Out-of-State Contractors: When Texas Claims You Owe Sales Tax

Like other out-of-state businesses, out-of-state contractors working in Texas must comply with the state’s sales tax laws. Out-of-state contractors may need to collect and remit Texas state sales tax in various circumstances, and their failure to do so can create exposure to liability for back taxes, interest, and penalties. This includes criminal penalties in some cases.

Out-of-state contractors can owe sales tax on items they purchase or lease for certain types of jobs in Texas. They can also owe sales tax based on the services they provide. As a result, a comprehensive approach to Texas state sales tax compliance is essential, and out-of-state contractors must also be prepared to defend against Texas sales tax audits when necessary.

When Out-of-State Contractors Can Owe Texas State Sales Tax

Out-of-state contractors’ Texas state sales tax obligations are set forth in three key provisions of Texas law: 34 Tex. Admin. Code Section 3.291 (Contractors); 34 Tex. Admin. Code Section 3.586 (Nexus); and, 2 Tex. Tax Code Section 151.0101 (Taxable Services).

While these sections do not address everything out-of-state contractors need to know about Texas sales tax compliance, they address compliance issues unique to the contracting industry and to out-of-state businesses.

Tax Responsibilities of Contractors Who Improve Property of Nonexempt Customers

Under 34 Tex. Admin. Code Section 3.291 states that contractors may owe sales tax on the purchase, lease, or rental of various items used for construction jobs involving nonexempt customers in Texas. For example, the following obligations apply to out-of-state contractors performing work in Texas:

• “A contractor must pay sales tax at the time of purchase, lease, or rental on the sales price of equipment used to perform a contract.” This includes equipment purchased, leased, or rented from an out-of-state vendor, unless the out-of-state vendor collects Texas use tax.
• Subject to certain exceptions, “a contractor must pay tax at the time of purchase on consumable items that are not physically incorporated into the customer’s property.” When collecting sales tax on consumables, a contractor must “separately state the charge for these consumable items to the customer and must collect sales tax from the customer, unless the customer qualifies for [an] exemption.”
• “A contractor who performs lump-sum contracts owes tax on all materials, consumable items, equipment, taxable services, and other taxable items that are used by the contractor or incorporated into a customer’s property.” In this scenario, the contractor must collect and remit sales tax on items purchased, leased or rented from out-of-state vendors, “unless the out-of-[vendors] seller collected and gave the contractor a receipt for Texas use tax.”

These are just a few illustrative examples. Section 3.291 imposes several additional sales tax requirements that are unique to contractors as well. Generally speaking, unless the law expressly states otherwise, these requirements apply to contractors working in Texas regardless of where their headquarters are located.

Taxable Services

In addition to paying sales tax on items purchased, leased, or rented for use in connection with construction projects in Texas, out-of-state contractors may also owe sales tax on certain services they provide to Texas customers. These are referred to as “taxable services,” and they are specified in 2 Tex. Tax Code Section 151.0101.

The Texas Comptroller provides an overview of taxable services on its website, and this overview provides more insight than the types of services that trigger an obligation to collect and remit state sales tax in Texas. Here are some of the most notable insights for out-of-state contractors:

• “All charges for labor and materials to rebuild, replace, alter, modify, or upgrade existing nonresidential realty are taxable.” However, this excludes charges for “the addition of new usable square footage.”
• Certain services are taxable regardless of whether they are provided for a residential or nonresidential property. These include, “[p]est control and extermination, garbage and other waste collection or removal, janitorial and custodial services (including parking lot sweeping or cleaning), landscaping and lawn maintenance (including tree surgery and plant leasing), and surveying.” Even if out-of-state contractors subcontract these services to in-state businesses, they may still be required to manage sales tax compliance.

Here too, these are just examples. If an out-of-state contractor provides taxable services in Texas, it must collect and remit sales tax in accordance with applicable law. To ensure compliance, out-of-state contractors should consult with local tax counsel before beginning work (and, if possible, before contracting). As noted above, failure to collect and remit Texas state sales tax can have serious consequences; and, if a contractor does not separately collect sales tax from a customer, it will be required to pay sales tax (and applicable interest and penalties) out of its contract revenue.

Physical Nexus for Out-of-State Contractors

Any business that has “nexus” with the State of Texas must pay sales tax as required by law. This includes “physical nexus”—and out-of-state contractors can establish physical nexus through various means. Under 34 Tex. Admin. Code Section 3.586, some examples of grounds for the Texas Comptroller to assert physical nexus for out-of-state contractors include:

• “[P]erformance of a contract in Texas regardless of whether the taxable entity brings its own employees into the state, hires local labor, or subcontracts with another;”
• “[H]aving employees or representatives in Texas doing the business of the taxable entity;” and,
• “[P]roviding any service in Texas, regardless of whether the employees, independent contractors, agents, or other representatives performing the services reside in Texas . . . [including] installing, erecting, or modifying property in Texas.”

Thus, out-of-state contractors working in Texas will have physical nexus in virtually all scenarios—and this means that they will need to proactively manage Texas sales tax compliance. This includes, but is not limited to, compliance with the provisions discussed above.

Request a Confidential Consultation with a Texas State Sales Tax Attorney

If you need to know more about Texas’s sales tax requirements for out-of-state contractors—or if your out-of-state contracting business is facing a Texas sales tax audit—we encourage you to contact us for a confidential consultation. Call 888-870-0025 or contact us online to request an appointment with a Texas state sales tax attorney at Brown PC.