York State contractors (Contractors) have the unusual burden of being considered the consumer of building materials under the state’s sales tax law. This seemingly simple concept can create havoc for Contractors. Due to this general rule Contractors must pay sales tax on all building materials purchased for both repair and maintenance (R&M) and capital improvements (CI) unless an exemption applies and a properly completed exemption form is in hands of the vendor (building materials supplier).
Repairs and Maintenance (R&M) vs. Capital Improvements (CI)
Understanding the distinction between R&M and CI projects is a critical first step when dealing with contracts involving real property in New Yok State: it’s either one or the other. Getting this distinction wrong can negatively impact Contractor relationships with clients and suppliers and result in a hit to your bottom line.
For R&M projects a Contractor cannot use the resale exemption; therefore, sales tax is due to the vendor upon purchase of the building materials. The Contractor must pay sales tax on building materials upfront and after charging and collecting sales tax from the customer on the R&M project, the Contractor becomes eligible for a credit for the sales tax they paid on the building materials purchased, claiming it via NY Form AU-11.
If the work is a capital improvement (CI), Contractors pay the sales tax on building materials upfront (just like R&M) and can only recoup the sales tax by incorporating it into the price for the CI. The sales tax cannot be a separate charge to the customer on the invoicing, and the contractor cannot claim a credit from New York for the sales tax paid (unlike R&M).
What Qualifies as Tax Exempt?
If the work is for a Tax-Exempt Organization or an Industrial Development Agency (IDA) no sales tax applies to building materials if the Contractor provides its vendor with a properly executed exemption form. If a contractor is an appointed agent of the IDA, additional sales tax exemptions may be available.
How New York State determines who to audit
To cash-hungry tax authorities, a Contractor’s business presents a potential revenue stream opportunity. An auditor’s job is to maximize that stream, and a sales and use tax audit is one of their primary tools. Contractors need to know what issues are likely to prompt an audit, including nexus but no registration, misuse of resale certificates, use tax reporting, a significant change in quarterly gross sales, higher than normal exempt sales, and ignoring a nexus/business activity questionnaire.
However, just because you’ve been selected for a sales and use tax audit does not mean you are automatically going to have to pay through the nose. Conversely, just because you have done everything right regarding these taxes does not mean you are not going to have to spend considerable time and money proving it. Understanding the ins and outs of sales and use tax applicability, along with the proper usage of exemption and resale certificates (issued or received), can play a significant role in helping Contractors reduce the risk of being audited.
There are ways Contractors can reduce risk of being audited, minimize the economic impact of an audit, and cut the costs of compliance and audit defense. Preparing and simplifying documents in advance can streamline the audit process and help prevent audit sampling methods that may be at a disadvantage. Understanding these pitfalls and incorporating them into your business’ best practices should prove beneficial.
Finally, too often the goal in sales and use tax compliance is focused on making sure that enough tax has been paid. Advising with a CPA for an analysis of sales and use tax procedures may reveal that the contractor is paying too much in taxes.
John Fontanella is a principal in The Bonadio Group’s tax department, with a focus on taxes for privately held businesses and their owners. John also specializes in sales taxes for contractors and manufacturers. He has been in practice as a CPA for 30 years.
Founded in 1978, The Bonadio Group is a nationally ranked Top 50 CPA firm offering accounting, tax, and consulting services to clients of all sizes. The Firm’s professionals deliver practical, proactive, and innovative solutions to help clients reach their financial, compliance, management, and personal goals. The Bonadio Group is the largest independent provider of accounting, tax, and consulting services in upstate New York— with offices in Albany, Batavia, Buffalo, East Aurora, Rochester, Syracuse, and Utica. The Bonadio Group also has offices in New York City, Rutland, Vt., and Dallas.
Disclaimer: The summary information presented in this article should not be considered legal advice or counsel and does not create an attorney-client relationship between the author and the reader. If the reader of this has legal questions, it is recommended they consult with their attorney.