California Contractor Taxes: What Contractors Need To Know
You need to know so many different things to be a successful licensed contractor in California.
From passing the CSLB Law and Business exam to knowing how to register as a business in California, to knowing the ins and outs of your local zoning and business codes — there’s a billion areas of knowledge that require a contractor’s understanding and expertise.
In a job that’s so demanding of your time and mental energy, the very thought of having to learn about taxes can make a contractor’s head spin. We know it better than anyone – we became contractors because we’re intuitive thinkers! And what’s more counterintuitive than the mind-bending maze that is the tax code in the U.S.?
With that in mind, here are the very basics of what taxes you’ll need to be aware of as a construction contractor in California. As always Y.M.M.V (your mileage may vary), so always take this advice as general advice – then do your own diligence to make sure you’ve got your t’s crossed and i’s dotted.
Without further ado, here’s a bird’s eye view of what you need to know about taxes as a California contractor.
What Do Contractors Pay In Federal Taxes?
First and foremost, let’s tackle federal taxes. What a California construction contractor owes to Uncle Sam is, frankly, extremely complex and can involve multiple different companies, contractors, subcontractors, and employees.
For example, if you’re a roofer who works solo, you may only need to pay the self-employment tax. However, if you’re a general contractor, your tax burden is usually going to be much greater, as you’re often paying for employees, subcontractors, and so on.
With all that said, here are the main areas of taxation from the Feds.
- Income Tax
- Construction contractors are required to report their earnings to the IRS and pay taxes on their income.
- The tax rate is determined by the contractor’s tax bracket, which is based on their income level.
- Self-Employment Tax
- Self-employed contractors are subject to self-employment tax, which covers Social Security and Medicare taxes.
- The self-employment tax rate is 15.3% – 12.4% for Social Security and 2.9% for Medicare.
- Employment Taxes:
- Social Security and Medicare Taxes (FICA):
- Both employers and employees contribute to Social Security and Medicare taxes.
- For 2023, the Social Security tax rate is 12.4% (6.2% each for employer and employee) on the first $147,000 of wages.
- The Medicare tax rate is 2.9% (1.45% each for employer and employee) on all wages.
- Federal Unemployment Tax Act (FUTA) Tax:
- Employers pay FUTA tax at a rate of 6.0% on the first $7,000 of wages paid to each employee per year.
- Credits against FUTA tax may be available based on state unemployment tax contributions.
- Social Security and Medicare Taxes (FICA):
- Excise Taxes:
- Certain types of businesses, products, and services are subject to excise taxes, amongst these, contractors may be liable for taxes for various materials or operational costs.
- For instance, if a contractor operates heavy trucks on public highways, they might be subject to the federal highway vehicle use tax. It really depends on what your job entails and the scope of your operations.
Contractor Federal Tax Compliance
In order to stay compliant with federal taxes you need to stay in line with the following advice:
- Tax Identification Number (TIN): Contractors need to obtain a TIN from the IRS for identification purposes.
- Filing Tax Returns: Contractors are required to file federal tax returns annually, reporting their income and expenses to the IRS.
- Quarterly Estimated Tax Payments: Self-employed contractors often need to make quarterly estimated tax payments to cover their tax liability.
Contractor Federal Tax Deductions and Credits
Contractors can reduce their taxable income by claiming various deductions such as business expenses, home office deductions, and vehicle expenses. You are probably already doing something like this. These are the most basic ways to save on your taxes.
Contractors may also qualify for tax credits and deductions. This is where having a tax expert can really come in handy, as they’ll help you identify and take advantage of these tax breaks.
Here’s a couple examples of common deductions in the construction industry, but there are literally dozens of these. Again – hire a tax professional to find more deductions!
- Food and Beverage Deductions: You can always deduct some portion of business-related food and beverages purchased from a restaurant. As long as the meeting is business-related, you can save some money on your taxes.
- Energy-Efficient Home Credits: You could save up to $5,000 on your taxes if you comply with Federal energy-efficient standards. This is based on the recently expanded tax credit under Section 45L./li>
California Taxes Contractors Need To Know
Now onto what you can expect in California in particular. One thing we love is property taxes (the highest in the nation), but we’re actually not even in the top 5 in terms of sales taxes…somehow.
