Dateline: 1/1/2017. This is a work in progress, check back for updates as we don't have all the answers yet. IF IN DOUBT AS TO WHETHER OR NOT TO COLLECT SALES TAX, WE SUGGEST YOU STRONGLY CONSIDER COLLECTING THE TAX AND/OR CONTACT THE NC DEPARTMENT OF REVENUE FOR GUIDANCE.
Remember this cardinal rule of tax, because we will come back to this tenet again and again: under NC sales tax law, a business is required to collect sales tax on transactions that are not exempt by law or regulation. Put another way, everything is taxable unless specifically excluded. And actually, the US and state income tax operate the very same way. Every item of income is taxable income unless there is a specific law or regulation exempting that income from tax. (Getting off subject a bit, but yes, even if you don't receive 1099 because the amount is below the reporting threshold of $600, it is still income because it is not exempt.)
Under prior law, an NC electrical contractor, plumbing contractor, landscape contractor, cabinet maker, or general contractor job was generally exempt from sales tax if associated with real estate. Instead, the contractor was considered as the end consumer. So the contractor paid sales tax on his/her materials, and the full job price was exempt from sales tax. And that rule still holds true for capital improvement "CI" projects (new construction, reconstruction, or a remodel - see definition) IF certain documentation requirements are met, as discussed later. What changes January 1, 2017, is this: for jobs that do not rise to the level of a capital improvement "CI", these jobs will be considered a repair, maintenance, and installation "RMI" services and the full job price, including labor and materials, will be subject to sales tax.
Abbreviations. These terms are used over and over, and we really don't want to type them each time:
CI = capital improvement job, exempt from sales tax when properly documented that it is exempt with form E-589CI.
RMI = repair, maintenance, or installation service where sales tax is collected on both labor and materials.
GC = General Contractor.
Our best source of information is a directive published by the NC Department of Revenue, SD-16-3, located here. Going back to the tenet of thefirst paragraph, remember that everything is taxable unless specifically exempted. The purpose of SD-16-3 is to explain to us the specific exemption from sales tax related to real property new construction, reconstruction or remodel contracts or jobs that qualify as capital improvements. If the job qualifies as a capital improvement, great, similar rules to the old rule (plus you MUST obtain a new affidavit E-589CI, found here, from either the general contractor or the homeowner, to document the job is a CI job). Whew, that's a mouthful. If the job does not meet the definition of a CI, or you don't get the E-589CI, you will need to collect sales tax on the full job price.
This hits contractors in at least four key areas:
Job income: If any of your jobs do not rise to the level of a capital improvement, you will now need to register with the NC Department of Revenue and collect sales tax on the full job price.
Job costs: Again, for jobs that do not rise to the level of capital improvement, you don't have to pay sales tax on your materials. Instead, you can file form E-595E, found here, with your distributor letting them know that you are re-selling the materials on non-CI jobs, and so you can buy the materials free of sales tax. Refer back to the tenet in the first paragraph: your distributor is required to collect sales tax from you unless there is an exemption. By providing your distributor with E-595E, you are providing the exemption - that you are reselling the materials. Consider this: if most of your jobs are non-CI jobs, file the E-595E with your distributor so that you remain price competitive. We have heard some contractors were going to just pay sales tax to their distributor regardless, and pass it along to customers. Probably not the right thing for your customer, and might affect your competitiveness.
Record keeping: You are going to need an accounting system to track this mess of information.
For income, you will need to track taxable and nontaxable job income, tax collected by county or jurisdiction, and amount of tax collected.
For CI jobs: you will need to have a system to obtain the E-589CI for each job and keep it filed for availability should you ever be audited. Further, if you buy (or store) materials under an E-595E exemption (where you did not pay sales tax on the materials), you will need to pay a use tax for those materials used on a CI job.
For purchases of materials, that might be used on both CI and non-CI jobs, you will need to keep track of usage so you can pay use tax properly. And for non-CI jobs, you will need to file E-595E with your distributors. Hopefully, most distributors will allow you to have taxable and exempt accounts so that you can separate your materials purchased between CI and non-CI jobs to ease your recordkeeping.
For mixed jobs: containing both capital improvements and repair services (RMI jobs), you will need to allocate the job revenue between CI and RMI services to see if the RMI portion of the job exceeds 10% of the total job (see discussion below for mixed jobs).
If you find the record-keeping overwhelming, we have some really cool cloud-based accounting programs that will ease your burden.
I like mind maps, visual diagrams used to organize information. Following is our mind map of particular parts of SD-16-3. It is not complete, as we're building it out as we go, check back from time to time. If you are a contractor or sub, you should read SD-16-3 in its entirety. There are lots of exclusions and definitions that your accountant or CPA cannot possibly explain in a short call or email. All of the terms are defined in SD-16-3 if you want to drill down for more information. Lastly, we color coded the sections: Green, no sales tax collected; red, collect sales tax, and yellow, well, watch out as you may or may not need to collect.
