New York’s Sales Tax Rules For Contractors
state tax notes The Nuts and Bolts of New York’sSales Tax Rules for Contractorsby Timothy P. Noonan, Lance E. Rothenberg, and Joshua K. LawrenceTimothy P. NoonanLance E. RothenbergJoshua K. LawrenceNoonan’s Notes is a column by Timothy P. Noonan, apartner in the Buffalo and New York offices of HodgsonRuss LLP. This month’s column is coauthored by Lance E.Rothenberg, a senior associate in the New York office, andJoshua K. Lawrence, a senior associate in the Buffalo office.In this article, the authors write about New York’s salesand use tax rules that apply to contractors in the construc tion industry and their customers.No matter who you talk to, people often complain aboutcontractors: The project is over budget; the project is de layed; the jobsite is hazardous; the contractor stopped takingcalls; there’s dust everywhere. Sound familiar? We think weknow why, but the problem may not be entirely the contrac tor’s fault. Part of the problem, at least, is the myriad andcomplex sales and use tax (sales tax) rules that contractorsand their customers must grapple with behind the scenes.Trying to keep abreast of the tax man is surely getting in theway of contractors focusing on their work.As a general matter, New York’s sales tax rules are not allthat easy to follow from a compliance perspective, no matterwhat the industry. The sales tax rules applicable to theconstruction industry, though, are particularly confusing,counterintuitive, and dense. There are special rules affectingthe taxation of capital improvements; repairs; maintenance;purchases of construction materials; purchases for resale;leasehold improvements; and new construction, amongothers. It turns out, that the right tool to get the job donemay well be a CPA or an attorney. Our punch list is long.We’ll explain.I. The FoundationTo explain the nuances, we first need to briefly reviewsome of the basics. Under New York’s rules, sales of goodsand sales of services are treated differently. The sales taxapplies broadly to the sale of tangible personal property.1When you buy a hammer, you generally pay sales tax. Incontrast, the sales tax applies only narrowly to the sale ofservices; typically, a particular service is taxable only if thestatute specifically says so.2 That’s why neither engineeringnor architectural services are subject to tax, but interiordecorating services are.3Construction services fall under many special rules. Tobegin, there are two taxable services that are particularlynoteworthy. First, the statute imposes tax on the service of‘‘installing, maintaining, servicing or repairing tangible per sonal property.’’4 For example, the charge for piano tuning istaxable,5 and so is the charge for installing a washer/dryer toexisting wiring and plumbing.6 Second, the statute similarlyimposes sales tax on the service of ‘‘maintaining, servicing orrepairing real property.’’7 For example, the charge for repair ing a broken window is taxable,8 as is the charge for somelandscaping services, such as regular lawn mowing.9Essentially, installation, repair, or maintenance serviceseither to tangible personal property or to real property aregenerally taxable. But here’s where it starts to get interesting.If the construction services performed rise to the level of a‘‘capital improvement,’’ as distinct from merely an installa tion, repair, or maintenance service, that service is nottaxable.10 For example, the charge for removing a portion ofa masonry wall for the purpose of installing a door andwindow is not taxable, even though the two statutes thatwere just mentioned might otherwise seem to impose tax.11Consequently, distinguishing whether a particular projectqualifies as a capital improvement or as just an installation orrepair is quite significant. And that is merely the beginning.1N.Y. Tax Law section 1105(a).N.Y. Tax Law section 1105(c).3N.Y. Tax Law section 1105(c)(7).4N.Y. Tax Law section 1105(c)(3).520 NYCRR section 527.5(a)(3).620 NYCRR section 527.5(a)(2).7N.Y. Tax Law section 1105(c)(5).820 NYCRR section 527.7(b)(1).920 NYCRR section 527.7(b)(3).10N.Y. Tax Law section 1105(c)(3)(iii) and (c)(5).1120 NYCRR section 541.2(g)(1).2State Tax Notes, June 29, 2015993For more State Tax Notes content, please visit www.taxnotes.com.(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.NOONAN’S NOTES
