Somewhere in your filing cabinet is the contract template you have been using for years, and the wording in it has been quietly deciding your tax position on every job since. Most contractors have never been walked through what that wording does, because the person who drafted it was solving a legal problem and nobody was in the room for the accounting one. If you are not certain which type your contracts actually are, that is the normal starting position rather than a gap in your competence.
Here is the short version, and then immediately the limit on it. Under a lump-sum contract you are the consumer of the materials: you pay tax to your suppliers when you buy, and you do not collect tax from your customer on the job charge. Under a separated contract you are a retailer of those materials: you buy them tax free against a resale certificate, and you collect tax from your customer on the materials line.
The limit matters more than the rule. That choice governs the work covered by Rule 3.291: new construction, residential repair and remodeling, and scheduled and periodic nonresidential maintenance. It does not govern taxable nonresidential repair, remodeling, or restoration. In the rule’s own words, lump-sum and separated contracts were previously treated differently and “this distinction is no longer valid when the contract is for the repair, remodeling, or restoration of nonresidential real property.” On that work the total charge is taxable whichever way you write the contract, so choosing a contract type will not change it.
What changes is who holds the tax, when it moves, which permits you need, and how much your books have to track. That last one is where the real cost sits, and it is almost never in the conversation when the contract wording gets chosen. The wording is also less forgiving than most contractors expect: if material and labor prices are separately stated anywhere in the contract, or in any document that becomes part of it, you have a separated contract, whatever you intended.
This guide sets out what each contract type does to your tax position and what each one asks of your accounting file, then walks three scenarios showing how the rules could land in practice. It describes the rules and illustrates them. It does not tell you which contract to use, and it is not a determination about your business: which structure suits you is a decision for you with your attorney and your CPA, and how the rules apply to a specific contract is a question for them or for the Comptroller. AliCat Solutions keeps the books behind these contracts for Central Texas builders and trades.
Estimated reading time: 16 min read
Overview
The lump-sum versus separated choice governs the work Rule 3.291 covers: new construction, residential repair and remodeling, and scheduled and periodic nonresidential maintenance. On that work, lump-sum makes you the consumer of materials and separated makes you a retailer of them. The distinction is no longer valid for taxable nonresidential repair, remodeling, and restoration, where the total charge is taxable regardless of contract form. Within its proper scope, the contract wording decides which one you are rather than your intention, and the separated route asks materially more of your bookkeeping.
What this guide covers
- The contract wording decides, not your intention
- The detail that surprises separated contractors
- Where the local tax lands is different under each
- Three scenarios, and how the rules could land
| Lump-sum contract | Separated contract | |
|---|---|---|
| What the contract says | One agreed price. Charges for incorporated materials are not separate from charges for skill and labor. A guaranteed-maximum contract counts as lump-sum where materials and all labor are not separately stated. | The price is divided into a separately stated amount for incorporated materials and a separately stated amount for all skill and labor, including fabrication and installation. |
| Your role | You are the consumer of all materials used on the job. | You are a retailer of the materials physically incorporated into the customer’s realty. |
| Tax on materials | You pay tax to your supplier at the time of purchase, unless you hold a valid tax-free inventory or a direct pay permit. | You may buy incorporated materials tax free against a resale certificate, then collect tax from the customer. |
| What the customer is charged | No sales tax on the lump-sum job charge for the work covered by this rule. | Tax on the agreed contract price of the materials, or your own cost of those materials, whichever is greater. |
| Local tax sourcing | Based on where the goods are first stored or used. Where the supplier collected less than the 2.0 percent local cap, additional local use tax is due. | Local tax on the materials charge is based on the location of the job site. |
| Permit | Needed only if you also sell, lease, or rent taxable items, or to issue a resale certificate. | Required. You must hold a permit and collect, report, and remit. |
Scope: this table describes work governed by Rule 3.291, meaning new construction, residential repair and remodeling, and scheduled and periodic nonresidential maintenance. For taxable nonresidential repair, remodeling, or restoration the lump-sum and separated distinction is no longer valid and the total charge is taxable either way. Equipment is treated the same under both: a contractor pays sales tax at the time of purchase, lease, or rental on equipment used to perform a contract, and separately stating a charge for equipment you use is not renting it to your customer.
The contract wording decides, not your intention
A lump-sum contract is one in which the agreed price is a single amount and the charges for incorporated materials are not separate from any charges for skill and labor, including fabrication, installation, and other labor you perform. Guaranteed-maximum contracts fall here when materials and all labor are not separately stated. A contract to improve realty that does not break out all charges for labor, fabrication labor included, is a lump-sum contract.
A separated contract divides the agreed price into a separately stated price for incorporated materials and a separately stated amount for all skill and labor. The part that catches people is the reach of that definition.
Three wording traps
- Anywhere counts. If material and labor prices are separately stated in any part of the contract, or in a document that becomes part of the contract under its terms, it is a separated contract.
