State sales tax rules vary significantly for construction contractors doing business in the DC region, and can substantially affect the final cost on a contract. For instance, a Virginia-based contractor bids on two separate construction contracts for a federal government agency. Both of the contracts are for the construction of a building, one contract will be performed in the District of Columbia and the other in Maryland. If all necessary materials and supplies for each contract are purchased in Virginia and subsequently transferred to the job site, a number of potential sales and use tax implications may arise.
First, the contractor should recognize that it may be eligible for exemptions because the customers are both government entities, which are relieved from state sales tax. However, just because a contractor’s customer can make tax-free purchases does not necessarily mean that the contractor can do the same when incorporating the materials into that customer’s real property. The sales tax rules in this area vary significantly from state-to-state.
The potential sales tax exemption for government construction contracts create an exception to the general rule followed in most states (including DC, MD, and VA), which is that a construction contractor is considered the consumer of materials that will be incorporated into real property. Thus, a contractor generally pays sales tax when purchasing those materials.
In our example, the Virginia contractor will temporarily store the materials at its Virginia location but use them at job sites in the District and Maryland. Our fictitious contractor should be aware that Virginia’s regulations allows the purchase of materials tax-free from Virginia if those materials are stored temporarily to be used in an exempt construction project in another state. Thus, the contractor will need to refer to the sales tax rules in DC and Maryland when determining if it can purchase the materials free from Virginia sales tax.
The District allows a contractor to make tax-free purchases of materials that will be incorporated in and become part of the real property of the United States or DC government. Therefore, the contractor can claim the Virginia exemption for the materials temporarily stored in Virginia that will be used in the contract in the District. However, in order to do so, it must make a written request to the Department of Taxation for a certificate of exemption.
Maryland also has an exemption for construction materials purchased for contracts performed for certain tax exempt entities, but the exemption is limited to private charitable, educational, and religious nonprofit organizations. The exemption does not apply to materials purchased for a government construction contract. Therefore, our contractor should factor in Virginia sales tax when bidding on the Maryland contract.
Further, the contractor has a potential use tax liability on the materials that will be used in Maryland. Maryland will not require use tax to be paid if the contractor paid at least a 6% sales tax in the state where the materials were purchased. Differing sales tax rates throughout Virginia locales adds another dimension to this complex issue, so contractors should pay special attention to these details when making its bid.
Contractors face myriad issues when dealing with sales tax. In addition to the example above other challenges may include bonding requirements, rules regarding fabricated materials, and varying treatment of time and materials contracts.
To learn more about the intricacies of sales and use tax laws, please join us on Thursday, July 24th for a complimentary webinar that addresses these important issues in greater detail. To register, click here.
For a review and analysis of your specific situation, contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301.231.6200.
Staying abreast of tax changes for your construction business can seem like a moving target, but continuous planning can help you minimize liability. In the second quarter of 2014, we saw a number of important tax developments that should be considered when managing your construction business.
No bankruptcy exemption for inherited IRAs.A unanimous Supreme Court held that inherited IRAs do not qualify for a bankruptcy exemption (i.e., they are not protected from creditors in bankruptcy). Under the Bankruptcy Code, a debtor may exempt amounts that are both (1) retirement funds, and (2) exempt from income tax under one of several Internal Revenue Code provisions, including one that provides a tax exemption for IRAs. The Supreme Court held that this exemption does not extend to inherited IRAs because funds held in them are not retirement funds. For this purpose, the term “inherited IRA” doesn’t include amounts inherited by the spouse of the decedent. This decision should be taken into account when selecting IRA beneficiaries. If a potential beneficiary is under financial distress, the IRA owner should consider naming a trust as beneficiary instead. The individual could be named as beneficiary of the trust without jeopardizing the full IRA funds in the event of a personal bankruptcy.
Purchase of underlying property didn’t prevent deduction for lease termination payment. The Court of Appeals for the Sixth Circuit has allowed a party that exercised an option to buy property that it was leasing to deduct a portion of the amount tendered in the transaction as a lease termination payment. In so doing, it rejected the IRS’s argument that the full amount tendered had to be capitalized as part of the purchase price. The dispute centered on an obscure tax law, which states that, where property is acquired subject to a lease, no basis is allocated to the leasehold interest. The IRS said that this provision precluded a deduction, but the Sixth Circuit disagreed. Because the lease terminated when the taxpayer acquired the property, the property was not acquired subject to a lease and the law at issue did not apply to bar the deduction. Years earlier, the Tax Court reached the opposite result in a case with similar facts.
