In previous posts, my partner, Dan Davis, CPA, addressed how states tax installation charges and how states tax contracts with exempt entities. This article includes a related question: how states tax property that is being installed when title to that property is not held by the installing contractor and tax was not previously paid. For example, California generally considers a contractor to be the consumer of equipment and machinery which is furnished and installed under a contract with the U.S. Government, but the contractor will not generally be considered the consumer of such property if title is held by the U.S. Government at the time of installation. In some states, the installing contractor is considered the consumer of the installed property, even when the contractor never takes title to that property.
In the majority of states, contractors are considered to be the consumers of materials that they furnish and install, which means tax applies to the contractors’ purchase price of such materials. When a contractor merely performs installation without furnishing the property installed, most states will not consider the contractor to be the consumer or “user” of the installed materials. (See Dan’s previous post regarding the taxability of installation charges.) If tax was not paid on the materials installed, most states will impose tax on the supplier or the purchaser of the materials. If the supplier lacks nexus with the controlling state and the purchaser is exempt from taxation, e.g., the U.S. Government, then the inquiry ends and no tax is collected on the installed materials. That’s not the case in all states, however.
Certain states consider the installing contractor to be the consumer of installed materials irrespective of whether the contractor ever held title to the materials. In those states, the installing contractor is liable for any tax not previously paid. To the extent the retailer or purchaser can be reached for the tax, the state will typically assert a dual obligation until one party or the other has satisfied the liability.
The states that consider contractors to be consumers of materials they install even if they never held title to such materials include, but are not necessarily limited to: Idaho, North Dakota, South Dakota and Tennessee.
When considering this issue in the context of a contract with the U.S. Government, the ability of a state to impose a tax based on the value of property owned by the U.S. Government is questionable at first blush, since the federal government is generally immune from state taxation pursuant to the U.S. Constitution. The issue was addressed by the U.S. Supreme Court in United States v. Boyd (1969) 378 U.S. 39.
In Boyd, the Supreme Court considered the validity of a use tax levied by Tennessee on contractors performing work on behalf of the Atomic Energy Commission (AEC) at its Oak Ridge, Tennessee complex. The contract established that title to all of the relevant property and supplies would pass directly to the U.S. Government prior to installation, and that the items would be purchased using government funds. Therefore, title to the items at issue was held by the U.S. Government at the time the property was installed. Notwithstanding the government’s ownership, Tennessee taxed the contractors’ use of the property under a statute that imposed tax on the installing party, based on the cost or fair market value of the property installed, irrespective of ownership, provided such tax had not been previously paid. This law had been intended to eliminate the so-called loophole that permitted contractors to avoid tax on U.S. Government contracts.
The contractors and AEC sued to recover the collected taxes, claiming that the collection infringed upon the implied constitutional immunity of the United States. Tennessee’s Supreme Court upheld the collection, pointing out that the incidence of tax was upon the contractor, not the U.S. Government. The courted stated that the tax is “imposed upon the use by a contactor of tangible personal property whether title is in him or in another, and whether or not the other has immunity from state taxation,” adding that the “contractor’s tax was intended to be and is a tax upon the use per se by such a contractor.” The U.S. Supreme Court affirmed the decision, pointing out that the determining factor is the legal incidence of tax, and that the imposition of tax upon a private contractor is permissible even though the economic burden of the tax is ultimately borne by the United States.
Similar issues have since been brought before the Supreme Court with the same result, although the court now includes an additional balancing test to determine if the tax is permissible in some cases. Under the balancing test, the state must show that the benefits of the tax outweigh the economic burden.
In summary, it is well settled that states may impose a use tax on installing contractors, irrespective of whether or not the installing contractor ever held title to the property, and even if title is held by an exempt entity such as the U.S. Government. Therefore, it is important for contractors to recognize and consider their potential exposure when they perform construction labor on property owned or supplied by others. This type of exposure is not limited to contracts with the U.S. Government.
Sub-issues to consider include how the measure of tax should be established, and what products or services should be included in the measure of tax. Typically, the installing contractor’s contract will not identify the cost price of the property to be installed, and when the contractor is not providing the property, it may not be privy to such information. If the actual cost price cannot be obtained by the state during an audit, the auditor may establish the taxable measure from an estimate or from what it considers to be the fair retail selling price. Establishing the taxable measure in that manner creates the potential for an excessive audited value. The law is not always clear on how the cost price should be established: for example, is it the cost of the manufactured property to the supplier, or the selling price to the purchaser? The difference can be significant.
Issues also may arise as to what specific property and services are to be included in the taxable measure. For example, what happens if the supplier makes separate charges for testing the property after it transfers title to the purchaser – before or after installation, or for tools and supplies that are sold with the property, but not installed? States will typically seek to include such charges in the measure of tax, but if the services or supplies are not related to the installation performed by the contractor, is it appropriate to do so? These questions generally require a fact-intensive inquiry and should be considered by contractors when they are preparing bids or are under audit.