Separated vs. Lump-Sum Contracts in Texas: The One Decision That Drives Most Contractor Audits

If you're a Texas contractor — whether you build pools, install HVAC, do plumbing, remodel kitchens, or run a general construction shop — there's one decision that has more impact on your sales tax exposure than anything else you do: how you structure your contracts.

The choice between a "lump-sum" contract and a "separated" contract changes who pays tax, when they pay it, on what amount they pay it, and ultimately how the Texas Comptroller will treat your work in an audit. Most of the contractor audit assessments I issued as a Comptroller auditor came down to this one issue. Not fraud. Not aggressive positions. Just contractors who didn't know the rule, didn't follow it consistently, or invoiced in a way that converted what they thought was one type into the other.

Here's the rule, in plain English, with the four scenarios that cover almost every situation you'll face.

What the two contract types are

A lump-sum contract is one in which the price you charge the customer is stated as a single total. The contract does not break out a separate price for materials and a separate price for labor. The invoice does not break those out either. Your customer sees one number.

A separated contract is one in which the price is divided into a separately stated amount for incorporated materials and a separately stated amount for skill and labor (which includes fabrication, installation, and other work performed by the contractor).

That's the legal definition. In practice, the dividing line is set by how you invoice, not by what your contract document says.

The trap: you can write "lump-sum" but invoice "separated"

This is the single biggest mistake I saw in the contractor audits I worked and reviewed at the Comptroller.

The contract language says "lump-sum total: $X." But the customer asks for a breakdown, or your software automatically breaks out materials, or the change order itemizes everything. The invoice the customer receives shows materials as one line and labor as another. The Comptroller treats that as a separated contract — regardless of what the contract document says.

The relevant standard is in 34 TAC §3.291: if the prices of incorporated materials and labor are separately stated in any part of the contract or in a document that becomes part of the contract — including invoices — that's a separated contract. Adding the line items together to give a total at the bottom doesn't fix it. Even a "memo" line breaking out the cost can convert a lump-sum into a separated contract.

If you've been writing lump-sum contracts but invoicing with itemization, the Comptroller will treat all of that work as separated contracts in an audit, and the tax treatment changes substantially.

Why it matters: the four scenarios

The tax treatment depends on two questions:

1. Is the work new construction or repair / remodel?
2. Is the property residential or nonresidential?

That gives you four scenarios. The contract type (lump-sum vs. separated) sits inside each one and changes the mechanics. Here's the matrix.

Scenario 1: New construction, residential

Examples: building a new house, adding a new room, installing a new pool at a residence, putting in a new sprinkler system on a residential lot.

• Lump-sum: You buy materials and pay sales tax at the supplier (you're treated as the ultimate consumer). You charge your customer a single total. You do not charge tax to the customer.
• Separated: You give your supplier a resale certificate (so no tax at purchase) and you charge your customer tax on the materials portion of the contract. No tax on labor for new construction. The amount you charge the customer for materials must be at least what you paid.

Scenario 2: New construction, nonresidential (commercial)

Examples: building a new office, putting in a new commercial pool, installing HVAC in a new commercial building.

• Lump-sum: Same as residential new construction — you pay tax on materials at purchase, no tax to customer.
• Separated: Same as residential — resale cert at purchase, charge customer tax on materials only, labor for new construction is NOT taxable.

In other words, new construction is taxed the same way for residential and nonresidential. It's the repair/remodel scenarios where they diverge.

Scenario 3: Repair / remodel / restoration, residential

Examples: kitchen remodel in a home, pool replaster on a residential pool, replacing a residential HVAC unit, plumbing repair in a house.

• Lump-sum: You pay tax on materials at the supplier. You charge your customer a lump-sum total. You do not charge tax to the customer.
• Separated: You use a resale cert at the supplier and charge the customer tax on the materials portion. No tax on labor for residential repair / remodel.

So under either contract type for residential repair, your customer either pays tax on the materials (separated) or you absorb it (lump-sum). Labor is not taxed in either case.

Scenario 4: Repair / remodel / restoration, nonresidential (commercial)

Examples: remodeling a commercial space, replastering a commercial pool, replacing HVAC in an office building, repairing plumbing in a restaurant.

This is the scenario that costs contractors the most money. Under nonresidential repair / remodel, the entire charge is taxable — labor and materials. The contract structure (lump-sum or separated) makes no difference. Both labor and materials are subject to sales tax.

A contractor who treats commercial remodeling like residential remodeling can end up under-collecting tax on every commercial job. Multiply that by three years of audit period and you have a major assessment.

