Omar Bennett
Sales tax laws have traditionally applied only to the sale of goods, not services. However, as the economy has shifted from manufacturing-based to service-based, many states have expanded their sales tax laws to include services. Sales tax on services varies from state to state, with some states imposing no sales tax on services, some taxing services by default, and others taxing only certain services. This has created a complex landscape for businesses to navigate, with service businesses often unsure of their sales tax obligations.
| Characteristics | Values |
|---|---|
| Services to tangible personal property | Taxed at the same rate as TPP in many states; TPP = items that can be touched and moved |
| Services to real property | Taxed in some states; includes work done on buildings and land, e.g. landscaping, janitorial services |
| Business services | Taxed in some states; includes services performed for companies, e.g. telephone answering, credit reporting, extermination |
| Personal services | Taxed in some states; includes personal grooming or other self-improvement services |
| Incidental property or equipment | Generally not taxed, but may be if audited and found to be the main purpose of the transaction |
| States with no sales tax on services | Alaska, Delaware, Montana, New Hampshire, Oregon |
| States that tax services by default | Hawaii, New Mexico, South Dakota, West Virginia |
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What You'll Learn
Taxable services vs. non-taxable services
Historically, sales tax laws in the US focused on the taxation of tangible personal property (TPP) and not services. TPP refers to items that can be touched and moved. However, as the US economy has shifted from manufacturing-based to service-based, several states have expanded their sales tax laws to include services.
Today, five US states (Alaska, Delaware, Montana, New Hampshire, and Oregon) do not impose any general sales tax on goods or services. Four states (Hawaii, New Mexico, South Dakota, and West Virginia) tax services by default, with exceptions for services specifically exempted by law. The remaining 41 states and the District of Columbia do not tax services by default, but specific services enumerated by the state may be taxed.
Each state has its own set of rules regarding which services are taxable, but they can be broadly categorized into six groups:
- Services to tangible personal property: Many states tax services that improve or repair TPP at the same rate as TPP sales. Examples include car repair, tailoring, and pet grooming.
- Services to real property: Work done on buildings and land, such as landscaping and lawn services, are often taxed.
- Business services: Services provided to companies, such as telephone answering and credit reporting, may be taxed.
- Personal services: Businesses providing personal grooming or self-improvement services may be taxed. Examples include massage parlors, Turkish baths, and escort services.
- Amusement services: Some states tax entertainment services, such as sightseeing tours, online games, and fortune-telling.
- Data processing services: Charges for data processing and information retrieval may be taxed.
It is important to note that the taxation of services varies greatly from state to state, and businesses should consult the specific laws and regulations in their state to understand their tax obligations.
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State-by-state variations
Over time, as the US economy shifted from manufacturing-based to service-based, several states began to impose sales and use tax on services as well. However, no two states tax the exact same specific services, and businesses that provide services may be unaware of these statutory changes, mistakenly believing they don't have to pay any sales tax.
Some states, such as Alaska, Delaware, Montana, New Hampshire, and Oregon, do not impose any general statewide sales tax on goods or services. Other states, like Hawaii, New Mexico, South Dakota, and West Virginia, tax services by default, with exceptions for services specifically exempted by law. The remaining states fall somewhere in between, taxing services enumerated by the state, but not by default.
For example, in Texas, taxable services include amusement services such as sightseeing tours, online games, and fortune-telling, as well as insurance services, and personal services provided by massage parlours, Turkish baths, or escort services. In New York, taxable services include written or oral credit rating services, and oral credit reporting services not delivered by telephone. Meanwhile, in Connecticut, taxable services include packing and crating services, parking services, and pet grooming and boarding services.
Colorado is another state with its own unique variations. While it generally does not impose sales tax on services, there are certain services that are specifically taxable under Colorado law, such as prepared food and drink sold by restaurants and short-term rentals of rooms and accommodations.
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The 'true objects test'
The service industry covers a spectrum of businesses, but they share the common element of performing activities with little or no transfer of ownership or use of property. Traditionally, sales tax was applied only to the sale of goods, not services. However, as the US economy has shifted from manufacturing-based to service-based, several states have expanded sales tax to include services.
The "true objects test" is an analysis used by state taxing authorities to determine whether a transaction is taxable. It helps to establish whether the service provided or the property acquired was the main purpose, or the "true object", of the transaction.
For example, a dental practice provides services and uses tangible personal property (TPP) in the form of X-rays and gold fillings. The client is paying for the service, and the TPP is incidental to the service provided. In this case, the service is the "true object" and the transaction is likely not taxable. Conversely, a computer repair business may install a range of new equipment and software. In this case, the TPP and software are the "true object" of the transaction, and sales tax is likely to be incurred.
