Understanding How Sales and Use Tax Applies to Cabinet Contractors in California Can Save You a Bundle of Tax
Sales and use tax rules for the construction industry are complex. Generally speaking, California construction contractors are considered consumers of materials and retailers of fixtures. Consumers must pay sales or use tax on the costs of the items they “use,” and retailers owe tax on the sale price of the items they sell. Like many areas of taxation, however, the devil is in details. The application of tax may vary depending on the item being installed, the form of the contract and even the manner in which the installation is performed. For example, if a contractor installs an exterior shutter by first attaching one piece to the structure and building it out from that point, it is treated different for tax purposes than if the shutter is prefabricated and attached as a single unit. Such is the case for California cabinet contractors and the difference in the amount of tax under each scenario is significant.
If a cabinet contractor is treated as the retailer of a cabinet it installs, tax will apply to its full selling price less an amount for installation. On the other hand, if a cabinet contractor is treated as the consumer of a cabinet it installs, tax will apply to its material costs. The difference between those two amounts is significant, especially when the contractor manufactures the cabinet in-house, as many do.
Determining if a cabinet and millwork contractor is the retailer or consumer, depends on whether the cabinet is determined to be a “fixture” or “material,” as those terms are defined under the law. Determining if a cabinet is a fixture or material, hinges on the degree of prefabrication costs in relation to the overall project labor and material costs.
California Code of Regulations, title 18 (Regulation), section 1521, subdivision (c)(2), provides the criterion for determining when an installed cabinet will be regarded as a fixture. The section states,
“A cabinet will be consider to be ‘prefabricated’ and a ‘fixture’ when 90 percent of the total direct cost of labor and material in fabricating and installing the cabinet is incurred prior to affixation to the realty. In determining this 90 percent, the total direct cost of all labor and materials in fabricating the cabinet to the point of installation will be compared to the total direct cost of all labor and materials in completely fabricating and installing the cabinet. If more than one cabinet is fabricated and installed under the contract, each cabinet will be considered separately in determining whether the cabinet is prefabricated.”
The above rule is commonly referred to as the “90/10 rule.” To apply the 90/10 rule, the cost of every item that becomes part of the end product (lumber, screws, bolts, hardware, varnish, etc.) and all of the labor to manufacture and install the product must be allocated either to fabrication or installation.
Installation begins when a part of the product is bolted, screwed, glued, or nailed onto realty. Labor to affix any additional components, either to the part that’s already attached or to other sections of the realty, is also regarded as installation. Costs of items installed after the body of a cabinet is affixed, such as doors, hinges, knobs, etc., should be added to the installation side of the formula. If the combined labor and item costs on the installation side exceed 10 percent of the total cost of furnishing and installing the cabinet, the unit will be regarded as a “material” for tax purposes, it will not be regarded as a fixture, and tax will only be due on the costs of the component materials.
On the other hand, if installation costs are 10 percent or less of the total costs (including the items that are installed after attachment to realty, e.g., knobs), the unit will be regarded as a fixture. This means sales tax will apply to the entire contract price, excluding only the retail installation labor itself. Installation labor is excluded from sales tax pursuant to Revenue and Taxation Code section 6012.
Understanding how tax applies provides an opportunity for well-informed contractors to save a significant amount of money. Under a lump sum contract, that savings goes straight to the bottom line! Moreover, the California Department of Tax and Fee Administration commonly selects cabinet contractors for audits, because the complexities commonly result in reporting errors. For the reasons, it is vital for California cabinet makers to make certain they are applying sales and use tax in the correct manner.
