As a construction contractor operating in Pennsylvania, you’re likely aware that you face a complex set of sales and use tax rules that depend on nuanced distinctions between real property improvements, tangible personal property (“TPP”) and exempt transactions. Mistakes in classification or lack of proper documentation can result in problems with vendors and customers, audit assessments and missed refund opportunities.
Real Property Versus Tangible Personal Property
Pennsylvania distinguishes between construction activities (affixing TPP to real estate) and sales activities (installing TPP that does not become a permanent part of real estate). Examples of construction activities include drywall and HVAC system installations, while the installation of an appliance would typically be considered a sales activity.
The contractor’s tax responsibility in the examples above turns on proper classification of each activity. If the activity is classified as a construction activity, the contractor pays sales/use tax on the materials for the drywall/HVAC installation and the labor is not taxable. Conversely, if the activity is classified as a sales activity, the contractor would charge sales tax on the materials and labor for the appliance installation.
While Pennsylvania has a regulation that provides examples of activities presumed to fall into the construction activities and sales activities buckets, factors like portability, damage upon removal and functional integrity have also been articulated by Pennsylvania courts as important factors when making this determination.
Exemption Opportunities
Pennsylvania allows exemptions for certain transactions with government agencies, purely public charities and qualified businesses operating in a Keystone Opportunity Zone. These exemptions apply to “building machinery and equipment (BME),” which includes HVAC systems, electrical components, alarms, medical systems and others.
To claim the exemption, Form REV-1220 (Sales Tax Exemption Certificate) should be submitted by a purchaser to its vendor. The form should include a statement that the property qualifies as BME and will be transferred to a tax-exempt entity. The certificate should be properly executed and submitted within 60 days of purchase.
Repairs Versus Building Maintenance Services
The first determination on taxability is to determine if the contractor is performing the repair or maintenance service on real property or TPP. If the contractor is doing something to real property, general maintenance services are taxable, while repair services are non-taxable. If the contractor is doing something to TPP, generally both repair and maintenance services are taxable, but unlike a real property scenario, the contractor’s customer might be able to provide an exemption certificate (e.g., manufacturing). In the real property scenario, a taxable maintenance activity generally involves keeping an item in normal working condition, whereas a non-taxable repair typically involves bringing the property back into working condition. However, it is always prudent to consult the regulations or your tax advisor, as certain activities are specifically defined as taxable or nontaxable.
Common Contractor Issues Include:
- Misclassifying construction versus sales activities.
- Charging sales tax on exempt construction labor.
- Failing to pay use tax on out-of-state purchases.
- Using resale certificates improperly.
- Claiming the manufacturing exemption on materials that are installed into real property.
Contractor Obligations
- Pay sales or use tax on all taxable materials, equipment and services used in construction contracts.
- Do not charge sales tax to customers on construction labor or materials affixed to real estate.
- Collect sales tax if selling TPP that is not permanently affixed to real estate.
- Do not separate state tax on invoices for construction materials. However, this tax can be embedded in the total price.
Contractors Can Reduce Exposure By:
- Maintaining detailed records, separating taxable and nontaxable charges.
- Clearly distinguishing between labor and material costs on invoices.
- Working with tax professionals to evaluate exemption eligibility and refund opportunities.
Navigating state and local taxes is particularly challenging for construction contractors in Pennsylvania due to complex sales and use tax regulations. RKL’s team of State and Local Tax (SALT) experts provides the support and expertise needed to manage these obligations with confidence. Our services are designed to help contractors like you optimize tax efficiency and compliance. Learn more about RKL’s SALT services or contact your RKL advisor for more information.