The true objects test is particularly relevant for technology companies, which may offer products or services that are difficult to classify for tax purposes. For example, electronically downloaded software and Software as a Service (SaaS) are considered a transfer of TPP and therefore taxable in Texas, while California considers them to be non-taxable services.
The application of the true objects test varies from state to state. While some states tax services by default, others only tax services that are specifically enumerated by the state.
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Bundled sales
The concept of "bundled sales" is important when considering sales tax on services. The taxation of services has evolved over time, with many states now imposing sales tax on services, in addition to tangible personal property (TPP).
In the context of sales tax, "bundled sales" refer to transactions that include a combination of taxable and non-taxable items or services. This can include tangible personal property and services, or different types of services that are taxed differently.
The taxation of these bundled sales can be complex and varies across states. To determine the taxability of a bundled sale, several methods are used, including the true object test or essence of the transaction doctrine, which aims to identify the primary purpose of the transaction. If the tangible personal property is incidental to the service provided, the entire bundle may be taxed as a service.
Another consideration is the de minimis rule, which comes into play when the taxable product or service constitutes a small portion of the total bundle, typically 10% or less. In such cases, the entire transaction may be taxed as a service, disregarding the trivial cost of the tangible personal property.
The specific application of these rules can vary by state, and businesses must be aware of the tax implications of their bundled offerings to ensure compliance with sales tax laws.
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Exemptions
Sales tax exemptions are statutory exceptions that relieve a company from collecting and remitting sales tax on certain products and services. In the United States, sales tax is governed at the state level, and each state has its own rules and laws. If a business operates in multiple states, it will likely encounter vastly different sales tax rules and regulations.
In most states, services are deemed non-taxable unless the statute specifically lists the service as taxable. Examples of taxable services in many states include telecommunications, data processing, or information analysis.
There are three main types of exemptions:
- Product or Service Exemptions: Certain products and services may be exempt, or partially exempt, in many states. These categories can include clothing, professional services, food, and other items. These types of exemptions vary by state and are sometimes referred to as excluded from the sales tax base. Exemption certificates are not needed when a product or service is deemed non-taxable in a state or jurisdiction—sales tax is simply not applied to the purchase.
- Resale Exemptions: When a buyer purchases items from a vendor, they may intend to sell the items or services to another business or consumer. Resale exemptions apply to goods acquired for resale in the same condition and may extend to goods used to become an integral part of a good to be resold. Resellers use resale exemption certificates to purchase goods for resale without paying sales tax.
- Buyer's Use of Property: These exemptions ensure that only the retail buyer, i.e., the consumer of the taxable good or service, will be liable to pay sales tax, and that intermediaries will not have to pay additional taxes, which would result in double taxation.
In most US states, sales to government entities are tax-exempt. For example, a state-run school in Alabama does not have to pay sales tax when purchasing supplies. However, a handful of states, like California and Minnesota, do not automatically consider state and local government entities to be tax-exempt. Sales to the US government are always sales tax-exempt.
Depending on the state, nonprofit organizations may be exempt from paying sales tax. This varies greatly from state to state. Non-profit organizations only need to apply once for an exemption in most states, but some states, including Florida, Missouri, and Maryland, require entities to file renewals every one to five years.
Manufacturers, distributors, wholesalers, and other vendors reserve the right to refuse service if they are unsure about a customer's tax-exempt status. Manufacturers are eligible to buy goods without paying sales tax if they intend to use those materials to manufacture other goods for resale.
To purchase items tax-free, a business or organization must provide an "exemption certificate" to each company it buys from. This is proof that the business is eligible to purchase items tax-free, either for resale or because it is an exempt entity. In some cases, a valid Certificate of Authority is also required to use an exemption certificate.
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Frequently asked questions
Traditionally, sales tax was applied only to goods and not services. However, this has changed in recent years, and now many states impose sales tax on services. Not all states require businesses to charge sales tax on services, and the services that are taxable vary from state to state.
Services can be broadly categorized into four groups: business services, personal services, services to tangible personal property, and services to real property. Business services include computer services, financial services, advertising services, and consulting services. Personal services include personal grooming or self-improvement services. Services to tangible personal property are those that improve or repair property, such as carpentry, car repair, and tailoring. Services to real property include landscaping, janitorial services, and work done on buildings and land.
To determine whether a service is taxable, you should consult the relevant state's tax authority website or a sales tax expert. Each state has different rules regarding which services are taxable, and these rules can be complex. In general, you must register for sales tax permits with each state in which you have a physical or economic nexus before collecting sales tax from customers.
