Sales Tax on Labor: A Primer for Contractors in NY

Sales Tax Laws in New York

Sales tax operates on the general principles of a tax on the sale and consumption of goods. New York imposes a sales tax on receipts from retail sales of goods and services unless a specific exception applies. As a general statement, the sale or furnishing of any goods, wares or merchandise for any purpose under any contract or agreement of any nature is subject to sales tax. This sales tax is imposed on consumers and vendees. When the seller or service-provider is a construction contractor, they may be required to collect sales tax from their customer and to remit the tax to the State. Where no sales tax is collected, it is the consumer or vendee’s obligation to remit the tax directly to the State. In other words, due to the existence of construction contracts, it isn’t always the ultimate customer that writes the sales tax check .
In contrast with sales tax imposed on vendors and consumers alike, use tax is imposed on the storage, use or consumption of any tangible personal property in the State where such property has been purchased "at retail" and the vendor has not collected and is not otherwise legally obligated to collect the New York State sales tax from the purchaser. Use tax is not imposed on property acquired for resale in the regular course of business. Where tangible personal property is picked up by the vendee from an out-of-state vendor, or received by the purchaser from an out-of-state vendor and then brought into New York, the burden is on the purchaser to pay use tax directly to the State or to report the tax on its income tax return. A construction contractor is considered a consumer with respect to materials and supplies purchased by the contractor for use in a construction contract, but is a vendor with a sales tax collection obligation with respect to other tangible personal property sold or furnished by a contractor in connection with real property.

Sales Tax on Labor Charges

Not all charges for repair or maintenance labor are subject to sales tax. Generally, a contractor’s charges for services are exempt from sales tax, provided that the charges are for exempt services and are separately stated on the customer’s bill or invoice. For example, a charge for painting the exterior of a house is an exempt service, whether performed by an independent contractor or as part of a taxable sale of "realty construction," provided that the charge for such labor is separately stated on the customer’s bill or invoice. However, materials that become a component part of real property are subject to sales tax. Although the contractor is not liable for the tax, the contractor should collect tax from the customer for the purchase of materials as a component part of real property. The contractor is permitted to deduct from the taxable amount due any amount separately stated for the exempt labor services, provided the charges are separately stated on the invoice. If a contractor performs both exempt and taxable services, they must be separately stated on the invoice.
In cases where the charges for separately stated exempt and taxable services are not separately stated on an invoice, the contractor has present the factual circumstances for the Department’s consideration to determine the proper application of tax to the contractor’s labor and materials charges. For example, on an invoice with no separately stated charges, a contractor charges $1,000.00 to re-surface a driveway, and $500.00 to install a new water heater. The total bill of $1,500.00 is taxable, but if the contract states that $500.00 of the total is for exempt labor, the contractor can deduct the $500.00 from the taxable $1,000.00 charge for labor and material for resurfacing the driveway.
As mentioned above, sales tax is permitted to be separately stated on the contract or invoice for separately stated labor charges provided the services rendered are exempt. What is also permitted is the collection and payment of sales tax by the contractor to the vendor on the cost of materials exempt from tax. As regards to repair or maintenance performed on a vehicle given to an auto body shop for allowed repairs, the contractor does not need to charge tax if they do not themselves sell the materials to the person receiving the repair or maintenance service; the contractor only has to collect and remit tax on the price they pay their vendor for the exempt materials resold in the repair or maintenance of the vehicle. The labor charges are not subject to sales tax, but the materials are subject to sales tax at 8 percent.
Further, if the integrity of the structure is changed, such as the demolition of a portion or the complete demolition of a building, project or other real property, the contractor is considered the consumer of all materials applied to the project (section 526.7). Thus, if the contractor purchases the materials in this situation, he is responsible for the payment of the sales tax on the materials (911 A-1318; 911 A-1930).
Generally, the charge to a customer for the installation of fixtures or supplies to real property is subject to tax unless the fixtures and supplies regularly held for sale are separately stated and the charges do not exceed 10 percent of the total charge (SCT 111.2). As a result, the installation of an air-conditioning system is considered the installation of tangible personal property subject to sales tax because the air-conditioning system is not regarded as a fixture.

