Does a home builder's 'tax included' contract language shift sales-tax liability to the contractor, and who is liable if a service later turns out not to qualify for the new-residential-construction exemption?

Plain-English summary

A home builder's independent contractor agreement stated that the contractor "acknowledges that all applicable Texas state and local sales and use tax that is owed on the Contractor's charge... is included in the Contract Price," with the contractor responsible for remitting that tax portion to the Comptroller. The taxpayer asked two questions: (1) does this language satisfy Rule 3.286(d)(4) so that Contract Price payments are recognized, for audit purposes, as already including the correct tax; and (2) is the home builder obligated to verify whether the contractor holds a sales tax permit?

On question 1, the Comptroller cited Comptroller's Decision Nos. 26,843 (1991) and 26,050 (1991) for the principle that a written agreement that the seller's price includes sales tax must be "unconditionally explicit." This contract's language — referring only to "applicable taxes" based on "material, labor or material and labor" — is too conditional, especially given the October 1, 1995 statutory changes that made landscaping, lawn care, pest control, surveying, building and grounds cleaning, and waste removal services nontaxable when purchased by a contractor/builder as part of improving real property with a new residential structure (or improvements immediately adjacent to it, used in residential occupancy).

Because it's hard for smaller service providers to determine whether a given job qualifies for that exemption, the Comptroller allows them to rely on the builder's own certification of qualification — defaulting to collecting tax until they get that certification. But if it later turns out the certified work didn't actually qualify (the letter's example: cleaning services performed on a model home, which wouldn't be a "residence"), the builder who issued the certification is liable for the tax, not the contractor — and the tax-included contract language offers the contractor no protection either way.

On question 2, the Comptroller explained that under the law effective October 1, 1995, many service providers perform only nontaxable services and aren't required to hold a permit at all — citing Administrative Hearings Nos. 28,461 (1992) and 32,994 (1995), which tie the permit question to whether the contract specifically calls for the price to include tax. An earlier case, Hearing 21,242 (1987), upheld tax-included language, but only because that vendor was a permitted seller of tangible personal property with no ambiguity about whose tax was being referenced — a materially different situation from this ambiguous services contract.

What this means for you

Home builders using "tax included" contract language with subcontractors

Generic references to "applicable taxes" on "material, labor, or material and labor" won't satisfy Rule 3.286(d)(4) — if you want a tax-included contract to actually shift tax-collection responsibility and hold up on audit, the language needs to unconditionally and explicitly state that a specific tax is included in the price. And remember: if you certify a service (like landscaping or cleaning) as part of new-residential construction and that certification turns out wrong, YOU are liable for the tax, regardless of what the contract says.

Landscaping, lawn care, pest control, surveying, cleaning, and waste-removal contractors working on residential construction

You can rely on a builder's certification that your job qualifies as part of new-residential construction (and is therefore nontaxable) — until you get that certification, presume the service is taxable and collect tax. If you never received a permit because you believed all your work was nontaxable, check whether your specific contracts' tax-included language is unambiguous enough to avoid a permit requirement.

Common questions

Q: Does saying "tax is included in the contract price" automatically shift tax liability to the contractor?
A: No — courts and Comptroller decisions require that language to be unconditionally explicit about which specific tax is included; vague references to "applicable taxes" don't qualify.

Q: If a builder wrongly certifies a job as tax-exempt new-residential construction, who pays the back tax?
A: The builder who issued the certification — not the contractor who relied on it, and not the contract's tax-included language.

Q: Is a home builder required to check whether its contractor has a sales tax permit?
A: Not necessarily — many service providers performing only nontaxable post-1995 services aren't required to hold a permit at all, and the permit question turns on the contract's own clarity about tax inclusion.

Q: Can another home builder rely on this exact letter?
A: No. This is a Texas STAR letter ruling binding on the Comptroller only for the taxpayer it addresses (34 Tex. Admin. Code Rules 3.1, 3.10); confirm your own facts with a tax professional.