Noonan’s Notes12N.Y. Tax Law section 1101(b)(9); 20 NYCRR 527.7(a)(3); 20NYCRR 541.2(g); New York State Department of Taxation and Fi nance, ‘‘Capital Improvements,’’ TB-ST-104 (July 27, 2012).1320 NYCRR section 527.7(a)(3)(ii)(a).14TB-ST-104, supra note 12.1520 NYCRR section 541.2(l).1620 NYCRR section 541.5(d)(2).1720 NYCRR section 541.7(b).1820 NYCRR section 527.7(b)(4).construction activities and classifies them either as capitalimprovements or as taxable installation, repairs, or mainte nance work.19 While instructive, not every situation is cov ered. Further, even New York acknowledges that the methodof installation may affect taxability, so determinations re quire a case-by-case review.20In L & L Painting, New York’s Tax Appeals Tribunalexamined the taxability of some construction services per formed to a drawbridge connecting Brooklyn andQueens.21 That case helpfully highlights the difficulty indistinguishing between a capital improvement and a repairor maintenance service. In brief, the work performed in cluded the removal of old paint and coatings, installation ofa temporary containment system to contain pollutants anddebris, and application of a special protective zinc-and epoxy-based coating to the bridge and its piers. The taxdepartment argued that the work amounted to painting andthat under its regulations,22 painting is nothing more than ataxable repair and maintenance service. In contrast, thetaxpayer pointed to the statutory three-prong definition of acapital improvement, as well as the end result test, andargued that the work amounted to a capital improvement.Disregarding the department’s painting regulations, the TaxAppeals Tribunal reasoned that when the facts satisfy thestatutory definition for a capital improvement, the work isentitled to capital-improvement treatment.23In practice, though, auditors tend not to apply the endresult test to the entire project. For larger projects, auditorsseem to request and review the contractor’s breakdown ofwork in order to find aspects that may not qualify as a capitalimprovement on their own.III. Certificate of Capital ImprovementThe good news is that these often complex and farreaching determinations — which heavily affect taxability(and audit exposure) — are supposed to be made by thecustomer. That’s right. The customer, not the contractor,makes the call.24 When construction services are beingprovided, the customer is asked, through the issuance of aForm ST-124, ‘‘Certificate of Capital Improvement,’’ to19New York State Department of Taxation and Finance, Publica tion 862, Sales and Use Tax Classifications of Capital Improvements andRepairs to Real Property (Apr. 2001).20TB-ST-104, supra note 12.21L & L Painting Co. Inc., Nos. 822266, 822227 (Tax AppealsTribunal) (June 2, 2011).2220 NYCRR section 527.7; 20 NYCRR section 541.2.23Id. (‘‘The capital improvement provision in Tax Law section1105[c][5] is not to be viewed as an exception as to which the taxpayerbears the burden of proof, but rather is to be construed under the rulethat ‘[a] statute which levies a tax is to be construed most stronglyagainst the government and in favor of the citizen’’’).2420 NYCRR section 541.5(b)(4)(i) (‘‘When a properly completedcertificate of capital improvement has been furnished to the contractor,the burden of proving the job or transaction is not taxable and theliability for the tax rests solely upon the customer’’).994State Tax Notes, June 29, 2015For more State Tax Notes content, please visit www.taxnotes.com.(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.II. Some Notes on Capital ImprovementsNew York employs a three-prong test to define a capitalimprovement. A capital improvement is any addition oralteration to real property that (1) substantially adds to thevalue of the real property or appreciably prolongs the usefullife of the property; (2) becomes part of the real property oris permanently affixed to the real property so that removalwould cause material damage to the property or article itself;and (3) is intended to become a permanent installation.12Each prong must be met to satisfy the test. That can lead tosome distinctions that may initially seem odd. Installingcarpet in a brand new building is a tax-free capital improve ment, but installing brand new carpet in your old apartmentis a taxable installation of tangible personal property.13Given those distinctions, misunderstanding the rules andimproperly accounting for transactions will leave you withthe feeling of having just stripped a screw.If installing a hot-water heater is a tax-free capital im provement, but replacing a thermostat on a hot-water heateris a taxable repair,14 how are contractors and customers toknow the difference? As a preliminary matter, step back andconsider whether the construction work is intended topermanently alter or improve real property. Carefully con sider each of the three prongs of the capital improvementtest.Then contrast those prongs with work that merely main tains, services, or repairs real property, which the regulationstell us are ‘‘terms which are used to cover all activities thatrelate to keeping real or personal property in a condition offitness, efficiency, readiness or safety, or restoring it to suchcondition.’’15 For example, charges for regular trash removalor rodent control are taxable maintenance services.16 Incontrast, when a contractor purchases trash or debris re moval services in connection with the performance of acapital improvement (such as knocking down that masonrywall to build that door and window), those charges are nottaxable.17Most importantly, New York employs the ‘‘end result’’test to aid in making those determinations. The regulationstell us that the imposition of tax on services performed onreal property ‘‘depends on the end result of such service.’’18If the end result of the service is the repair or maintenance ofreal property, the service is taxable. If the end result of thesame service is a capital improvement to real property, theservice is tax free. To assist with those types of determina tions, New York has issued guidance that lists many types of
