5.3 Contractor Tax Obligations

Relevance to the NC General Contractor Exam

Taxation is a non-negotiable aspect of running a compliant construction business. The NC GC exam extensively tests a candidate's understanding of employer tax responsibilities and state-specific taxation rules. You will be tested on the mechanics of payroll taxes, including who pays what percentage for FICA and FUTA. Crucially, the exam focuses heavily on North Carolina Sales and Use Tax laws. Construction contractors have a unique status under NC tax law compared to standard retailers. Understanding when you are deemed a consumer of materials versus a retailer, and how to handle Form E-589CI (Affidavit of Capital Improvement), is essential to pass the exam and avoid devastating Department of Revenue audits.

Employment Taxes (Payroll Taxes)

When you hire W-2 employees, you take on significant tax withholding and contribution responsibilities as an employer. These are generally referred to as employment or payroll taxes.

FICA (Social Security and Medicare)

The Federal Insurance Contributions Act (FICA) mandates a payroll tax on the paychecks of employees, as well as a matching contribution from employers, to fund Social Security and Medicare.

• Social Security: The tax rate is 6.2%. The employer withholds 6.2% from the employee's gross wages and then contributes a matching 6.2% out of the company's pocket. This tax only applies up to a specific annual wage base limit (which adjusts yearly for inflation).
• Medicare: The tax rate is 1.45%. The employer withholds 1.45% from the employee's paycheck and matches it with another 1.45%. Unlike Social Security, there is no wage base limit for Medicare; it applies to all earned wages.
• Total FICA: The total FICA burden is 15.3% (7.65% from the employee, 7.65% from the employer). Contractors must deposit these funds regularly (usually monthly or semi-weekly) using the Electronic Federal Tax Payment System (EFTPS).

Unemployment Taxes: FUTA and SUTA

Unemployment taxes fund the unemployment compensation programs for workers who lose their jobs.

• FUTA (Federal Unemployment Tax Act): This tax is paid entirely by the employer; nothing is deducted from the employee's wages. The standard FUTA tax rate is 6.0% applied only to the first $7,000 of wages paid to each employee during the year. However, if you pay your state unemployment taxes on time, you generally receive a credit of up to 5.4%, reducing the effective federal FUTA rate to just 0.6%.
• SUTA (State Unemployment Tax Act): North Carolina, like all states, levies its own unemployment tax, also paid by the employer. In NC, the rate varies based on the employer's history of unemployment claims (their "experience rating"). New employers are assigned a standard starting rate until they establish a track record.

North Carolina Sales and Use Tax

Navigating Sales and Use tax in North Carolina requires understanding your specific role in a transaction. The rules differ dramatically depending on whether you are classified as a standard contractor or a retailer-contractor.

Contractors as Consumers

The general rule in North Carolina is that general contractors and subcontractors are considered the consumers of the materials, supplies, and equipment they purchase to fulfill a construction contract. Because you are the ultimate consumer of these goods as they are permanently incorporated into a building (a "capital improvement"), you are required to pay the applicable North Carolina sales tax at the time of purchase from your supplier (e.g., when buying lumber at a supply house).

When you later bill the property owner for the completed project, you do not charge them sales tax on the materials or the labor. The contract price is simply a lump sum (or cost-plus) that inherently absorbs the taxes you already paid to your suppliers.

Form E-589CI: Affidavit of Capital Improvement

To prove to a supplier that a transaction is for a capital improvement (and thus the contractor should pay the tax, not charge it to the end user), contractors use North Carolina Form E-589CI, the Affidavit of Capital Improvement. This form acts as a shield, documenting that the services and materials are meant to be permanently attached to real property. Subcontractors will also issue this form to the general contractor to verify that their work on the project constitutes a capital improvement.

Use Tax

What happens if you drive a truck to a neighboring state, buy tax-free materials, and bring them back to North Carolina for a project? You cannot escape the tax. Use tax is effectively a "back-up" sales tax. If you purchase tangible personal property for storage, use, or consumption in North Carolina without paying NC sales tax at the time of purchase, you must calculate and remit the equivalent "Use Tax" directly to the NC Department of Revenue. This levels the playing field so that local NC suppliers aren't disadvantaged against out-of-state sellers.

Retailer-Contractors

A special category exists for "Retailer-Contractors." These are businesses that both operate a retail store selling materials to the general public AND perform contracting work. For example, a flooring company that has a showroom selling tile directly to homeowners, but also sends crews out to install tile. A retailer-contractor can purchase their inventory tax-free by providing a Certificate of Exemption to their supplier. When the materials are taken out of inventory:

1. If sold directly to a customer over the counter, they charge the customer sales tax.
2. If withdrawn from inventory to be used by their own crews on a contracting job, they must accrue and pay the use tax on the cost price of those materials at the time they are withdrawn.