When was the last time your company underwent a state sales tax audit? Most modular companies that have gone through one will tell you they’d rather endure a root canal. Sales and use tax audits are notoriously painful for businesses in the modular industry, and the reasons are many.
Whether you’re a residential or commercial modular manufacturer, a modular builder, or a wholesaler, the way you structure your contracts and transactions can make or break the audit outcome. And unfortunately, auditors are highly motivated to uncover liability.
Start Early—But It’s Never Too Late to Adjust
Ideally, sales tax compliance should start from day one. But even if your company has been operating for years, it’s not too late to review and restructure your sales and use tax approach.
If you’re entering new markets, it’s critical to research each state’s tax code. Every state has its own interpretation and requirements for sales and use tax law—and these nuances directly affect your risk exposure.
Why State Tax Law Doesn’t Fit the Modular Industry
Problem 1: Most state tax laws were written before the modular industry existed or without understanding how it works. This leaves tax officials scrambling to match outdated laws to a modern, specialized industry.
Problem 2: Many auditors don’t fully understand their own tax law’s application to modular construction. As a result, initial tax assessments are often large—and inaccurate.
If you disagree with an auditor’s findings, you may be required to pay the disputed tax upfront or post a bond just to appeal. Even if you win the appeal, it could take years to recover those funds.
Many companies end up negotiating and paying a reduced sum, even when the tax is wrong, just to move on.
The Exemption Advantage—and Its Challenges
Modular manufacturers typically purchase large quantities of building materials using a manufacturer’s exemption. But here’s the issue: at the time of purchase, the manufacturer doesn’t know which state the materials will end up in.
That matters because tax treatment varies depending on whether the finished building is:
- Permanently installed → Considered a capital improvement to real property
- Not permanently installed → Considered tangible personal property
This distinction has a major impact on how much tax you owe—and when.
Why Modular Construction Got Hit Harder
In the late 1990s, many state tax departments began treating all modular buildings as tangible personal property. That meant manufacturers had to remit tax on 100% of the sale price—including labor, shipping, and profit.
Meanwhile, conventional builders only paid tax on materials.
That led to a scenario where modular manufacturers paid double the tax for the same end product, simply because it was built off-site.
Challenging the Status Quo: A Legal Path Forward
Industry advocates argued that permanently installed modular buildings should be taxed the same as site-built construction, only on the materials.
Some states agreed:
- If the manufacturer pays the set crew, the building qualifies as a capital improvement, and the tax is owed on materials only.
This means if you structure your contract and documentation correctly, you can cut your tax burden in half.
What You Can Do: Contracts and State Law Matter
Proper tax strategy for modular businesses often involves:
- A contract between the manufacturer and the building contractor
- A separate contract between the manufacturer and the set crew
This layered structure can provide a legal basis for reduced tax liability, but it’s only effective if executed with state-specific compliance in mind.
And remember: no two states are exactly alike. What works in Pennsylvania may not apply in Ohio, New York, or New Jersey.
The Commercial Side Faces More Challenges
While residential modular tax issues have seen progress, the commercial modular industry continues to face hurdles.
- Many states still define taxable modular units as only those used for residential purposes
- Others don’t recognize commercial re-locatable buildings as capital improvements
- A few states do not require permanent installation, offering opportunities for smart structuring
If you’re in commercial modular construction, you’ll need to pay close attention to contract language and installation status, and be ready to adapt to each state’s unique rules.
Don’t Let Taxes Take You by Surprise
Navigating sales and use taxes in the modular industry isn’t easy, but you’re not in it alone. With the right legal guidance and proactive planning, you can significantly reduce your tax liability and avoid costly surprises during an audit. Whether you’re just starting or have been in business for decades, now is the time to take a hard look at how you’re structuring your transactions.
If you’re unsure where to begin, reach out to Steve Snyder for a comprehensive review of your contracts and tax practices. The right strategy today can save you years of stress—and thousands of dollars—tomorrow.
Call (717) 975-7799 or schedule your consultation online on our contact page.