Employer health insurance tactic may backfire. The IRS has warned of costly consequences to an employer that doesn’t establish a health insurance plan for its employees, but reimburses them for premiums they pay for health insurance (either through a qualified health plan in the Marketplace or outside the Marketplace). According to the IRS, these arrangements, called employer payment plans, are considered to be group health plans subject to the market reforms of the Affordable Care Act. These reforms include the prohibition on annual limits for essential health benefits and the requirement to provide certain preventive care without cost sharing. Such arrangements cannot be integrated with individual policies to satisfy the market reforms. Consequently, such an arrangement fails to satisfy the market reforms and may be subject to a $100/day excise tax per applicable employee.
More enforcement of responsible person penalty likely.If an employer fails to properly pay over its payroll taxes, the IRS can seek to collect a trust fund recovery penalty equal to 100% of the unpaid taxes from a person who is responsible for collecting and paying over payroll taxes and who willfully fails to do so. A recent report issued by the Treasury Inspector General for Tax Administration has found the IRS has often not taken adequate and timely action in assessing and collecting the responsible person penalty. The report also makes recommendations for improvements, which the IRS has agreed to implement, making enforcement more likely.
Taxpayer Bill of Rights. In an effort to help taxpayers better understand their rights, the IRS has adopted a “Taxpayer Bill of Rights,” which dictates that previously disparate clauses are now prominently displayed in one place on the IRS’s website, falling into these 10 broad categories:
Next year’s inflation adjustments for health savings accounts.The IRS has provided the annual inflation-adjusted contribution, deductible, and out-of-pocket expense limits for 2015 for health savings accounts (HSAs). Eligible individuals may, subject to statutory limits, make deductible contributions to an HSA. Employers as well as other persons (e.g., family members) also may contribute on behalf of an eligible individual. Employer contributions are generally treated as employer-provided coverage for medical expenses under an accident or health plan and are excludable from income. Typically, a person is an “eligible individual” if he is covered under a high deductible health plan (HDHP) and is not covered under any other health plan that is not a high deductible plan, unless the other coverage is permitted insurance (e.g., for worker’s compensation, a specified disease or illness, or providing a fixed payment for hospitalization).
For calendar year 2015, the limitation on deductions is $3,350 (up from $3,300 for 2014) for an individual with self-only coverage. It’s $6,650 (up from $6,550 for 2014) for an individual with family coverage under a HDHP. Each of these amounts is increased by $1,000 if the eligible individual is age 55 or older. For calendar year 2015, a “high deductible health plan” is a health plan with an annual deductible that is not less than $1,300 (up from $1,250 for 2014) for self-only coverage or $2,600 (up from $2,500 for 2014) for family coverage, and with respect to which the annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) do not exceed $6,450 (up from $6,350 for 2014) for self-only coverage or $12,900 for family coverage (up from $12,700 for 2014).
For more information about these changes or other tax issues, please contact an Aronson tax advisor at 301.231.6200 or contact us online.
Construction contractors conducting business in multiples states face no small task when it comes to complying with the varying sales and use tax rules applicable to the construction industry. Although most states do not impose sales tax on construction services, contractors need to be aware of the rules pertaining to how sales tax applies to the purchases they make of materials and supplies used in performing contracts.
Generally, purchases by construction contractors of tangible personal property that are furnished in connection with a construction contract are deemed to be used and consumed by the contractor, as opposed to such purchases being treated as purchase for resale to the contractor’s customer. Thus, sales tax is payable by the contractor upon purchase of the property. This general rule is easy enough to remember.
However, difficulties arise when a contractor is performing contracts in various states that each has their own exceptions to this rule. Now, layer on
On June 24, 2014, the District of Columbia Council will have its second vote on the District’s fiscal year 2015 budget (Fiscal Year 2015 Budget Support Act of 2014, B20-0750), which includes tax rate decreases for both individuals and businesses. The reduced tax rates, and a number of other tax reform items, were last minute amendments to the budget that passed the initial vote on May 28th by an 11-2 margin. The last minute changes to the budget implemented many of the proposals recommended to the Council in December 2013 by the D.C. Tax Revision Commission. The tax reform items are aimed at making the District’s tax system more competitive with its neighbors.
Some of the noteworthy tax changes in the proposed budget include the following:
The most powerful tax planning strategy available to an entrepreneur is the selection and integration of an entity structure and accounting method that balances personal needs with the overall business model. Tax constraints and limitations make the selection process complicated, but with some careful planning and foresight, you can achieve tax optimization throughout the business life cycle and design your ideal exit strategy.
The process generally starts with an evaluation of your short-and long-term personal goals and business objectives, including mapping alternate options that address the following issues: