Top audit triggers and most-common pitfalls for contractors
Under New York sales-tax law, contractors have the unusual burden of being considered the consumer of building materials, making them prime targets for audits. As a general rule, contractors must pay sales tax on all building materials, for both repairs and maintenance (R&M) and capital-improvement (CI) purchases, unless an exemption applies (e.g., purchasing building materials for tax-exempt entities).
Understanding the distinction between R&M and CI projects is critical 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 result in substantial penalties and loss of profits.
Repairs and maintenance
Because New York state contractors have the unusual burden of being considered the consumer of building materials, a resale exemption does not apply, and sales tax is due to the vendor. Contractors pay the sales tax on building materials upfront and after charging and collecting sales tax from the customer on the R&M project, contractors become eligible for a credit for the sales tax they paid on the materials purchased.
If the work is a capital improvement, 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 is tax-exempt?
If the work is for a tax-exempt organization or an Industrial Development Agency (IDA) no sales tax applies to building materials. The contractor must provide its vendor with a properly executed exemption form. However, if a contractor is an appointed agent of the IDA, additional tax exemptions are available (please review the IDA agreement).
The top audit triggers for contractors
Given the information above, no wonder contractors are a prime target for a New York State sales-tax audit. Make no mistake: 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.
Understanding the ins and outs of New York 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.
The best defense is a good offense
There are ways contractors can reduce the 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.
Finally, too often the goal in sales and use tax compliance is focused on making sure that enough tax has been paid. Consulting with a CPA for an analysis of sales-and-use tax procedures may reveal that the company is paying too much in taxes.
John Fontanella, CPA, is a principal in The Bonadio Group’s tax department, with a focus on taxes for privately held businesses and their owners. He also specializes in sales taxes for contractors and manufacturers.
Author’s note: 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.