Taxes, escalation, allowances and contingency

After direct costs, general conditions and markups, four items remain that can quietly add or remove several percent from a bid: sales taxes, escalation, allowances and contingency. Each is easy to misunderstand. Taxes depend on who is legally the consumer of the materials and on the jurisdiction. Escalation depends on when the money will be spent, not when the bid is submitted. Allowances are amounts the owner tells bidders to carry, with rules about what they include. Contingency is the price of uncertainty, and its size should reflect how much the estimate does not yet know. CON-200 introduced taxes on materials and price escalation at the level of individual quotes; this lesson treats them at the level of the whole bid.

Sales taxes in a construction bid

In the United States, there is no federal sales tax, and each state (and often counties and cities) sets its own rules. In most states, a contractor building real property is treated as the consumer of the materials it incorporates into the building: it pays sales tax when it buys the materials (or use tax if the seller did not collect it), and the tax becomes part of the contractor's cost. The contractor does not charge sales tax on its contract price to the owner in those states, so the estimate must include the tax on materials in the direct costs.

There are important exceptions. Some states treat construction contractors as retailers of the materials in some situations, collecting tax from the owner on the materials portion of the contract. A few states tax the contract price or the contractor's gross receipts: for example, Hawaii's general excise tax and New Mexico's gross receipts tax apply to construction receipts, and in Washington State the prime contractor generally collects retail sales tax on the full contract price of most private construction. Projects for exempt owners such as federal agencies or some nonprofits may or may not allow contractors to buy materials tax-free, depending on state law. The estimator must confirm current treatment with the firm's tax adviser for each state.

Because most material tax sits inside subcontract quotes, the general contractor's main task is to make sure every quote states its tax basis consistently: whether provincial or state taxes are included, and on a Canadian bid that federal tax is excluded. A quote that includes recoverable tax, or excludes non-recoverable tax, distorts leveling (Lesson 7).

Escalation to the midpoint of construction

Construction prices change over time. A bid submitted today will be built over the next year or two, and the costs that matter are the costs at the time each item is bought, not at the time of the bid. Firm quotes from subcontractors and suppliers fix some prices, but many quotes are valid only for 30 to 90 days, some contain escalation clauses for volatile materials, and the general contractor's own labor rates will rise with collective agreements. Escalation is the allowance for these increases.

A common method is to escalate each cost from the pricing date to the midpoint of the period over which it will be spent. For the whole project, the midpoint of construction (or more precisely, the cost-weighted midpoint of the spending curve) is a reasonable proxy. Because escalation compounds, the factor is the annual rate raised to the number of years from the pricing date to the midpoint.

Published indexes, such as the Producer Price Index for inputs to construction from the Bureau of Labor Statistics and commercial cost indexes from publishers such as ENR, give a picture of recent cost changes. Past changes are not a forecast, but they help calibrate the rate. Volatile materials such as steel, copper, aluminum and some electrical equipment can move much faster than the general index, and tariffs on steel and aluminum imports imposed and raised in 2025 added to their volatility.

Allowances

An allowance is an amount specified in the bid documents for an item whose details have not been decided, such as finish hardware, signage, artwork, or the cost of unknown site conditions. Every bidder carries the same amount, so the allowance does not affect competition. The contract then adjusts the price up or down when the actual cost is known. The key question is what the allowance covers. In many contracts, a cash allowance covers only the net cost of the materials or the subcontract, and the contractor's other costs (handling, installation if not included, overhead and profit) must be included elsewhere in the bid. If the estimator assumes the allowance covers everything, those costs are missing.

Under AIA A201, allowances cover the cost to the contractor of materials and equipment delivered to the site and all required taxes, less applicable trade discounts; the contractor's costs for unloading and handling at the site, labor, installation costs, overhead, profit and other expenses contemplated for allowance amounts are included in the contract sum but not in the allowances. Supplementary conditions often modify these rules, so the estimator must read them.

Contingency

Contingency is an amount added to cover costs that are expected to occur but cannot be identified individually at the time of the estimate: quantity errors, minor scope omissions, pricing uncertainty, unexpected conditions within the contractor's risk. It is not a substitute for pricing known risks (which should be priced explicitly, Lesson 11 and CON-350) and not a hidden profit. Different parties carry different contingencies. A contractor's estimating contingency covers its own uncertainty in a stipulated price bid. A design contingency in an owner's budget covers design development. An owner's construction contingency covers changes the owner will pay for after award. Confusing them leads to double counting or gaps.

The size of contingency should reflect the maturity of the information. AACE International's recommended practice for estimate classification describes typical accuracy ranges by class: a class 5 estimate (concept screening, about 0 to 2 % of design complete) might range from 20 to 50 % low to 30 to 100 % high, while a class 1 estimate (check estimate or bid on complete documents) might range from 3 to 10 % low to 3 to 15 % high. CON-200 introduced these classes; here they help explain why contingency is large early and small at bid time.

One way to set contingency is to model the uncertainty in the main cost items and simulate many possible outcomes. A Monte Carlo simulation draws random values for each uncertain item from a chosen distribution, adds them up, repeats the process thousands of times and reports the distribution of total cost. The contingency is then the difference between the base estimate and a chosen confidence level, such as the 80th percentile (P80).

import random
random.seed(42)
# Uncertain cost items: (base estimate $, low factor, most likely factor, high factor)
items = {
    "Self-performed concrete": (1_920_000, 0.95, 1.00, 1.15),
    "Mechanical":              (2_850_000, 0.97, 1.00, 1.08),
    "Electrical":              (1_640_000, 0.97, 1.00, 1.07),
    "Envelope":                (1_480_000, 0.96, 1.00, 1.10),
    "Other subcontracts":      (2_300_000, 0.98, 1.00, 1.05),
    "General conditions":      (  910_000, 0.95, 1.00, 1.12),
}
base = sum(v[0] for v in items.values())
totals = sorted(sum(b * random.triangular(lo, hi, ml) for b, lo, ml, hi in items.values())
                for _ in range(20_000))
p50, p80 = totals[len(totals) // 2], totals[int(0.8 * len(totals))]
print(f"Base estimate ${base:,.0f}")
print(f"P50 ${p50:,.0f}  P80 ${p80:,.0f}")
print(f"Contingency to reach P80: ${p80 - base:,.0f} ({(p80 - base) / base:.1%})")

Base estimate $11,100,000
P50 $11,302,199  P80 $11,414,510
Contingency to reach P80: $314,510 (2.8%)

Because the uncertainties are skewed upward (costs are more likely to rise than fall), even the median outcome is above the base estimate. A contingency of a few percent brings the bid to the 80th percentile. Simulation is only as good as its inputs, and it ignores correlations between items unless they are modeled, but it makes the discussion of contingency explicit and repeatable instead of a number pulled from the air on bid day.