SALES TAX DOES NOT GET COLLECTED ON THE JOB PRICE IF:
Real property contract, if
Capital improvement that is:
An addition or alteration to real property
New construction, reconstruction, or remodel
Requires a permit
Becomes part of the property
Remodeling
Removal would cause material damage
If CI job absolutely must document with E-589CI from GC or owner
Includes:
Excavation, removal of debris
Underground utilities
Replace or install HVAC unit or system (but not repair to such)
Replacement or installation of roads, driveways, parking lots, and sidewalks
Services to maintain or improve lawns, yards, trees, including mowing and trimming
Installation of equipment/fixtures if removal would damage the structure and is capitalized for tax or reporting purposes.
Painting or wallpapering
Replacement or installation of:
Roof
Septic
Plumbing
Electrical
Commercial refrigeration
Irrigation
Sprinkler
Or another similar real property system.
BUT NOT to repair or replace:
Electrical components
Gas logs
Water heater
Or single items not new construction, reconstruction or remodel
Editorial note: [If in doubt, collect sales tax or call NC Department of Revenue for guidance]
Addition/alteration for a lessee or tenant where the title does not vest with the owner/landlord upon installation. [This is a strange one, with implications that a contractor inquires whether the customer owns or leases the building, and if leased, if the lease does not provide all improvements vest with the owner/landlord, you will need to collect sales tax. Consider asking these questions if you work with tenants, and we guess you'll need to get a copy of the customer lease provision to document should you get audited.]
A fixture replacement in or on a building unless the replacement is part of remodeling. [Here's another tricky one, that will require documentation. Read the definition.]
A single repair, maintenance, or installation service.
EXAMPLES WHERE TAX DOES NOT GET COLLECTED
Tile and flooring company removes old tile or shower liner, installs new tile or liner for $10,000. The tiles would incur material damage were the homeowner choose to remove; thus the project is a real property contract with respect to a capital improvement. The contractor is liable for sales tax on the materials purchased. Homeowner MUST issue an E-589CI to the flooring company. No sales tax on the $10,000. The flooring company pays sales tax to its distributor for materials.
The homeowner hires a contractor to convert attic space to additional living; require re-do to roof trusses, add a dormer, plumbing, electrical, wiring, and insulation. A permit is required. This is a capital improvement. The contractor should obtain an E-589CI from the homeowner, and GC is liable for sales tax on his/her purchase of materials. The contractor must issue E-589CI to each subcontractor; otherwise, subcontractors would need to charge GC with sales tax. Each subcontractor, with E-589CI in hand, is liable for sales tax on his/her respective materials and would not charge sales tax on the job when billed to the GC.
Note: GC's may issue a "blanket" E-589CI to subs for all of their jobs. Generally limited in use.
Homeowner updates kitchen cabinets including new cabinets, tile flooring, paint, and sink. Upon completion, the appearance of the room will be substantially different. This is a remodel and is a capital improvement.
The owner decides to relocate the kitchen sink, range, fridge, and dishwasher in the same room with electrical and plumbing systems altered and relocated. Permits are required. This is a capital improvement.
... more coming later.
EXAMPLES WHERE TAX SHOULD BE COLLECTED
The homeowner hires a home improvement business to reface cabinet doors, drawer fronts and handles for $2,500. No permit is required. This is an RMI service and the contractor should collect sales tax on the $2,500 job price, but may purchase materials free of tax if E-595E is filed with the distributor.
An electrical contractor is hired to add three new outlets to accommodate new equipment in an office. This is an RMI service and sales tax should be collected.
CAUTION: MIXED TRANSACTIONS
If the job includes both capital improvement and RMI services:
If RMI service is less than or equal to 10% of the job, then the entire job, including the RMI service, will be considered a CI job. [Contractor will need to document this computation in case of an audit.]
If RMI service is greater than 10% of the job, then the contractor will need to collect sales tax on the RMI service and thus must determine the allocated price for each RMI service under some reasonable method.
A drywall contractor is hired by a homeowner for a complete bathroom renovation. The contractor will hang and finish the drywall for the bathroom. The homeowner also requests that the contractor repair a small hole in the wall in another part of the house. The homeowner issues form E-589CI to the contractor. The contractor quotes the job at $1,500 ($1,450 for the bathroom, $50 for the repair). Since the repair is only 3.33% ($50/$1,500) of the job, which is less than 10%, no tax is charged to the homeowner.
Same example as above, but the repair is for $151, which is then 10.06% of the job, making the repair part of the job taxable.
Note: If the wording on either your terms sheet or the job billing indicates that an RMI service is a part of a CI job, you must make this allocation and attach it in your files to cover you should you get audited.
For now, we'll end with a caveat. Do a great job of documentation, and you'll do fine. If you are sloppy, you may get whipsawed: paying tax both on your materials, and paying the tax on the full job price that you did not collect, but could have collected, from the customer. Sales tax is an avoidable tax to you as a contractor - you merely need to collect or not based upon the exemptions available. But if you don't collect tax when you should have, don't count on being able to go back against the customer. Document properly when the jobs are exempt and err on the side of collecting the tax if in doubt.
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Steve Moss
capital improvement, contractors, NC, RMI, sales tax
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