Multistate Tax for Construction Contractors: Nexus, Apportionment, and PL 86-272

A contractor who builds in one state files one state return. A contractor who takes a project across the border files two, sometimes three, and the complexity multiplies from there. Multistate construction work creates tax obligations that most contractors do not anticipate until the second state sends a notice: income tax nexus and apportionment, payroll tax registration, workers’ compensation coverage, nonresident employee withholding, and contractor licensing. Each obligation has its own trigger, its own filing, and its own penalty for noncompliance. The stakes are not theoretical. States aggressively audit construction companies because the work is visible (permits are public records), the payments are large, and the noncompliance rate is high.

What creates nexus in another state?

Nexus is the legal connection between a business and a state that gives the state the right to impose tax. For construction contractors, the analysis is straightforward: if you send workers or equipment to a job site in another state, you have nexus there.

There are two types of nexus, and construction triggers both. Physical presence nexus is the traditional standard. A single employee working on a single project in another state for even a few days creates physical presence. Equipment stationed at a job site creates it. A subcontractor relationship can create it if the contractor has employees supervising the sub’s work. The U.S. Supreme Court established this standard in Quill Corp. v. North Dakota (1992), and although the South Dakota v. Wayfair (2018) decision changed the landscape for sales tax, the physical presence test remains the primary nexus trigger for income tax in most states.

Economic nexus is the newer standard. After Wayfair, many states adopted economic nexus thresholds for income tax (not just sales tax). These thresholds vary by state but typically apply when a business exceeds a revenue threshold (often $500,000 in sales) or a factor presence threshold (such as 25% of payroll, property, or sales in the state). For a construction contractor performing a $2 million project in another state, the economic nexus threshold is usually met on the revenue factor alone, even before considering the physical presence that the job site creates.

The practical result: if you are performing construction work in another state, assume you have nexus. The question is not whether you owe tax, but how much.

Why doesn’t PL 86-272 protect construction contractors?

Public Law 86-272 (15 USC 381) is a federal statute that prohibits a state from imposing a net income tax on a business whose only activity in the state is the solicitation of orders for the sale of tangible personal property, provided the orders are sent outside the state for approval and the goods are delivered from outside the state. It was enacted in 1959 to protect traveling salespeople and interstate commerce from state tax overreach.

Construction contractors sometimes assume PL 86-272 protects them because they are based in one state and merely “doing business” in another. It does not, for two independent reasons.

First, construction is a service, not a sale of tangible personal property. PL 86-272 protects sales of goods (tangible personal property), not the performance of services. A contractor who builds a building, paves a road, or installs an HVAC system is providing a service at a job site, even though the work involves materials. The service nature of the work disqualifies it from PL 86-272 protection entirely. Courts and state tax agencies have consistently held that construction contracts are service contracts for this purpose, even when the materials component is substantial.

Second, the in-state activity goes far beyond solicitation. Even if construction were somehow classified as a sale of tangible personal property (it is not), PL 86-272 only protects solicitation activities. A contractor who stations workers at a job site, stores equipment and materials, maintains a project office or trailer, and performs physical construction work is engaged in far more than solicitation. These activities independently disqualify the contractor from PL 86-272 protection.

The bottom line: PL 86-272 is irrelevant to construction contractors. Do not rely on it.

How is income apportioned across states?

Once a contractor has nexus in multiple states, the next question is how much income each state gets to tax. The answer is apportionment, the formula states use to divide a multistate business’s income among the states where it operates.

Most states use a single-sales-factor or three-factor apportionment formula. The traditional three-factor formula (still used by some states for construction) averages three ratios: the percentage of sales in the state, the percentage of payroll in the state, and the percentage of property in the state. Each factor compares the in-state amount to the total everywhere. The trend in recent years has been toward a single-sales-factor formula, where only the sales ratio matters.

For construction contractors, “sales” are typically sourced to the location of the project. A $3 million contract to build a warehouse in Georgia is $3 million of Georgia sales, regardless of where the contractor is headquartered. Payroll is sourced to the state where the work is performed, not where the employee lives or where the payroll check is issued. Property includes the cost of equipment and materials at the job site in each state, typically measured as an average of beginning-of-year and end-of-year values (with rented property often valued at eight times the annual rental).

The apportionment rules vary significantly by state. Some states use a throwback rule that reassigns sales to the home state if the destination state does not tax the income. Some states have special industry apportionment rules for construction. The key principle is that the project location drives the sourcing, so a contractor who works in five states will generally apportion income to all five, weighted by revenue, payroll, and property in each.