Here’s the ins and outs of California’s robust (and exhausting) tax schedule.
Sales and Use Taxes For California Contractors
Sales and use tax laws in California are particularly nuanced for construction contractors (what else is new?). The truth is what a contractor pays in taxes highly depends on the nature of the construction work and the size and scope of the business.
However, there are some key areas that you can expect to be hit by taxes, the main ones being Sales and Use Taxes. We’ll also cover some of the key areas around these taxes – notably the seller’s permit that is required whenever a contractor installs a fixture.
This is all coming from the California Department of Tax and Fee Administration – the authority responsible for contractor taxation:
- Sales Tax: In general, sales tax in California applies to the sale of tangible personal property unless the law provides a specific exemption or exclusion. When construction contractors sell or purchase tangible personal property, they are subject to sales tax.
- Use Tax: Use tax kicks in when taxable items are procured without paying California sales tax from an out-of-state vendor for use in California. The use tax also applies to items removed from inventory for use in California when sales tax wasn’t paid at the time of purchase.
- Consumer and Retailer Classification: Contractors are classified as consumers of materials they use in projects and as retailers of fixtures they install or sell equipment or machinery.
- What this means is that for fixtures installed by a contractor, or a piece of equipment sold, they must register for a seller’s registration permit.
- Seller’s Permit Registration: The majority of contractors are required to register for a seller’s permit with the California Department of Tax and Fee Administration (CDTFA), enabling them to engage in retail sales of tangible personal property.
- If you are a general contractor or a contractor who works primarily for the federal government – you are exempt from this requirement.
Employment Taxes For California Contractors
- Payroll Taxes: Every employer must pay into four buckets. They are:
- Unemployment Benefits (UI)
- State Disability Insurance (SDI)
- Personal Income Tax (PIT)
- Employment Training Tax (ETT).
- California State Unemployment Tax (SUTA):
- Employers pay SUTA tax to fund unemployment benefits. This goes into the UI fund.
- The SUTA tax rate varies for each employer based on factors like the employer’s history of unemployment claims.
- Employment Training Tax (ETT):
- Employers also pay ETT to fund training programs for unemployed workers.
- The ETT rate is 0.1% on the first $7,000 of wages paid to each employee per year.
- State Disability Insurance (SDI):
- Employees contribute to SDI through payroll deductions to fund short-term disability benefits and Paid Family Leave (PFL).
- The SDI tax rate for 2023 is 1.2% on the first $147,298 of wages.
Visit the EDD website for more information on UI and ETT.
Tax Planning Considerations for 2023
Somehow, April is right around the corner. Here’s some things to focus on as you prepare your taxes for the coming tax season.
- Bye-Bye, Bonus Depreciation: The phase-out of bonus depreciation initiates in 2023, with a reduction to 80% bonus depreciation. Be aware of how this can affect your capital expenditure planning and tax liabilities.
- Interest Deductions Reduced: Basically, you won’t be able to deduct as much interest this year, so be careful when planning how much you’re going to write off.
- Tax Bracket Adjusted For Inflation: The IRS has been adjusting tax brackets to reflect inflation’s effect on nominal descriptors like income. Make sure to adjust any projections in line with inflation.
When In Doubt…Hire It Out
You’re a contractor – you know all about hiring out work to people who have the specialized, expert knowledge to get the job done.
You can apply that same logic to your financial life, too! Accountants are experts in the world of taxes, and can help you navigate the maddening world of taxes, exceptions, credits, exemptions, and so on!
We recommend reaching out to someone in your area who specializes in construction law – there will be one in most major cities or towns, or you can probably find recommendations from your colleagues and local network. These “Class T” (ha ha) contractor tax specialists can help save you money and time as you subcontract out this part of your job to people who know better.
Either way, make sure you have a deep, full understanding of everything you’re responsible for as a contractor – from materials to employment tax.
KMCO – Tax Planning For Construction Contractors (we can’t recommend this article enough!)
CDTFA – California Department of Tax and Fee Administration
EDD – Payroll Taxes – Employment Development Department
IRS – Credit for builders of energy-efficient homes