Sales Tax Contractors and Services

The general rule regarding contractor services is that they are not taxable because the contractor is improving real property and generally does not come into possession of material or supplies in making those improvements. As you might expect, however, there can be exceptions, and one of those exceptions is that the provision of certain contractor (and related) services does make the contractor a "retailer" subject to tax as well.
In New York, taxable contractor services include:
Depending on the specific service, the tax is either imposed on the contractor, or on the customer. For example, interior cleaning and maintenance of a building is a "retail" service, and if the contractor provides such services, it must collect the tax from the customer.
When the contractor’s service is instead to install tangible personal property, such as when new carpeting is provided, finance charges, including interest or service charges, imposed to finance the purchase of such carpeting are taxable. However, there are other exceptions to the general rule as to the imposition of tax on contractor services that a contractor will need to be able to identify.

Contractor Services, Regulations, and Principles

With some exceptions, the full amount paid by a Contracting Customer is subject to sales tax. NY Tax Law § 1101(b)(5) imposes sales tax on "a transfer of tangible personal property by any means whatsoever for a consideration." Unless an exemption applies, there is a transfer of some tangible personal property or a service enumerated by the State as taxable (see, e.g., Tax Law § 1105(c)), both of which are satisfied in the above example. For most Contractors—barring specific exemptions from the State—sales tax is assessed on the total amount of consideration exchanged with the Contracting Customer. This is true even if the Contractor separately itemizes the amounts representing labor, materials, and/or services on an invoice. NY Tax Regs. § 527.9(e)(1). Thus, separate statements on the invoice even of those amounts are not necessarily effective to avoid taxation to the extent regulations require inclusion of entire consideration received for the Contracting Customer’s general retaining and arrangement of Contractor services. With limited exceptions, such as transactions involving governmental entities and exempt organizations, Contractors have a corresponding obligation to collect and remit the funds to the State. NY Tax Law § 1132. For making such payment or remittance, the Contractor is permitted a fee of five percent of the amount required to be paid for collection expenses. Contractor possesses a corresponding duty to issue a receipt for sales tax collected, either on a separate receipt form (which must be preprinted or designed by Contractor) or incorporated into a sales invoice. NY Tax Regs. § 533.5(b). Additional obligations and requirements apply where Contractors work for exempt organizations. Section 1115 of the New York Tax Law provides a list of exempt organizations. In short, Contractors who receive exemption certificates from qualifying organizations may rely on the certificates for transactions with the organization. NY Tax Regs. § 541.7. However, Contractors still have obligations imposed on them as to collecting during the state audit process and exemptions with regards to payment collections. Id. This means that Contractors cannot just issue a receipt and forget about it. They still must properly and sufficiently document exemption certificates in certain circumstances.

Common Rules

One of the biggest issues associated with collections for construction services is the failure to charge sales tax on labor. Many contractors are not aware of the fact that generally, all construction work, including labor, is subject to sales tax in New York. The failure to charge sales tax will create a liability when the Department of Taxation and Finance (DTF) completes a sales tax audit.
Clients also fall victim to the general misconception that sales tax is the responsibility of the contractor – it is not. Sales tax is the liability of the purchaser, not the contractor. Both clients and contractors need to understand what labor charges sales tax is paid on .
Many contractors believe if they are a residential contractor, they don’t charge sales tax on labor, because sales tax is not paid by consumers on labor. This is not the case. Residential contractors must charge sales tax on all labor. The biggest shock to contractors and clients is that sales tax is due on labor when contract work involves new construction, even on residential buildings. The only time sales tax is not due on labor is for buildings that are aesthetically upgraded and/or repaired (i.e. a renovation). For example, work to install a façade on a building is not taxable, whereas installing new doors and windows is. This is a grey area, and contractors would be wise to seek advice before determining whether a particular project is tax exempt.

