How could a Texas contractor structure a separated contract for work on an exempt organization's real property?

Plain-English summary

The Comptroller answered five questions about separated new-construction contracts for exempt organizations.

First, the bid did not have to be separated. An owner could accept a lump-sum or unit-price bid and later sign a binding contract that separately stated labor and materials. Likewise, draw requests did not change the contract type: a separated draw under a lump-sum contract stayed lump-sum, and a lump-sum draw under a separated contract stayed separated.

Standard American Institute of Architects forms could be amended into separated contracts if the amendment complied with Rule 3.291's definition and terms. For incorporated materials, the agreed contract price had to include at least the contractor's cost plus directly related costs.

On a separated new-construction contract for an exempt organization, the contractor could give suppliers a valid resale certificate for incorporated materials and accept the exempt customer's exemption certificate instead of tax. Government entities did not have to issue an exemption certificate; a contract or purchase voucher was sufficient proof. Underestimating materials had no real tax consequence on an exempt job, but could create liability when the customer was taxable.

The letter also said incorporated materials could be bought for resale under separated new-construction contracts and nonresidential repair or remodeling contracts. Effective October 1, 1991, contractors improving exempt organizations' realty generally had to pay tax on equipment and consumable supplies, except when consumables met the conditions of the Day Zimmerman court case and were treated as resold to the owner.

What this means for you

Construction contractors

Contract classification comes from the legal agreement, not from estimates, bids, invoices, or draw schedules. If separated treatment is intended, the signed contract must separately establish labor and material prices under Rule 3.291.

Exempt organizations and government entities

Exemption documentation still matters. A qualifying nongovernmental entity supplies an exemption certificate; a governmental contract or purchase voucher can serve as proof for the items sold to it.

Accountants and tax professionals

Monitor the stated materials amount against actual costs. The letter required the contract price for incorporated materials to cover the contractor's cost and directly related costs, and warned that underestimation could matter on taxable-customer jobs.

Common questions

Must the original bid separate labor and materials? No. The parties could accept a lump-sum or unit-price bid and later execute a separated contract.

Can draw requests change a lump-sum contract into a separated contract? No. The binding contract controls.

Could standard AIA forms be used? Yes, if amended to satisfy Rule 3.291's separated-contract requirements.

Could the contractor buy incorporated materials for resale? Yes, under the qualifying separated contract described, using a valid resale certificate and the exempt customer's documentation.

Did the exempt-job treatment cover equipment and ordinary consumables? Generally no. The letter said contractors had to pay tax on those purchases beginning October 1, 1991, subject to the stated Day Zimmerman exception for qualifying consumables.

Citations and references

• 34 Tex. Admin. Code Rule 3.291 (contractors; lump-sum and separated contracts)
• 34 Tex. Admin. Code Rule 3.322 (exempt organizations)
• H.B. 11 (contractor legislation discussed in the letter)
• Day Zimmerman court case (consumable-supply resale conditions discussed in the letter)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9202L1233C03

Original ruling text

February 27, 1992

Dear *****:

I am writing as I promised to confirm my telephone conversation with your
office and to respond to your written questions. I apologize for the
delay and trust the information I forwarded to you was helpful.

You stated you had basic questions regarding the legislation that changed
the exemptions for contractors improving realty belonging to exempt
organizations. I will restate your questions below with response.

1) Does the job have to be bid with the amounts separated or can the bid
be lump sum as long as the contract is written showing labor and materials
separated.

Response: It is permissible for the property owner to accept lump-sum or
unit-price bids from the bidders and subsequently enter into a separated new
construction contract with the successful bidder. I have enclosed a copy of
Mr. Sharp's letter which continues this policy.

2) I have been told by different people in the Comptroller's office
that by breaking my draw requests down into labor and material costs (draws
against a lump-sum contract) will satisfy the requirement for separated
contracts and will not require sales tax. I have also been told that this
breakdown of labor and material does not make a lump-sum contract a separated
contract and I would still be liable for sales tax. Which is correct?

Response: The type of draw (lump-sum or separated) does not change the
terms of the contract. he terms of the legal and binding contract between the
property owner and the contractor will determine whether the contract is
lump-sum or separated. Neither a separated draw under a lump-sum contract nor
a lump-sum draw under a separated contract changes the terms of the contract.

3) If the contract must be written as a separated contract can we
simply modify the lump-sum contract to say "The owner shall pay the
contract sum of $XX,XXX.XX...which is the sum of $XX,XXX.XX for labor and
$XX,XXX.XX for material? If the above is not adequate can you please suggest a
form for separated contracts? AIA (American Institute of Architects) Document
Contract forms are the standard documents used on construction projects and to
the best of my knowledge there are no separated contract forms.

Response: It is acceptable to amend the standard AIA forms to change
them from lump-sum contract documents to separated contract documents. The
amendment must comply with the separated contract definition and terms found in
the enclosed version of Rule 3.291. This rule has not yet been revised to
reflect the House Bill 11 amendment; however, the definitions of separated and
lump-sum contractors should not be changed. I will forward a copy of the revised
version when it is available.

4) I have been told by people in the Comptroller's office that the amount indicated
as the material portion of a contract will not be interpreted as the limit of
material which can be purchased and be incorporated into the job without paying
sales tax. Example: If I estimate and indicate on a contract that the cost for
materials is $50,000.00, but due to errors in bidding or during construction
materials costs rise to $55,000.00. Would I be expected to pay sales tax on the
difference of actual versus estimated: in this case, $55,000.00 - $50,000.00 = $5,000.00?

My understanding is that this will not happen. Am I correct?

Response: The statute states that a separated contractor cannot sell the
incorporated materials in a separated contract for less than the contractor
paid for the incorporated materials. The rule for contractors states that the
agreed contract price on the incorporated materials must include the
contractor's cost of the incorporated materials and all other costs that are
directly related to the incorporated materials. When you are contracted to
improve realty for an exempt organization under a separated new construction
contract, you may issue a properly completed and valid resale certificate to
your suppliers when purchasing the incorporated materials; you will, in turn,
accept a properly completed exemption certificate from the exempt entity in
lieu of tax on the incorporated materials. Governmental entities are not
required to issue exemption certificates. The contract or purchase voucher is
sufficient proof that the taxable item(s) were sold to an exempt entity. If
you underestimate the materials on a job for an exempt organization, there is
no real tax consequence to you. However, if the customer is a taxable entity,
you could incur a tax liability.

5) Finally, can you please tell me what exactly is tax exempt or what the criteria
is for determining what is tax exempt?

Response: I am not sure I totally understand this question. Therefore,
I have enclosed a copy of Rule 3.322 which states the entities that are
automatically exempt and those that may submit information to qualify for
exempt status. If you are questioning which items may be "exempted" or
"purchased for resale" under certain conditions, then I have enclosed the
guidelines for contractors dated August 15, 1991, and the rule for contractors.
Incorporated materials may be purchased for resale under separated new
construction contracts and under nonresidential repair or remodeling contracts.
Again, when the contract is with a qualifying exempt entity, an exemption
certificate may be accepted in lieu of tax. Effective October 1, 1991, as a
person improving realty for exempt organizations, you must pay tax on the
equipment and consumable supplies when purchased. There are certain conditions
under which consumable supplies may be purchased tax free for resale, much like
the incorporated materials; when the conditions of the Day Zimmerman court case
are met, consumable supplies are considered resold to the property owner.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change.

You may also write to Tax Administration Division, Comptroller of Public Accounts.

Sincerely,

Tax Administration Division