One of the most common questions I am asked is whether a specific product or service is subject to sales tax or is it exempt. Obviously, there are many different factors that go into answering these questions, but there are some general guidelines that can help determine whether something is taxable or exempt.
Another frequently asked question is whether or not a customer is allowed to claim an exemption on his or her purchases. Many sellers and purchasers have some level of uncertainty when it comes to managing exemptions. At the most basic level, if the purchaser is exempt, it is his or her responsibility to declare their exempt status and provide the required documentation to the seller at the time of the purchase. If this doesn’t happen on an otherwise taxable sale, the seller is liable for the tax.
So what are the key items in understanding when a sale is taxable or exempt? And what do you need to know to ensure that a customer (or you) can claim an exemption? I’ve identified 4 questions you should ask to help find the answers to these questions.
The product or service you’re selling is the first key item to consider when determining if a sale is taxable or exempt. Sales of tangible personal property are generally subject to sales tax. But in some states, specified services are subject to sales tax. If you only sell services, your sales might be exempt. But you’ll need to consult the tax law in the states where you sell services to find out if the services you sell are taxable there. Also watch out for bundling any tangible property with the service. This could change the taxability.
One other thing about services: The taxability of a service could vary based on some very discrete distinctions. For example, if you’re a repairman, the tax treatment of the services you provide may vary based on whether you are doing “repair services” or “maintenance services.” You’d need to check the specific tax laws for a state to see what are considered taxable services.
There are different types of purchasers you may sell to whose purchases are exempt. Many governmental entities are not required to pay sales tax on purchases. For example, states are prohibited from taxing direct sales to the Federal Government. State and local government entities are also often exempt – but not always.
Non-profit and charitable organizations are also often exempt. Examples can include schools, churches, non-profit hospitals, and charitable organizations. One thing to keep in mind: For most states that grant an exemption to non-profit organizations, the exemption only applies to their purchases of items used in conducting exempt activities. If the organization makes sales that compete with for-profit companies, their sales are generally subject to sales tax.
Note that many states also offer exemptions geared at specific industries such as manufacturing, research & development, and high-tech, among many others. If you make sales to purchasers in these industries, an exemption may apply.
Remember that proper exemption documentation must be provided in order to claim an entity or type of use exemption. These vary by state as you might have guessed!
At the most basic level, sales tax is imposed on sales where the transfer of title or possession occurs within the taxing jurisdiction. Therefore, if a sale occurs in interstate commerce, the original state where the sale occurs cannot tax the transaction. The destination state, however, will likely subject the transaction to its use tax. If the vendor is registered to collect the destination state’s tax, the use tax should be collected and remitted to that state. If the vendor is not registered, the purchaser has the liability to remit the consumer’s use tax.
But, the challenges come in when it isn’t just a simple pick up at the seller’s location or a direct ship of tangible goods. Drop shipments create challenges when a seller isn’t registered in the customer state but the shipper might be. And if selling services, should the state where the service is performed have the right to tax the transaction or where the customer is located? Does it matter based on the type of service? It can. And with remote services , this becomes a real challenge. The seller might not even know where the customer is located. So, then what happens? Some states have default logic which could result in using a customer billing address and if no address is available at all, it might be sourced to the seller’s location.
The last key item to consider is what is included in the “sales price” that is subject to tax. For example, is a discount included in the sales price subject to tax or is it excluded from the tax base? Is a coupon included in the sales price? Are delivery charges included? Whether or not these items are considered to be part of the taxable “sales price” can vary from state to state. And if you are providing both tangible personal property and services in the same transaction, are the services subject to tax or are they exempt? In this case, whether or not the services are separately stated from the tangible personal property on the invoice to your customer and even whether they are mandatory or optional may determine if the services are taxable or exempt.
Want to learn more? Watch our on-demand webinar – Sales Tax 101 – at your own convenience and gain the confidence that you’re handling sales tax correctly with training from one of the foremost experts.
This blog post is also published on Linked In: https://www.linkedin.com/pulse/sales-tax-101-determining-when-applies-diane-yetter