For pass-through entities (S corporations, partnerships, LLCs taxed as partnerships), the apportionment happens at the entity level, and the individual owners then pick up their share of income apportioned to each state. This means the individual owners may have filing obligations in every state where the entity has nexus, even if the owners never personally set foot in that state. The compliance burden for a five-state contractor organized as an S corp with three shareholders is fifteen state returns (five entity-level returns plus two individual returns per owner per state, depending on composite filing availability).

What are the payroll tax and workers’ comp requirements?

State income tax is only one layer. Payroll taxes and workers’ compensation create separate obligations that are triggered by the first dollar of wages paid for work performed in another state.

State unemployment insurance (SUI) must be paid in the state where the employee performs the work, not the state where the employer is located. If a Texas-based contractor sends a crew to Georgia for a six-month project, the contractor must register for Georgia SUI, report wages to Georgia, and pay Georgia SUI rates. Most states follow the “localization of services” test: if an employee performs all or most of their work in one state, wages are reported to that state. If the employee works in multiple states with no single state dominating, additional tie-breaking rules (base of operations, direction and control, residence) determine which state gets the SUI wages.

Workers’ compensation is state-regulated, and most states require coverage for employees working within their borders, regardless of where the employer is based. A contractor with a workers’ comp policy in Texas must either have the other state listed on the policy (the “other states” endorsement, which works for most but not all states) or purchase a separate policy in the state where the work is performed. Four states operate monopolistic state funds (Ohio, North Dakota, Washington, and Wyoming) where coverage must be purchased from the state fund, and a private policy’s “other states” endorsement does not satisfy the requirement. Working without proper workers’ comp coverage in another state is a misdemeanor in many jurisdictions and can result in stop-work orders, fines, and personal liability for the contractor’s owners if a worker is injured.

The interaction with prevailing wage requirements compounds the cost. On a Davis-Bacon project in another state, the contractor must pay prevailing wages (which are higher than market), register for and pay that state’s SUI, and secure workers’ comp at the prevailing wage payroll base. The workers’ comp premium alone can be 30-50% higher than the same scope at market rates because the premium is calculated on payroll dollars.

How does nonresident employee withholding work?

When a contractor sends employees to work in another state, the contractor must withhold state income tax from those employees’ wages for the state where the work is performed. This obligation exists even if the employee is a resident of a different state and even if the assignment is short.

Some states have reciprocal agreements that simplify this. If an employee lives in State A and works in State B, and the two states have a reciprocity agreement, the employer withholds only for the employee’s home state. But reciprocity agreements are limited (they exist mainly among neighboring states in the Midwest and Mid-Atlantic), and many common construction corridors (Texas to Georgia, California to Nevada, Florida to the Carolinas) do not have them.

Without a reciprocity agreement, the contractor withholds for the work state, and the employee claims a credit on their home state return for taxes paid to the other state. The contractor’s obligation is to withhold correctly for the work state; the employee’s obligation is to file a nonresident return in the work state and claim the credit on the home state return. If the contractor fails to withhold, the contractor is liable for the tax, penalties, and interest.

Several states have de minimis thresholds: if the employee works in the state for fewer than a specified number of days (often 20 or 30 days), withholding is not required. But many states, including New York, have no de minimis threshold at all. One day of work in New York triggers a withholding obligation. Tracking employee work days by state requires a system, whether it is job costing timesheets coded by project location, a mobile time-tracking app, or a GPS-based system.

How does sales tax work on cross-state materials?

The sales tax treatment of construction materials varies dramatically by state, and the answer depends on the type of contract, the type of work, and sometimes the type of property being improved. The fundamental question is whether the contractor is the “end user” of the materials (paying sales tax at purchase and not collecting from the customer) or a “reseller” (buying tax-exempt and charging the customer sales tax on the installed price).

In end-user states (the majority approach, including New York, California, Ohio, and many others), the contractor pays sales tax when purchasing materials. The materials become part of real property when installed, and the contract with the property owner is not subject to sales tax because it is a service of improving real property, not a retail sale. The contractor builds the sales tax cost into the bid and pays it at the supply house.

In reseller states, the contractor purchases materials tax-exempt using a resale certificate and charges sales tax to the customer on the installed price, which may include both materials and labor. Texas is the best-known example, though even Texas distinguishes between new construction (contractor is the end user) and repair or remodeling (contractor may be a reseller and collects tax on the charge).

Several contract-type states make the distinction based on how the contract is structured. In a lump-sum contract (one price for the entire job), the contractor is typically treated as the end user and pays sales tax on purchases. In a time-and-materials contract (materials billed separately), the contractor may be treated as a reseller of the materials and must collect sales tax on the materials portion billed to the customer. This distinction exists in states like Connecticut and Minnesota, and getting it wrong means either double-paying (tax on purchases AND tax collected from the customer) or underpaying (buying tax-free and not collecting from the customer).