- A total does not undo it. Adding the separated charges together to give a sum total does not change the contract into a lump-sum contract.
- Invoicing terms bind you. A contract that requires separated invoices is a separated contract, and a cost-plus contract is separated wherever the cost of labor is stated apart from the cost of incorporated materials.
The practical consequence is that a contractor can believe they are running lump-sum jobs while their contract template, or their progress billing format, has quietly made every one of them separated. That is not a paperwork nicety. It changes whether you should have been collecting tax from the customer, and the exposure runs backwards through every job the template touched.
This is a good reason to have somebody read the template rather than the invoices. Our guide to the Texas contractor collection duty covers the collection duty this sits inside.
The detail that surprises separated contractors
Under a separated contract you are a retailer of the materials incorporated into the realty, and you collect tax from the customer based on the agreed contract price of those materials. Then comes the sentence that decides how you have to keep your records.
The tax rate must be applied to the agreed contract price of the materials, or to the price of the materials to the contractor, whichever is greater.
In other words, you cannot move margin off the materials line to reduce the tax. If you agree a materials price with the customer that is below what you actually paid, tax is still calculated on what you paid. The rule assumes the temptation and closes it.
This has a direct bookkeeping consequence that a lot of contractors discover late. To apply that test at all, your file has to hold your actual material cost per job, matched against the agreed materials price per job, at the level of the contract. A chart of accounts that pools all material purchases into one expense account will not answer it without being linked back to invoices and job-cost detail, and a bank feed on its own certainly will not.
- Material purchases coded to the job, not just to an expense account
- The agreed contract materials price recorded against the same job
- Supplier invoices retrievable per job, because the comparison is per contract
- Resale certificates handled properly: a seller who accepts one must retain it for four years, and your own contracts, invoices and certificates are kept under the records rules that apply to you
Setting an accounting file up to hold this is a one-time job. Reconstructing it across a year of finished contracts is not. This is the part of the work job costing exists to do.
Where the local tax lands is different under each
The two contract types source local tax differently, and on a business working across the Austin metro that difference is not academic.
Under a separated contract, local taxes on the materials charge are based on the location of the job site. Two jobs in different local taxing jurisdictions can therefore carry different local rates on the same materials, bought from the same supplier, in the same week. Which rate applies to a given address is looked up rather than assumed: the Comptroller publishes a rate locator for exactly this, and jurisdiction boundaries do not follow city limits tidily.
Under a lump-sum contract you are the consumer, so you pay at purchase, and additional local use tax is due where the local taxes collected by your supplier came to less than the two percent local cap, based on where the goods are first stored or used. A yard in one jurisdiction and jobs in another can create a use tax accrual that nobody is watching.
Neither of these is difficult once the file is set up to track job-site location as a field rather than as a line in a job name. Both are close to impossible to reconstruct afterwards from a bank feed, which is the usual state of affairs when the question first gets asked.
Three scenarios, and how the rules could land
The rules above are general. What they mean for you depends on facts only you and your advisers have, so rather than recommending a structure, here are three situations we see and the questions each one raises. None of these is a determination about your business, and each would need confirming against your actual contracts.
Scenario one: a residential remodeler working locally
- The facts: repairs and remodels on family dwellings, no commercial work, materials bought from two local suppliers.
- Where the rules point: labor on residential repair and remodeling is not taxable, so the live question is materials, and that is where the contract type does its work.
- What would need checking: whether the current template already separates material and labor prices anywhere, which would make these separated contracts whatever the intention was.
- What the books would need either way: material cost per job, retrievable per contract.
Scenario two: a commercial contractor doing tenant improvements
- The facts: nonresidential remodel work, occasionally alongside genuine new construction on the same site.
- Where the rules point: for the taxable nonresidential repair and remodeling, contract type no longer changes the treatment, so a decision made purely on contract structure would not move that part of the position at all.
- What would need checking: whether any single contract mixes new construction with remodeling, and whether the remodeling portion sits above or below five percent of a lump-sum charge.
- What the books would need: the allocation, and the documents that show how it was reached.
Scenario three: a builder doing new construction across several jurisdictions
- The facts: ground-up work and initial finish-outs, job sites in different local taxing jurisdictions.
- Where the rules point: this is Rule 3.291 territory, so contract type is live, and under a separated contract local tax on the materials charge sources to the job site.
- What would need checking: the rate applicable to each specific address, looked up rather than assumed, and whether a permit and resale certificates are in place if the separated route is used.
- What the books would need: job-site address as data, and the greater-of comparison between agreed materials price and actual cost.
The common thread is that in every scenario the tax question belongs to the Comptroller’s rules and your CPA, and the bookkeeping question belongs to whoever keeps your file. The second one is where most of the recurring cost sits, and it is the part we can speak to directly.
