In Arizona, contractors don’t charge a separate sales tax on labor, but labor isn’t fully tax-free either. The state taxes contractors under the Transaction Privilege Tax on 65 percent of the total contract price, with the other 35 percent excluded as an assumed labor share. So whether you’re asking do contractors charge sales tax on labor in Arizona as a homeowner reading an invoice or as a contractor writing one, the honest answer is that some labor cost is folded into the taxed 65 percent, and on smaller jobs labor isn’t taxed at all.
The 65/35 Split That Determines How Labor Is Taxed
Arizona doesn’t have a conventional sales tax. It has the Transaction Privilege Tax, which is legally the contractor’s obligation for the privilege of doing business in the state, not a tax the customer owes.1Arizona Joint Legislative Budget Committee (JLBC). Transaction Privilege Tax Contractors routinely pass the cost through as a line on the invoice, but the underlying tax is on the business, not on the buyer.
For most construction work, the applicable TPT classification is “prime contracting,” which covers new construction, reconstruction, and any modification that materially adds value or expands an existing structure. Under this classification, the tax base is 65 percent of the gross contract price.2Arizona Legislature. Arizona Code 42-5075 – Prime Contracting Classification Exemptions Definitions The remaining 35 percent is excluded because the legislature assumed labor costs represent roughly 35 percent of a typical contract.1Arizona Joint Legislative Budget Committee (JLBC). Transaction Privilege Tax
That 35 percent exclusion is a flat statutory assumption, not a reflection of your actual labor-to-materials ratio. If your crew costs run 20 percent of a job, the tax base is still 65 percent of gross receipts. If they run 50 percent, the tax base is still 65 percent. So labor isn’t separately taxed, and it isn’t fully excluded either. Some portion of it sits inside the taxed 65 percent.
When Labor on Smaller Jobs Isn’t Taxed
Not every construction contract triggers prime contracting TPT. Under changes enacted retroactive to July 2021, Arizona replaced the older nature-of-work exemptions for maintenance, repair, replacement, and alteration projects with a simpler dollar-threshold test. A contract is exempt from prime contracting TPT if it doesn’t exceed:3Arizona Legislature. SB1721 – TPT Prime Contracting Classification
- $100,000 per unit for residential projects
- $1,000,000 for nonresidential projects
The full contract price determines whether you clear the threshold. Subcontractor payments and other deductions can’t be pulled out to bring a job under the limit.3Arizona Legislature. SB1721 – TPT Prime Contracting Classification
When a contract qualifies for this exemption, the contractor doesn’t owe TPT on the gross price at all. Instead, the contractor pays retail TPT on the materials purchased for the job, either at the point of sale or by self-reporting afterward.4Arizona Department of Revenue. MRRA Contracting Labor charges on these exempt contracts are effectively untaxed. For a homeowner hiring someone to repaint the house or replace a water heater, that is the practical reality: the tax rides on the materials only.
Extra exemptions exist for work performed for qualified nonprofits, government entities, and certain electricity-generating or renewable energy facilities. Claiming any of these requires the contractor to obtain and keep a valid exemption certificate from the customer.5Arizona Department of Revenue. Modification Contracting
Modification Work vs. Maintenance Work
The line between taxable prime contracting and materials-only treatment often turns on whether the job counts as modification or maintenance.
Modification work materially adds to the value, size, or utility of an existing structure. Adding a room, building a patio enclosure, or converting a garage into living space are all modifications. Modification work that exceeds the dollar thresholds falls squarely under prime contracting and is taxed on 65 percent of gross receipts.5Arizona Department of Revenue. Modification Contracting
Maintenance and repair work preserves the existing condition without expanding it. Repainting a building, swapping a worn water heater for a comparable unit, or patching a roof all sit on the maintenance side. Work like this generally qualifies for the dollar-threshold exemption, with the contractor paying retail TPT on materials only.
The gray zone is where contractors get into trouble. Replacing a standard water heater is maintenance. Upgrading the whole plumbing system while you’re at it starts to look like a modification. ADOR auditors examine the scope and effect of the work, not the label on the invoice. Itemizing labor and materials carefully on every invoice is the main evidence a contractor uses to defend the classification if audited.5Arizona Department of Revenue. Modification Contracting
How TPT Shows Up on an Invoice
Because TPT is the contractor’s tax, not the customer’s, there’s no legal requirement to break it out the way a retailer breaks out sales tax. Most contractors do pass it through as a line item, but the amount reflects the 65 percent calculation applied to the whole job, not a separate tax on labor hours. If you see a percentage that looks like sales tax on your bill, it is TPT being recovered from you, and it’s already accounting for the 35 percent labor exclusion built into the tax base.
Prime contractors can also deduct the sales price of any land included in the contract, along with payments made to licensed subcontractors, from gross receipts before applying the 65 percent calculation.2Arizona Legislature. Arizona Code 42-5075 – Prime Contracting Classification Exemptions Definitions Those deductions come off first, and then the 65 percent rate is applied to what’s left.
The Rate Depends on the Job Site
The state base TPT rate is 5.6 percent. Counties and municipalities stack their own rates on top, so the combined rate at a given job site varies and can exceed 10 percent in some jurisdictions.1Arizona Joint Legislative Budget Committee (JLBC). Transaction Privilege Tax
The rate that applies is set by the physical address of the project, not the contractor’s office. Two identical remodels a few miles apart can end up with different tax figures because they cross a municipal line. ADOR runs a free address-based rate lookup where you enter the job site and get the exact combined state, county, and municipal rates.6State of Arizona Department of Revenue. Address Search
What This Means If You’re Hiring a Contractor
The short version for a customer: don’t expect to see a separate “sales tax on labor” line, and don’t assume its absence means labor is untaxed. On residential jobs at or under $100,000, or nonresidential jobs at or under $1,000,000, the contractor generally only pays tax on materials, and any tax passed through to you reflects that. On larger jobs classified as prime contracting, tax runs on 65 percent of the total contract, which quietly captures a portion of the labor.
Arizona’s contracting tax framework has gone through significant changes in recent years, with additional updates taking effect in mid-2025. Anyone relying on the numbers here for a real project should confirm current rates and classification rules directly with ADOR’s contracting guidelines before signing.