For a multi-state contractor, the complexity multiplies. Buying materials in State A (where the contractor has a resale certificate) and installing them in State B (which treats the contractor as the end user) creates a use tax obligation in State B and an improperly claimed exemption in State A. The contractor must track materials by job location, not just by purchase location.

What’s use tax and why do auditors target contractors?

Use tax is the complement to sales tax. When a contractor purchases materials in a state with no sales tax (or a lower rate) and uses those materials in a state with a higher sales tax rate, the contractor owes use tax to the state where the materials are consumed. The use tax rate is typically the same as the sales tax rate in the destination state, offset by any sales tax already paid to the origin state.

Auditors target construction companies because the amounts are large and the compliance rate is low. Contractors routinely buy materials at their home supply houses (where they have accounts and volume pricing), load them on trucks, and haul them to job sites in other states. The purchase invoices show the home-state address, the sales tax is computed at the home-state rate, and nobody thinks about the use tax obligation in the job-site state until the audit notice arrives. State auditors know this pattern. They pull contractor permit records, cross-reference them with sales tax filings, and look for contractors who performed work in the state but never filed a use tax return.

The fix is straightforward but requires discipline: track materials by project location, compute the use tax differential for each job-site state, and file use tax returns in those states. The cost is real, but it is a legitimate project cost that belongs in the bid.

What about state contractor licensing?

Most states require construction contractors to hold a state-issued license before performing work. The licensing requirements are separate from the tax obligations but create an additional compliance layer. Working without a license can void the contract (making the contractor unable to collect payment through the courts), trigger fines and misdemeanor charges, and create liability exposure if the work is defective.

Licensing requirements vary dramatically by state. Some states (such as California, Arizona, and Nevada) require licensure for virtually all construction work and have rigorous examination, experience, and financial requirements. Other states (such as Texas and most Northeastern states) regulate licensing at the local or specialty level rather than through a statewide license. Some states require a separate license for each trade (electrical, plumbing, HVAC, general contracting), while others issue a single contractor license with trade endorsements.

The licensing process typically requires proof of experience (often four years as a journeyman or foreman), a written examination (trade knowledge and business/law), proof of insurance (general liability and workers’ comp), and a financial statement or bond. The timeline from application to license can be 60-90 days, which means a contractor who wins a bid in another state may not be able to start work until the license is in hand. Planning ahead is critical: apply for the license before pursuing work in a new state, not after winning the contract.

Some states allow a contractor licensed in another state to obtain a reciprocal license with reduced requirements, but true reciprocity is limited. The National Association of State Contractors Licensing Agencies (NASCLA) offers a commercial contractor accreditation that is accepted by about 20 states as a pathway to licensure, which can simplify the process for contractors who regularly work across multiple states.

How does all of this interact with worker classification?

The multistate layer makes worker classification even more consequential. Misclassifying an employee as an independent contractor in one state is already a problem. Misclassifying across state lines multiplies the exposure, because each state the worker performs work in has its own classification test, its own penalties, and its own enforcement agency.

A worker who would be classified as an independent contractor under one state’s common-law test might be reclassified as an employee under another state’s ABC test. California’s AB5 law, for example, uses the ABC test, which is substantially harder for a hiring business to satisfy than the IRS common-law test. If a Florida-based contractor sends workers classified as 1099 contractors to a California project, and California reclassifies them as employees, the contractor owes back payroll taxes, penalties, workers’ comp premiums, and potentially prevailing wages (if it was a public project) to California.

The safest approach for multistate construction is to classify workers correctly in the most restrictive state where work is performed, which typically means treating field workers as W-2 employees. The bonding and insurance requirements of most project owners reinforce this: surety companies expect to see a W-2 workforce, and the bonding underwriting process examines the contractor’s worker classification practices.

What should contractors do before working out of state?

The compliance checklist for entering a new state is longer than most contractors expect. Before mobilizing to a job site across state lines, the contractor should confirm five things: contractor license status, state income tax registration, payroll tax registration (SUI and withholding), workers’ compensation coverage (check for monopolistic state fund requirements), and any project-specific requirements (retainage holdback rules, lien law compliance, bonding).

The cost of noncompliance is not just the tax and penalties. It includes the inability to enforce the contract (in states where unlicensed work voids the agreement), stop-work orders that delay the project, and reputational damage with the project owner. For contractors who regularly work in multiple states, the retirement plan and benefits structure should also be reviewed to ensure compliance with each state’s requirements.

The revenue threshold for getting this right is lower than most contractors assume. A single $500,000 project in another state is enough to create meaningful tax exposure, licensing risk, and payroll compliance obligations. The time to address multistate compliance is before the first truck crosses the state line, not when the notice arrives.

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.