One practical caution that applies across all three. A separated contract with nobody maintaining the certificates, the job-level material costs, and the job-site sourcing creates obligations that are not being met. Whichever structure you and your advisers land on, someone has to do the monthly work it implies. If the records have not been kept for a while either way, that is a cleanup rather than a template problem.
Common questions about contract type
Q: How do I know which type my contracts actually are?
A: Read the contract and anything that becomes part of it under its own terms, including the billing format it requires. If material and labor prices are separately stated anywhere in those documents, it is a separated contract, even if the bottom line shows a single total. A contract requiring separated invoices is separated. A cost-plus contract is separated wherever the cost of labor is stated apart from the cost of incorporated materials. Many contractors find their template has made the decision for them, which is worth checking before assuming.
Q: Under a separated contract, can I set a low materials price to reduce the tax?
A: No, and the rule anticipates it. The tax rate is applied to the agreed contract price of the materials or to the price of the materials to you, whichever is greater. If the agreed price is below your actual cost, tax is calculated on your cost. The practical requirement this creates is a bookkeeping one: your file has to hold both figures per job, because the comparison happens contract by contract rather than in aggregate.
Q: Does the contract type change how equipment is taxed?
A: No. A contractor pays sales tax at the time of purchase, lease, or rental on the sales price of equipment used to perform a contract, and accrues and remits use tax where tax was not paid at purchase. That applies regardless of contract type. Separately stating a charge for equipment that you use is not treated as renting that equipment to the customer, so it does not convert your own equipment cost into a rental to your client.
Q: Do I need a sales tax permit for a separated contract?
A: For a separated contract within Rule 3.291’s scope you are a retailer, so you must hold a permit and collect, report, and remit tax. A permit is also what lets you issue a resale certificate, including for a tax-free inventory where you do not yet know whether an item will be resold or used on a lump-sum job; a certificate may reference a pending permit application, subject to the applicable validity rules, so confirm your position rather than assuming either way. A seller who accepts a resale certificate must retain it for four years.
Q: Which contract type should I choose?
A: That is not a question we answer, and you should be wary of a bookkeeper who does. It sits inside your contracting and pricing strategy and it turns on facts about your work, so it belongs with you, your attorney, and your CPA. What we can tell you is what each option would cost you in monthly bookkeeping and what your current file can and cannot support today, and the scenarios above are meant to show the shape of the question rather than to answer it for you. If a specific contract is genuinely borderline, the Comptroller’s guidance invites a direct query and that is usually faster than a debate.
What we do once the contract is signed
AliCat Solutions keeps the books behind construction and trade contracts across Cedar Park, Round Rock, Leander, Georgetown, and the wider Austin metro. That means job-level costing that can answer the materials comparison, certificates filed and retained, and returns that go in on time. Our Texas sales tax and compliance work covers calculation, filing and remittance, multi-jurisdiction tracking, and documentation support.
Citations
- 34 Tex. Admin. Code section 3.291, Contractors. The rule defining lump-sum and separated contracts, including guaranteed-maximum and cost-plus treatment, the consumer and retailer roles, the greater-of test on the separated materials charge, local tax sourcing to the job site, and the equipment and permit requirements. https://www.law.cornell.edu/regulations/texas/34-Tex-Admin-Code-SS-3-291
- Real Property Repair and Remodeling (Texas Comptroller of Public Accounts, publication 94-116). The Comptroller’s plain-language guidance on contractor tax responsibilities under each contract type for repair, remodeling, and new construction work. https://comptroller.texas.gov/taxes/publications/94-116.php
- Texas Sales and Use Tax Frequently Asked Questions, Resale Certificates (Texas Comptroller of Public Accounts). The resale certificate requirements, including the four-year retention rule and the point that a permit number or a copy of a permit is not a substitute for a properly completed certificate. https://comptroller.texas.gov/taxes/sales/faq/resale.php
- 34 Tex. Admin. Code section 3.357, Nonresidential Real Property Repair, Remodeling, and Restoration. The rule that limits everything above: lump-sum and separated contracts were previously treated differently, and that distinction is no longer valid where the contract is for the repair, remodeling, or restoration of nonresidential real property. https://www.law.cornell.edu/regulations/texas/34-Tex-Admin-Code-SS-3-357
Related reading
- Do I need to collect sales tax as a Texas contractor?
- Is remodeling labor taxable in Texas when new construction isn’t?
- How do I track job costs in a construction business?
- Contractor or employee? The Texas classification question
- Texas sales tax and compliance services
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About the author: Alicia Hoffman, CPA is the founder of AliCat Solutions. A CPA since 1996 with two decades in corporate finance, mostly at Dell, and a BBA from Texas A&M, she built AliCat to bring corporate-grade bookkeeping discipline to small service businesses across Central Texas, backed by a written 3-Point Guarantee.
