If a homebuyer pays extra for upgrade choices (change orders) on a new residential construction contract, can the builder charge sales tax on the labor portion of those change orders?

Plain-English summary

A realtor asked on behalf of out-of-state homebuyers whether a homebuilder could legally charge sales tax on labor for change orders — upgrade choices the buyers made over and above the home's base price, on a residential new-construction project.

The Comptroller confirmed the general rule first: labor for new residential construction is never taxable, whether the base contract is lump-sum or separated. What differs between contract types is how materials are taxed — under a lump-sum contract, the builder is the consumer of incorporated materials (pays tax to suppliers, charges the customer a nontaxable lump sum); under a separated contract, the builder is the retailer of incorporated materials (collects tax from the customer on the materials price, with labor stated and taxed separately as nontaxable).

The key point for change orders: they follow whatever classification the base contract uses, per 34 TAC § 3.291(b)(5):

• Base contract is lump-sum: change orders are treated as lump-sum too, even if the change-order invoice happens to break out a charge for incorporated materials separately from other charges. The whole change-order charge stays nontaxable to the customer (the builder still pays tax on materials as consumer).
• Base contract is separated: if a change order is billed as a lump-sum amount (not separately breaking out labor from materials), the Comptroller treats the entire lump-sum change-order amount as though it were for materials only — meaning it's all taxable — unless the contractor can show the amount attributable to labor, in which case only the materials portion is taxed and the labor portion is not.

So a separated-contract builder who bills change orders as an undifferentiated lump sum, without documenting the labor component, risks having the whole change-order charge treated as taxable materials — even portions that are really labor.

What this means for you

Homebuyers negotiating change orders on new construction

Labor for new residential construction, including change orders, is never taxable. If your builder is charging tax on labor specifically, that's not correct — though the builder may still owe tax on materials depending on how the base contract and change orders are structured.

Homebuilders and general contractors

If your base contract is separated, make sure your change-order invoices actually break out labor from materials — otherwise the whole change-order charge gets treated as taxable materials by default, exposing you to over-collecting or under-remitting tax depending on how you bill it.

Realtors and buyer's agents

This letter is a good reference to hand to clients disputing tax charges on new-construction change orders — the key question to ask the builder is what type of base contract governs, since that answer controls both the general materials-tax mechanics and the specific change-order rule.

Common questions

Q: Is labor for new residential construction ever taxable?
A: No, never — regardless of whether the base contract is lump-sum or separated, and regardless of change orders.

Q: Do change orders follow the same contract classification as the base contract?
A: Yes, per 34 TAC § 3.291(b)(5) — a lump-sum base contract keeps change orders lump-sum, and a separated base contract's change orders are analyzed accordingly.

Q: What happens if a separated-contract builder bills a change order as an undifferentiated lump sum?
A: The entire change-order amount is treated as if it were materials (and thus taxable) unless the contractor can show how much of it is attributable to labor.

Q: Can any homebuyer or builder rely on this exact answer?
A: Not directly. 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 contract's classification with a tax professional.

Citations and references

Rules and publications:

• 34 Tex. Admin. Code § 3.291(b)(5) (Contractors; change orders)
• Comptroller Publication 94-105, "Guidelines for Collecting Local Sales and Use Tax"

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/200010769L

Original ruling text

October 6, 2000

From: Emilio Lerma
[email protected]

To: **

Subject: Question regarding tax on labor for residential new construction

Dear **:

I am responding to your e-mail inquiry regarding sales tax on residential new
construction.

You state you are a realtor and that a contractor is charging your customers
sales tax on labor and materials on separated contracts on change orders for
new residential construction. These charges by the buyer are over and above
the base price of the home. You want to know if there is sales tax on labor
for new residential construction.

A person who builds new structures or repairs and remodels residential realty,
is considered a contractor. The type of contract that is executed will
determine how the tax on materials is treated. The labor for new construction
of realty is not taxable. Below, I have outlined different situations along
with the tax obligations.

Under a lump-sum contract, a contractor is considered the consumer of all
materials incorporated into a customer's property. As a consumer, a contractor
must pay tax to suppliers at the time the incorporated materials are purchased.
The contractor will also pay sales and use tax on consumable supplies and all
equipment bought, leased, and rented for use on the job. The lump sum charge to
the customer is not taxable

Under a separated contract, a contractor is considered the retailer of all
materials physically incorporated into the realty. As a retailer, a separated
contractor must collect sales tax from the customer based on the agreed upon
contract price of the incorporated materials. The separately stated charge for
labor is not taxable. A separated contractor may issue a resale certificate to
purchase the materials. The contractor must pay sales tax on consumable
supplies and all equipment bought, leased, or rented for use on the job.

The local sales tax collected by the separated contractor on the materials
incorporated is allocated based on the local taxing jurisdictions where the job
site is located. Please refer to our bulletin "Guidelines for Collecting Local
Sales and Use Tax" (94-105), for information on collecting local tax on taxable
services.

The terms of the contract control change orders. If the contract is lump-sum,
change orders will be treated as lump-sum even if the change orders show
charges for incorporated materials separate from other charges. If the
contract is a separated contract, and the charges are for lump-sum amounts, the
lump-sum amounts will be treated as though for incorporated materials only
unless the contractor can show the amount attributable to labor. See Rule
3.291(b)(5) concerning Contractors.

To view or down load Rule 3.291 and publication 94-105, please go to our web
site address at
http://www.window.state.tx.us/taxinfo/rulendx/rulelist3.html#sst and
http://www.window.state.tx.us/taxinfo/taxpubs/taxpubs.html#sales respectively
and scroll to the specific rule and publication.

This opinion is rendered based on the facts presented. Other facts though
similar, may yield different results.

If you have any questions or require additional information, you may submit
inquiries to our tax help Internet address at [email protected], call
1-800-531-5441, extension 6-5809 or write to Tax Policy Division, Post Office
Box 13528, Austin, Texas 78711-3528.

Sincerely

Emilio S. Lerma
Tax Policy Division

On Wed, 27 Sep 2000 11:48:08 -0500 ** wrote:

Please send me a reference to the rule (or a copy of the rule) that stipulates
whether or not a contractor is allowed to require a customer to pay 8.25% tax
(or any % tax) on labor in a separated contract for new construction of
residential property. The contractor is charging my customers tax on labor on
the change orders, which are choices by the buyer over and above the base price
of the home. Invoices for these change orders include tax on labor as well as
the items that cost the builder more than materials included in the basic sales
price. These customers are from out of state and asked me to answer the
question of required tax on labor. I am a Realtor and not an attorney and need
a reference from you.

Thank you for your help.

** my email is **