Quick reference table

Note on nonresidential repair: because the entire charge is taxable, the contractor uses a resale certificate at the supplier so the materials aren't taxed twice (once at purchase, once when re-billed to the customer).

Practical examples

Example 1: Pool company doing a new residential pool

Customer wants a $50,000 pool. Materials cost the contractor $20,000.

As a lump-sum contract: Contractor pays $1,650 sales tax (8.25% of $20K) at the pool supply store. Bills the customer $50,000, no tax. Done.

As a separated contract: Contractor uses a resale cert at the supply store ($0 tax at purchase). Bills the customer $25,000 materials + $25,000 labor + $2,062.50 tax (8.25% on the $25,000 materials portion). Customer pays $52,062.50.

Under separated, the contractor must mark up materials to at least cost. Pricing is more transparent for the customer.

Example 2: HVAC contractor doing a residential repair

Customer wants a new compressor on an existing residential AC unit. Parts cost $1,200. Labor is $600.

As a lump-sum contract: Contractor pays $99 sales tax at the parts supplier. Bills the customer $2,000 lump-sum, no tax.

As a separated contract: Contractor uses resale cert ($0 at purchase). Bills the customer $1,500 parts + $600 labor + $123.75 tax (on the $1,500). Customer pays $2,223.75.

Example 3: HVAC contractor doing a commercial repair

Same job, but in a commercial property. Parts cost $1,200. Labor is $600.

Either way: Entire $2,000 is taxable. Contractor uses resale cert at supplier ($0 at purchase). Bills the customer $2,000 + $165 tax. Customer pays $2,165.

If the contractor billed this commercial job the way they would have billed a residential lump-sum job — $2,000 with no tax to the customer — the contractor owes the $165 (plus penalty plus interest) to the Comptroller. Across hundreds of commercial jobs over three audit years, this becomes a six-figure assessment.

The five mistakes I saw most often on the auditor side

1. Lump-sum contracts ruined by itemized invoices. The contract was lump-sum. The invoice software automatically broke out materials and labor. The Comptroller treats it as separated. The contractor never charged tax to the customer on the materials portion, so the contractor owes the tax.
2. Treating nonresidential repair like residential repair. The contractor used the residential lump-sum mechanic on commercial jobs. The entire charge is taxable on those jobs. The contractor owes tax on every commercial repair across the audit period.
3. Resale certificate at the supplier without follow-through. The contractor used a resale cert (so no tax at purchase) but billed the customer as if it were a lump-sum (no tax to customer either). The Comptroller assesses the tax on the materials.
4. Inconsistent practices. Some contracts handled one way, some the other, no documentation explaining why. Auditor takes the most-taxable interpretation across the board.
5. Calling renovation "new construction." A house addition is new construction (the new room). Replastering an existing pool is repair, not new construction. The reclassification can flip the entire job's tax treatment.

How auditors detect this in your records

If you're under audit (or about to be), expect the auditor to look at:

• Sample contracts — read for separated vs. lump-sum language
• Sample invoices — see how charges actually appeared on the bill
• Resale certificates given to suppliers — if you've ever given one, the auditor wants to know whether you collected tax from your customers on the corresponding work
• Exemption certificates from customers — for any tax-exempt commercial customer, are the certificates valid and on file?
• Cross-reference between supplier purchase records and your invoicing — did materials purchased tax-free under a resale cert actually flow through to a customer who got charged tax?

The auditor isn't trying to trick you. They're applying a methodology. Most of the assessments come out of the cross-references: the contractor used resale certs but didn't charge customer tax, or itemized invoices on a "lump-sum" job, or treated commercial like residential. (For what the rest of the audit looks like, see the audit process, week by week.)

What to do this week

If you're not under audit yet:

• Pull 10 recent invoices. Look at each one. Is it consistent with how the contract was written?
• Pull 5 contracts. Check whether the language matches your invoicing. If not, decide which way you want to standardize and update both.
• For any commercial repair / remodel work, confirm you're treating the entire charge as taxable.
• If you've used resale certificates with suppliers, walk forward through your invoices and confirm you charged the customer correctly.

If you are under audit:

• Don't volunteer any of this to the auditor before getting a clear picture of your own exposure.
• Review your contracts and invoicing patterns yourself first.
• Get a free 15-minute consultation with someone who's been on the auditor's side of this before signing anything or admitting anything.

Sources & references

• Texas Comptroller — Real Property Repair and Remodeling (Pub 94-116)
• Texas Comptroller — Homebuilders and Real Property Services (Pub 94-157)
• 34 TAC §3.291 — Contractors