Citations and references

Statutes and rules:

• 34 Tex. Admin. Code § 3.286(d)(4) (tax-included pricing must be unconditionally explicit)
• Tax Code § 151.102(b) (seller's sales/use tax collection liability)
• Tax Code § 151.107 (definition of retailer engaged in business in this state)

Comptroller decisions and hearings cited:

• Comptroller's Decision No. 26,843 (1991)
• Comptroller's Decision No. 26,050 (1991)
• Administrative Hearing No. 28,461 (1992)
• Administrative Hearing No. 32,994 (1995)
• Administrative Hearing No. 21,242 (1987) (distinguished)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9709952L

Original ruling text

September 18, 1997

Dear*****

Thank you for your letter of September 12, 1997, concerning "tax included
contracts" between home builders and taxable service providers.

The contractual language submitted states that the "(c)ontractor acknowledges
that all applicable Texas state and local sales and use tax that is owed on the
Contractor's charge to the Home Builder for either the material, labor or
material and labor associated with the Work is included in the Contract Price
in section 3 of this Agreement for each Job Assignment. Upon payment of the
Contract Price by the Home Builder, the Contractor will promptly remit the
sales tax portion thereof to the Comptroller of Public Accounts. In addition,
the Contractor shall pay all applicable sales taxes or use taxes on consumable
supplies and on equipment purchased and used by the Contractor in performing
the work..."

You asked the following questions;

1. Does the enclosed Independent Contractor Agreement meet the requirements of
   34 TAC Section 3.286(d)(4) so that Contract Price payments made by the Home
   Builder pursuant thereto will be recognized for sales and use tax audit
   purposes as payments that include the proper amount of tax owed on taxable
   transactions between the Home Builder's sales and use tax liability thereon as
   provided in Tex. Tax Code Ann. Section 151.102(b), assuming that the Contractor
   qualifies as a "retailer engaged in business in this state" as that term is
   defined in Tex. Tax Code Ann. Section 151.107 and used in 151.102 (b)?

Response. Comptroller's Decision Nos. 26,843 (1991) and 26,050 (1991), stand
for the well-established principle that, "...[I]f the parties are going to
agree in writing that the seller's price includes sales tax, that agreement
must be in terms that are unconditionally explicit." In the case at hand, the
contract refers to "applicable taxes" and continues to say that the basis of
the tax is either the "material, labor or material and labor." This coupled
with the statutory tax law changes effective October 1, 1995 make the language
very conditional. Landscaping, lawn care, pest control, surveying, building
and grounds cleaning, and waste removal services are non taxable services if
purchased by a contractor or home builder as part of the improvement of real
property with a new residential structure to be used as a residence or other
improvement immediately adjacent to the new structure and used in the
residential occupancy of the structure.

Since it is difficult for the smaller service providers to ascertain the
taxability of these jobs, we have allowed the contractor/service provider to
rely on certification from the builder to determine if the jobs qualified for
exemption. The service providers have been told to presume that the landscaping
service is a taxable service and collect tax on the total charge until they
obtain a certification from the builder that the landscaping service is part of
the improvement of real property with a new structure to be used as a
residence. If it is later determined that the work does not qualify as a
nontaxable service as certified by the builder or developer, the person who
issues the certification (i.e.; cleaning services performed on a model home)
will be held liable for the tax. In other words, the builder will be liable
and the contractual language submitted will offer no protection.

2. In connection with question number 1, is the Home Builder under any
   obligation to determine whether a sales and use tax permit has been issued to
   the Contractor, again assuming that the Contractor qualifies as a "retailer
   engaged in business in this state"?

Response. Under the law effective October 1, 1995, many service providers will
only be performing non taxable services and will not be required to be
permitted. Administrative Hearings no. 28,461 (1992) and 32,994 (1995) have
held that whether the vendor is permitted or not for tax collection is related
to whether the contractual agreement specifically calls for the amount to
include tax. An earlier case 21,242 (1987) which allowed a tax included
statement is distinguished from these cases as the vendor (in Hearing 21,242)
"was a permitted seller of tangible personal property. Therefore, there was no
ambiguity or confusion regarding his tax collection responsibilities....
Second, since the vendor was a seller of tangible personal property, there was
no doubt that the tax referred to on the purchase order was the tax on the
transaction at issue rather than, say, the tax paid by the vendor to another
party." as discussed in response number 1, there is ambiguity in whether any
contractual amounts include tax.

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

You may call me toll free at 1-800-531-5441, ext. 5-0613. The direct line is
512/475-0613. You may also write to Tax Policy Division, Comptroller of Public
Accounts.

Sincerely,

Kevin Koller
Tax Policy Division