Sales Tax on Construction Contracts
Under Minnesota sales tax laws, a contractor is the consumer of materials purchased to make improvements to real property under a lump sum contract. That means the contractor pays sales tax on the cost of materials purchased for a project, but does not charge tax to the contractor's customer. The tax cost is built into the lump sum contract price.
The University of Minnesota has a broad sales tax exemption that allows the U to purchase building materials exempt from sales tax. However, when the U hires a contractor under a time and materials lump sum contract the University's exempt status does not flow through to the contractor. The contractor must pay the sales tax on the materials the contractor purchases, and that cost is reflected in the lump sum contract price.
If the U hired the contractor under a labor only contract, the U could buy the materials exempt from sales tax. Depending on the scenario, this alternative could be cost effective since there would be no tax due on the materials used in the project.
For example, the U wants to replace carpet in a building. Under scenario 1, the new carpet is purchased tax exempt by the U for $60,000 and a contractor is hired under a labor only contract to install the carpet. Under scenario 2, a contractor is hired under a lump sum contract to provide and install the carpet. The contractor will need to pay tax when purchasing the carpet. If the contractor pays the same price for the carpet, this would be a tax cost of $4,665 dollars at the Minneapolis campus rate of 7.775%. Presumably, this would be factored into the total lump sum contract price.
There are numerous other factors to consider aside from tax when deciding whether to purchase materials directly, including warranty issues, timing issues, and increased administrative costs. The big picture should be viewed along with the potential tax savings before electing to change the structure of an improvement to real property.