The Confluence of State Taxes and Construction Law

There are many state and local tax implications on Washington State construction projects.  Two areas of particular importance for construction contractors are sales taxes due on work performed, and business and occupation taxes (“B&O”) due on a contractor’s gross receipts.  While the two types of taxes seem simple in theory, they can get complicated in practice.

  1. 1.                  Who Pays Sales Tax on Settlement Amounts?

It is clear that sales tax is due on labor, materials and equipment supplied on a construction project.  It is the general contractor’s responsibility to collect sales tax from the owner and remit the sales tax payments to the State.  There is also a statute in Washington, RCW 82.08.050, which states that it is “conclusively presumed” that the price in any contract does not include sales tax.  The effect of this statute is that if a contract does not state whether the quoted price includes sales tax or not, then the price does not include sales tax and the owner must pay sales tax in addition to the price stated in the contract.

This rule also applies to settlement agreements even though the settlement agreement made between an owner and general contractor may contain language stating that the payment is “full and final” and that the parties completely release all claims against each other.  This specific issue was addressed in the Port of Tacoma v. State of Washington Department of Revenue, 1997 WL 236133 (Wash. Bd. Tax. App. 1997).  In that case, the Washington Board of Tax Appeals ruled that the Port of Tacoma was responsible for the sales taxes due on the settlement amount that it negotiated with the general contractor.  The Port was responsible for $139,440 in sale tax due on the settlement it negotiated with the general contractor, even though the settlement agreement was full and final and the parties executed a mutual release.  This can be a rude awakening for owners because they end up having to pay for sales tax on top of the settlement payment amount they negotiated with the general contractor.

The practice pointer from the Port of Tacoma case is that whenever you are negotiating a settlement with an owner, or even a general contractor, the settlement agreement should specifically state whether the settlement amount includes sales tax.  If you are an owner, here is an example of a clause that makes clear that the settlement amount includes sales tax:

This settlement amount is inclusive of Washington Sales Tax (“WSST”) and _____________________________ (“General Contractor”) assumes all responsibility for WSST and will indemnify and defend _____________________________ (“Owner”) for all claims related to payment of WSST.

  1. 2.                  B&O Tax Implications for Developer/General Contractors.

B&O taxes are generally calculated based on a business’ gross receipts.  While this seems simple in practice, it gets complicated for developers who are also general contractors.

Many developers/general contractors prefer to set up their entity structure to have a “project-specific” LLC that owns the property and have a separate general contractor entity that contracts with the “project-specific” LLC and subcontracts with the subcontractors on the project.  This set up is commonly done in an attempt to limit liability and for federal tax purposes.

The problem with this set-up from a B&O tax perspective is that the developer/general contractor could be subjecting itself to double B&O tax obligations.  The reason for this is that the project-specific LLC will have B&O tax obligations when it receives money upon the sale of the property under development and the general contractor entity will have B&O tax obligations based on the receipts it receives from the project-specific LLC.  The general contractor incurs the B&O tax obligations even if the payments are just being disbursed to the subcontractors.  Although the B&O tax rate is relatively low for many general contractors, the taxed amount can add up quickly if you are an active developer.

There is a way around this if you set up the general contractor entity as an agent for the project specific LLC, but this gets complicated.  It is advisable that developer/general contractors contact legal counsel to devise a proper entity set-up, construction contracts and agreements to ensure that you are not paying double B&O tax in these instances.

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