Noonan’s NotesMaterialsVendorsSales tax due onpurchase.ContractorOwnerSubsNo sales tax due if workperformed is component ofexempt capital improvement.certify whether the work performed ‘‘will result in a capitalimprovement to the real property.’’25 The contractor mustlikewise certify that he has entered into a contract to per form the work described in the certificate and that thecertificate has been accepted in good faith.26Whether a customer has the requisite knowledge of con struction work and a sufficient understanding of these com plex sales tax rules to properly make those determinationsremains an open question to us. However, these rules aredesigned to benefit the contractor by relieving him of liabil ity. And case law establishes that a Certificate of CapitalImprovement is no less valid merely because the contractormay be in a better position than the customer to assesswhether the work meets the test.27 While sales are generallypresumed to be taxable, when a vendor accepts an exemp tion certificate in good faith, he is generally relieved of hiscollection liability.28 A certificate is accepted in good faithwhen a contractor has no actual knowledge that the certifi cate is false or is fraudulently presented and the contractorexercises reasonable ordinary due care.29 We can imaginevarious situations, though, when that standard is not alwaysso easy to apply.3025New York State Department of Taxation and Finance, ‘‘New YorkState and Local Sales and Use Tax: Certificate of Capital Improve ment,’’ Form ST-124 (Feb. 2012).26Id.27See Saf-Tee Plumbing Corp. v. Tully, 77 A.D.2d 1, 3-4 (3d Dep’t,1980).2820 NYCRR section 532.4(a), (b).2920 NYCRR section 532.4(b)(2)(i); supra note 25.30For instance, these issues can be exacerbated when dealing withleasehold improvements. Tenant alterations are generally presumedtemporary. As such, what might be a capital improvement if done atthe direction of a building owner could nonetheless be treated as ataxable installation when done at the direction of a tenant.No sales tax charged unlesstaxable work is being performed.IV. Contractor PurchasesSo far, we have spent a lot of time talking about thedifferences between a tax-free capital improvement and ataxable installation, maintenance, or repair service. As dis cussed, distinguishing between the two classifications can betricky. But the importance of properly characterizing atransaction cannot be overemphasized. That determinationaffects the taxability of both ends of the transaction. Itgoverns the taxability of the contractor’s charges to itscustomer for the construction service. It also dictates thetaxability of the contractor’s purchases and subcontractsnecessary to perform the construction service.A. Capital Improvement JobsLet’s first consider projects that qualify as capital im provements. See Figure 1 for an illustration. No sales tax isdue from the customer on the contractor’s fee (whether forlabor or materials or both) for completing the capital im provement.31 Contractors should, of course, obtain a Cer tificate of Capital Improvement from the customer. Whatabout the tax treatment of the contractors’ purchases? Con tractors who are performing a capital improvement mustpay tax on the cost of their materials.32 But no tax is due onlabor charges of subcontractors, provided the subcontrac tors are performing a component of the capital improve ment project.33 Subcontractors, though, must pay tax ontheir purchases.3120 NYCRR section 541.5(b)(2).20 NYCRR section 541.5(b)(1).33See, e.g., New York State Department of Taxation and Finance,‘‘Taxability of Drilling Test Wells and Associated Services,’’ TSB-M 10(4)(S) (Mar. 15, 2010) (when subcontracted drilling services areperformed as a constituent part of a capital improvement to realproperty, charges are not subject to tax); New York State Departmentof Taxation and Finance, ‘‘Sales Tax Treatment of Certain TemporaryFacilities Provided at Construction Sites,’’ TSB-M-14(15)S (Oct. 23,32(Footnote continued on next page.)State Tax Notes, June 29, 2015995For more State Tax Notes content, please visit www.taxnotes.com.(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.Figure 1.Capital Improvements
