If a lump-sum contractor tells customers in writing that the contract price 'includes sales and use tax' instead of separately stating the tax, has the contractor erroneously collected tax on the entire contract amount that must now be remitted as error tax?

Plain-English summary

A San Antonio auditor asked Tax Administration Division for guidance on a recurring situation: under 34 Tex. Admin. Code § 3.286(d)(3), a contractor must either separately state the sales tax on the bill or contract, or give the customer a written statement that the stated price "includes" the tax. The auditor's own proposed answer was that when a lump-sum contractor uses the "tax included" written-statement option instead of separately stating the tax, this amounts to erroneously billing and collecting tax on the entire lump-sum charge, and the "error tax" would have to be reported and remitted to the state -- on top of the tax the contractor already owes on its materials as the ultimate consumer.

The Tax Policy Division rejected that reasoning. Drawing on two prior Comptroller hearing decisions (Hearing No. 1102 and, more directly on point, Hearing No. 22,436), the letter explains that a contractor's bid letters or invoices stating that "tax is included" in the lump-sum price do not, by themselves, prove the contractor collected tax over and above the agreed price. In Hearing No. 22,436, the administrative law judge found that a similar notation was "nothing more than a representation of one of the elements used in formulating the original bid," not an amount actually collected in addition to the lump sum -- so there was no unjust enrichment and no improper use of state taxing power against the customer, only "inconsistent and potentially confusing invoicing procedures."

Applying that reasoning here, the letter concludes that as long as the customer paid no more than the original lump-sum price, there is no evidence of unjust enrichment and no error tax to remit. Under Tex. Tax Code § 151.056(a), a lump-sum contractor is the ultimate consumer of materials incorporated into the real property being improved, so no additional tax is owed by the customer on the lump-sum amount regardless of how the "tax included" language is phrased. The written statement is most likely just evidence to the customer (and, in this case, apparently required by a particular customer of its vendors) that the contractor has properly paid or accrued tax on its materials -- not a representation that tax is being charged to the customer. If a contractor's records show it truly did collect an amount over and above the lump-sum price, that excess must be remitted to the state or refunded to the customer; conversely, if the contractor mistakenly absorbed tax on labor (which isn't taxable to a lump-sum contractor in the first place), the contractor could instead be eligible for a refund of tax paid in error.

What this means for you

Contractors using lump-sum contracts

If you're a lump-sum contractor and you satisfy Rule 3.286(d)(3) by giving customers a written statement that the price "includes" sales and use tax (rather than separately stating a tax line), that statement alone does not turn the whole contract into tax you collected and must remit. You remain the ultimate consumer of your materials and owe tax on your material costs, not on the full lump-sum price, as long as you didn't actually charge the customer anything beyond the agreed price. For clarity going forward, the letter suggests including the "tax included" language directly in the body of the contract along with a breakdown of the taxes and rates being accrued on materials.

Auditors and accountants reviewing contractor invoicing

Don't automatically treat a "price includes tax" notation on a lump-sum contractor's invoice as proof of erroneous collection requiring error-tax remittance. Check the contractor's records to see whether any amount was actually collected over and above the lump-sum price -- only that excess (if any) would need to be remitted or refunded to the customer.

Businesses that require "tax included" language from their vendors/contractors

The letter notes that some customers require contractors to include this language on invoices as evidence that sales/use tax has been paid or accrued on materials -- a practice traced to Hearing No. 1102, where the ALJ held the Comptroller may assess either party absent evidence tax was reported and paid. That practice is legitimate documentation, not itself a tax collection event.

Common questions

Q: If a lump-sum contractor writes "price includes sales tax" on invoices instead of stating a separate tax amount, does the contractor have to remit tax on the whole contract price?
A: No, not merely because of that language. The letter concludes there's no unjust enrichment or improper tax collection unless the contractor's records show it actually collected an amount over and above the agreed lump-sum price.

Q: Who is the "ultimate consumer" of materials in a lump-sum contract, and what does that mean for tax owed?
A: Under Tex. Tax Code § 151.056(a), the lump-sum contractor is the ultimate consumer of materials incorporated into the real property being improved. The contractor owes tax on those materials; no additional tax is due from the customer on the lump-sum contract amount.

Q: What if the contractor did absorb sales tax on labor by mistake?
A: The letter states that if the contractor absorbed tax (on labor) in error, the contractor would be eligible for a refund of tax accrued in error, rather than owing error tax to the state.

Q: What are the two compliant ways to handle sales tax under Rule 3.286(d)(3)?
A: A seller/contractor may either (1) separately state the sales tax amount on the bill, contract, or invoice, or (2) provide a written statement that the stated price already includes the tax -- both options give the customer notice that tax has been collected or accounted for.

Citations and references

Statutes:

• 34 Tex. Admin. Code § 3.286(d)(3) (contractor must separately state tax or provide written statement that price includes tax)
• Tex. Tax Code § 151.056(a) (lump-sum contractor is the ultimate consumer of materials incorporated into realty)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9205L1173E08

Original ruling text

May 8, 1992

TO: Johnny Chacon, San Antonio Audit, 2I60

FROM: Gilbert Zamora, Tax Administration Division

SUBJECT: Contractors- Error Tax

SITUATION

Rule 3.286, Section (d)(3) states, "the amount of sales tax must be separately
stated on the bill, contract or invoice to the customer or there must be a
written statement that the stated price includes the tax."

