What Is Use Tax for Contractors?

Use tax is the tax you owe directly to your state when you use, store or consume taxable items there without having paid sales tax on them. For contractors it comes up when materials are bought from out-of-state suppliers that didn't charge tax, when items bought with a resale certificate get used on a job, and on tools and equipment.

How does use tax work?

Every state with a sales tax also has a use tax. Sales tax is collected by the seller at the register. Use tax is owed by the buyer when taxable goods are brought into the state, or used in it, without sales tax having been paid. The rate is generally the same, and the point is to stop buyers from avoiding tax by purchasing from sellers who don't collect it. For a trades business, that means every tax-free purchase that ends up on a job or in the shop needs a second look.

Use tax = cost of taxable items used in-state without sales tax × your local sales tax rate

When does a contractor owe use tax?

How the rules look in five states

• California. Contractors are generally the consumers of materials and owe tax on their cost. Purchases from out-of-state vendors that didn't charge California tax go on the sales and use tax return under "Purchases Subject to Use Tax." Contractors who don't need a seller's permit but have $100,000 or more in annual gross receipts must register for a Consumer Use Tax Account. See the California tax guide.
• Texas. Under a lump-sum contract the contractor pays tax on all supplies, materials, equipment and taxable services when buying them. Materials bought with a resale certificate and then used in a lump-sum job are owed as use tax. See the Texas tax guide.
• New York. Building materials bought for capital improvement work are taxable to the contractor. Materials bought without tax, for example from an out-of-state supplier, trigger use tax when used in the state. See the New York tax guide.
• Washington. Prime contractors buy materials that become part of the project with a reseller permit, but owe sales or use tax on equipment, tools and supplies they consume. Using a reseller permit for consumer items carries a 50% misuse penalty under RCW 82.32.291. See the Washington tax guide.
• Florida. Under lump sum, cost plus, fixed fee, time-and-materials and similar real property contracts, the contractor is the final consumer of materials and must pay tax to suppliers on all purchases, including those for its own use. Contractors performing taxable fabrication owe use tax on the fabricated cost. See the Florida tax guide.

How do you track and report use tax?

1. 1

   Flag tax-free purchases when you enter them.

   In your bookkeeping system, mark every purchase where the invoice shows no sales tax: online orders, out-of-state suppliers, resale-certificate buys. A "use tax" tag or account makes the year-end total a report, not a hunt.

2. 2

   Decide which were really exempt.

   Materials that will be resold on a separated or retail-sale-plus-installation contract may stay exempt. Materials consumed on lump-sum jobs, tools, equipment and supplies usually aren't.

3. 3

   Apply the right rate.

   Use the combined rate for the location where you used the item, which for job materials is often the job site. Take credit for any tax legitimately paid to another state, if your state allows it.

4. 4

   Report it on your return.

   If you hold a seller's permit, your sales and use tax return has a line for purchases subject to use tax. If you don't, your state has a consumer use tax return or account.

5. 5

   Keep the paper.

   Supplier invoices, resale certificates you issued, and job records tying materials to contracts. Auditors reconcile your purchases to your use tax line.

Use tax vs. sales tax

Whether you owe tax on materials at all depends on how your state taxes contractors; see sales tax on labor vs. materials for the main models.

Common use tax mistakes

• Assuming "no tax on the invoice" means no tax. It usually means the tax is now your job.
• Blanket resale certificates. Giving every supplier a resale certificate, then consuming the goods, builds a use tax liability all year.
• Forgetting tools and equipment. Trucks, trailers, compressors and tools are rarely exempt.
• Using the shop rate for every job. Some states source use tax to where the material is used.
• No system. Use tax owed at year end is impossible to reconstruct from a shoebox of receipts.