Calculating Sales Tax on a Job with Mixed Charges

It is common for a project to involve taxable services and nontaxable labor. In those cases, the contractor must separate the various job elements so that sales tax is collected on the portion of the charge that is subject to tax. A mixed transaction can consist of a combination like pest control where the service is subject to sales tax but the materials (the pesticides) are not, a pool installation project where the contractor provides both the pool and the installation service, or a job where a new floor is installed and an existing floor removed.
The following example demonstrates how a contractor calculates a mixed transaction:
ABC Floor Company is going to install new computer tiles at DEF Corp. in return for $500. The job will require 5,000 sq. ft. of tile which ABC can purchase for $4,500. ABC must pay sales tax on its purchase of the tile. After installation, ABC is going to pull up the existing carpet tiles and dispose of them. The labor associated with this nontaxable service is $400.
The carpet tile removal charges are nontaxable. The installation charges are subject to tax with respect to the tile except to the extent that the labor is reasonably separated, specifically identifiable, and separately invoiced.
The first step for contractors in this situation is to see whether the total charge is subject to tax. If both the labor and materials are exempt, then the entire transaction is not subject to tax. If either is subject to tax, then the contractor has to separate what is subject to tax from what is not.
Here, aside from the installation of the new tile, all elements of the job are not taxable. Therefore, we do not have to separate the charges to determine if any portion is subject to tax. In this case, 1) the tiles are not subject to tax, 2) the carpet tile removal is not subject to tax, and 3) the installation has several components: 4) the tiles, 5) the adhesive, 6) the installation labor, and 7) the profit. The installation charges are subject to tax only to the extent that they are labor for installing the tiles themselves. Profit is not taxable. However, ABC must charge tax on the entire installation bill unless the charges are separately stated, identifiable, and reasonable.
If the charges are not separately stated, identifiable, and reasonable, ABC must then allocate the tax between the tile and the labor. Let’s say the parties agree that the retail price of the tile is $5,000 and the cost to ABC is $4,500. ABC could allocate the markup of $500 all to the labor charges. In that case, ABC would charge tax on the entire $1,400 installation bill.
If ABC had kept time records showing that the labor required for the installation of the tiles was not more than 50% of the labor costs, then ABC could find those records reasonable and allocate 50% of the charges to the nontaxable labor.
Time records are not the only method for apportioning charges between taxable and nontaxable labor. Another method is to allocate based on the higher of the true cost or the retail price of the materials. For example, if the parties agree that the retail price of the tiles is $10,000 (as opposed to $5,000 as shown in the example above), then ABC must allocate at least 50% of the markup ($2,500) to the tile itself. So, ABC would owe tax on $6,000: $500 + $1,000 (50% of the labor for tile installation) + $2,500 (50% of the profit on the tile).

Collecting NY Sales Tax

To comply with state laws, keep all records regarding your sales in an organized and easily accessible manner for at least six years from the end of any period you’re taxed on. This includes, and is not limited to, all records related to income and purchases, employee records and all other business-related records. If you were to be audited, these will be crucial to prove how tax was calculated for all work performed.
In terms of record keeping, it is helpful to keep track of the time you work on specific projects so that it can be easily accessed to provide to tax authorities . This not only helps track hours that may be taxable or not, but also it establishes a history of where your time is spent. Also, it is equally important to have an accurate understanding of the location of your employees at any given time. This includes, but isn’t limited to, time spent in the field, at the shop or on personal time.
Most importantly, all time and field notes for both calculations and actual work performed for a client should be billed in the same invoice. When possible, if a tax-exempt item or service is mixed in with a taxable service of product, make certain to bill them as two separate items on the invoice with taxes applied accordingly.