Based on the aforementioned rule, all sellers are allowed to use either of
these two options. The separation of tax and the written statement serve the
same purpose since the purchaser has been given notice that tax has been
collected by the seller.

QUESTION

Based on the facts presented above, if a lump-sum contractor does not
separately state the tax, but instead, provides a written statement to their
customer(s) that the stated price includes sales and use tax, has the
contractor erroneously collected tax on the entire amount?

ANSWER PROPOSED BY AUDITOR

When a lump-sum contractor (new construction or residential),erroneously bills
(and collects) the tax on the entire charge to a customer, the separately-
stated error tax should be reported to the state. Furthermore, the lump-sum
contractor is still liable for tax on all materials purchased, since the
contractor is the ultimate consumer.

DISCUSSION

Upon further inquiry from me requesting additional information on this specific
situation, you indicated that this was a general situation that is occasionally
encountered by your auditors, and that a specific contract, bid sheet, invoice,
and/or the written statement to customers is not available. However, you
stated that, as a general practice, **requires all its vendors and
contractors to provide a written statement or note on invoices/ contracts that
the stated price includes applicable sales taxes.

In researching your question I ran across the following hearing which may
explain why **requires this statement from its vendors. In Hearing
No. 1102 (fiche #244D03), involving the **, which later merged with
**, the ALJ held that "...in the absence of evidence that tax has
not been reported and paid to the State on a transaction, the Comptroller may
look to either party for the tax. Where there is not evidence whether the tax
was included in the retailer's price and paid to the state, the theoretical
possibility of multiple tax collection is not considered a valid defense to an
assessment against the purchaser." Requiring its vendors to state that a
transaction includes applicable taxes is **'s "evidence" that sales
tax has been paid/reported to the State by the vendor on that transaction.
Hearing No. 22,436 (fiche #926B05), involving a lump-sum contractor (Claimant)
where the Claimant's bid letters indicated that taxes were included in the
lump-sum bid but did not set out a specific amount for sales tax, is closer to
the situation that you present. In this case the Claimant maintained a tax-free
inventory and accrued and reported tax on its cost of raw goods plus the value
of its own fabrication labor in fabricating doorjambs cabinets, shelves, and
teller cages it installed. Tax should only have been accrued on the cost of raw
goods, but the auditor denied Claimant a refund on the basis that final
invoices to customers stated a tax amount that was "collected" from the
Claimant's customers.

The ALJ concluded that Claimant is a lump-sum contractor and that:

the notation on some contracts that the lump-sum amount includes tax has no
bearing on whether the contracts are lump-sum or separated. Further the method
of invoicing does not change the determination that Claimant is a lump-sum
contractor." As a lump-sum contractor Claimant was the ultimate consumer of
the materials used and incorporated in its jobs. No tax was due from its
customers on the lump-sum contract amounts.

The ALJ further disagreed with the Tax Division in stating,

...it is my opinion that Claimant aid not directly collect or receive tax money
represented to be tax from its customer. Instead, I conclude that: the amounts
set out as tax on the final invoice were nothing more than a representation of
one of the elements used in formulating the original bid. The amount set out
was not collected over and above the original lump-sum consideration...

The ALJ concludes that there was no unjust enrichment nor did the Claimant use
the powers of the State to gain additional monies from its customers. He calls
it an "exercise in semantics" to assert that the Claimant collected the tax set
out in the invoices from its customers and states: "It is not at all obvious
from these facts that the Claimant 'collected' any tax at all from its
customer." The ALJ further states that the State has shown only that the
Claimant is guilty of "inconsistent and potentially confusing invoicing
procedures."

RESPONSE

Similarly, in the situation that you present, there is no evidence of unjust
enrichment. The lump-sum contractor does not collect tax from the owner, but
only provides a written statement to the owner that the contract price includes
applicable tax, and the owner pays no more than the original agreed lump-sum
price. The question here is whether the phrase "includes sales and use tax" as
used by the contractor means the contractor is assessing the tax against the
customer, absorbing the tax, or is merely providing evidence to the customer
that all applicable taxes due and owing (on materials) by the contractor have
been paid.

The contractor's records should reveal whether the contractor did indeed
collect sales tax over and above the agreed lump-sum price. If so, then the
tax must have been remitted to the state or refunded to the customer. However,
I do not believe this to be the case. Under a lump-sum contract the contractor
is the ultimate consumer of the materials used and incorporated into the realty
being improved [Texas Tax Code _151.056(a)]. No additional tax is due from the
customer on the lump-sum contract amounts. If the contractor absorbed the tax
(on the labor) in error, the contractor would be eligible for a refund on tax
accrued in error.

The more likely scenario, especially if the contractor is doing work for
**, is that the contractor is providing evidence to the customer
that the applicable taxes on materials incorporated into real property have
been properly paid or accrued. As in Hearing No. 22,436, the contractor in this
situation is guilty only of using a confusing method to relay to the customer
that the contractor has paid or accrued sales or use tax on all materials used
on the job. A statement to this effect within the body of the lump-sum
contract along with a breakdown of the taxes and tax rates to be charged (see
fiche #1060A01 and #1060A05) would have been sufficient to satisfy our
requirement.