My Customer’s Exempt from Sales Tax, but is my Construction Contract?

Construction contractors in the region face anything but uniformity when it comes to dealing with the rules addressing sales tax as it applies to projects for tax exempt customers (e.g., government entities and nonprofits). Not only does the scope of the exemptions offered in the region (i.e., the District, Maryland and Virginia) differ, the compliance requirements vary as well.

Generally, construction contractors are considered the consumers of the materials and supplies they purchase for use in their projects. This is because the contractor is providing a service, not reselling tangible personal property. Thus, contractors are generally required to pay sales tax when purchasing their materials and supplies. Contractors can at least be rest assured that the local jurisdictions all follow this foundational sales tax principle. Unfortunately, that’s where the similarities end and the differences begin, especially when it comes to construction contracts with customers that are tax exempt entities.

Virginia is somewhat simple in that there is no exemption from tax for contractor purchases that will be incorporated into the real property of a tax exempt entity. The only options for avoiding sales or use tax on such purchases for projects in Virginia are for the contractor to be named as an authorized purchasing agent by the exempt entity or simply have the tax exempt customer make the purchases directly. Complications can arise when materials are temporarily stored in Virginia for a project in another jurisdiction. In this case, Virginia will allow, by Department of Taxation preapproval, construction contractors to make purchases tax-free if the same purchases could have been made tax-free in the jurisdiction where the project is located. Thus, applicability of Virginia’s temporary storage exemption hinges on whether there is an available exemption in the other jurisdiction.

In contrast to Virginia, Maryland and the District both have sales and use tax exemptions for purchases of materials to be incorporated into the real property of certain tax exempt customers. However, the scope of the exemptions is different. Maryland’s exemption applies to purchases of materials for projects for nonprofit organizations as well volunteer fire, ambulance, or rescue squads. Notably absent from Maryland’s exemption are material purchases for projects with government organizations. The District’s exemption applies to nonprofits (i.e., “semi-public institutions”) as well as federal or District of Columbia government entities.

It’s important for contractors to realize that the exemptions in Maryland and the District only apply to materials and supplies that will become part of the real property of the tax-exempt customer. A contractor must still pay tax on tools and supplies purchased for use on a contract for a tax-exempt organization.

The regional rules for purchases of materials by construction contractors are a fair reflection of the nation as a whole in terms of the wide variance in available exemptions. Whenever contractors are venturing into unchartered jurisdictions, it’s critical to understand the applicable sales tax rules upfront. A proactive approach will facilitate accurate bidding on jobs, and allow for compliance on the front-end as opposed to potential penalties and interest on the back-end of a project.

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