Noonan’s NotesMaterialsVendorsSales tax due on purchase,but contractors may beentitled to refund or credit.ContractorOwnerSubsSales tax charged onentire project.No sales tax due becauseof resale exclusion.From a policy perspective, contractors are treated as theultimate consumers of the tangible personal property thatthey purchase to build the capital improvement.34 As such,contractors’ purchase or rental of materials and supplies inconnection with a capital improvement cannot be made forresale. In fact, contractors are prohibited from using typicalsale-for-resale exemption certificates.35 Therefore, contrac tor purchases are subject to tax, while the contractors’ fee forthe capital improvement service is not. Taxes on the contrac tors’ purchases are generally passed on to the customers inthe form of a higher overall fee, but they cannot be itemizedas sales tax payable by the customers.B. Repair or Installation JobsNow let’s consider projects that qualify as taxable instal lation, repair, or maintenance services. See Figure 2 for anillustration. Sales tax is due from customers on the contrac tors’ full invoice amount for the taxable labor and materi als.36 What about the tax treatment of the contractors’purchases now? Those, too, are subject to tax, but with acaveat: Purchases of any tangible personal property by con tractors for use or consumption in a taxable installation,repair, or maintenance service are subject to tax.37 Unlikewith capital improvements, though, contractors who pro 2014) (subcontracts to provide temporary facilities at constructionsites, which are a necessary prerequisite to the construction of a capitalimprovement to real property, are considered part of the capital im provement).3420 NYCRR section 527.7(b)(5).3520 NYCRR section 532.4(d)(5) (‘‘Contractors who are purchas ing tangible personal property for use in performing capital improve ment work or repairs on real property are not permitted to use a resalecertificate’’).3620 NYCRR section 541.5(d)(1)(i) (tangible personal property)and (d)(2) (real property).3720 NYCRR section 541.5(d)(3).vide a taxable service may be entitled to a refund or credit oftax paid regarding any materials that are incorporated intoreal property and are later transferred to the purchasers inconjunction with the taxable service.38Let’s focus on that for a moment. Repainting a buildinggenerally is not a capital improvement. As such, the cus tomer will pay tax on the contractor’s fee for the paintingservice. Likewise, the contractor will pay tax on the purchaseof materials, tools, and supplies necessary to get the job done(for example, paint, spackle, brushes, and drop cloths). Thecontractor will be entitled to a refund or credit for tax paidon the cost of those materials that are incorporated into thebuilding, such as the paint and spackle.39 The contractorwould not get a credit or refund, though, for the brush ordrop cloths, which are consumed rather than transferred tothe customer.Further, when dealing with a taxable installation, main tenance, or repair service, contractors can purchase subcon tractor services tax free under a resale exclusion. That is, thesubcontractor services will be treated as if they have beenpurchased for resale to the customer.40V. Exempt OrganizationsA customer’s own tax-exempt status may also relieve thecontractor from collecting tax on an otherwise taxable repairor maintenance project in New York. For instance, somecategories of organizations enjoy tax-exempt status on theirdirect purchases of labor and materials from contractors,regardless of whether the work constitutes a capital improve ment or a taxable installation, maintenance, or repair. Butwhether the contractor’s purchases relating to work for an38Id.Id.4020 NYCRR section 541.5(d)(1)(iii).39996State Tax Notes, June 29, 2015For more State Tax Notes content, please visit www.taxnotes.com.(C) Tax Analysts 2015. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.Figure 2.Repairs and Installations
Noonan’s NotesHere’s how that works: Generally, contractors workingfor an exempt organization may purchase supplies andmaterials tax free only when the items will be incorporatedinto real property owned by the EO. One common miscon ception among contractors and subcontractors is that theproperty owner’s tax-exempt status automatically carriesover to the prime contractor, so that all purchases of mate rials and labor by the prime contractor become tax exempt.That kind of blanket exemption can exist, but only inspecific cases when the EO and the prime contractor haveentered into a written agreement in which the prime con tractor is designated to act as a legal agent of the EOregarding purchases.41 Otherwise, a contractor should notassume that all its purchases are exempt just because it isdoing work for an EO.As with capital improvement projects, a contractor work ing for an EO should accept and retain proper documenta tion on the exempt nature of its work. The contractorshould accept Form ST-119.1, ‘‘Exempt Organization Ex emp
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