Quick assessment tool that will help you determine which of your products and services are taxable…
Service providers must have a much different perspective when it comes to sales tax in most states than retailers. Businesses that provide strictly non-taxable services do not need to collect and remit sales tax on their sales of services.
However, even if non-taxable services make up the bulk of your sales, if you sell anything else alongside the services like a tangible good, you must be prepared to do your due diligence for sales tax purposes. You don’t want to make a simple but far-reaching mistake that can create a sales tax burden for your business.
Regardless of the type of services you provide, you need to pay attention to things like how you are crafting your invoices and listing the items sold and how each state you are selling into writes their sourcing rules and definitions.
Here are a few common mistakes to avoid when it comes to sales tax on services to ensure you’re not needlessly creating an outstanding sales tax obligation for yourself.
If you charge a single price for a bundle of taxable and nontaxable goods and services, the state will likely consider you a seller of goods rather than services and impose tax on the entire sales price.
The state will look at the intention of the buyer and seller and the “true object” of the transaction to determine whether the transaction is taxable or not. For example, let’s say you sell dishwashers but also provide delivery and installation services as a bundle. You charge one lump sum price to customers for this bundle of the good and the services.
In this case, the state would likely determine that the “true object” or the intent of the purchaser in the transaction is to receive the new dishwasher, not the delivery and installation services. As a result, the non-taxable services become subject to tax.
Fortunately, there is an easy way to avoid this situation: separately state the taxable and nontaxable items on the invoice or contract provided to the purchaser. When you clearly describe what you are selling and break out the individual services and goods onto different lines on the invoice (and contract) it helps ensure that nontaxable services don’t become subject to sales tax.
Rules differ by state, but generally, if an invoice has both a taxable and nontaxable component, the nontaxable component must be separately stated, or the entire receipt becomes subject to tax. In some states, if the predominant cost of the items lumped into one amount is taxable, the entire amount is subject to tax.
On the other hand, some states allow the percentage of taxable items in the lump-sum amount to only be subject to tax. Or there may be a “de minimis” rule, meaning a certain percentage is used to determine the predominant cost in a service transaction. For example, Texas will allow 5% of the bundled charge to represent taxable materials in an otherwise nontaxable service transaction. If the materials exceed 5% of the total bundled price, then the entire charge becomes taxable.
States that tax services either follow a “benefit received” or a “services performed” rule to determine sourcing for sales tax, meaning the location where the sale is taxed.
Almost every state that taxes services follows the “benefit received” rule. States with this rule will tax a service performed anywhere if the benefit of the service is enjoyed/received in their state. “Benefit received” rule states impose tax on the purchaser of the service if the service provider is not registered to collect tax in the state.
For example, if you are a Utah accounting firm who provides services to an Ohio client, you would source the tax for those services to Ohio as that is where the client is receiving the benefit of those services. Ohio is a “benefit received” state, and professional services like accounting are generally sourced to where the benefit is received regardless of where the service provider is located.
“Services performed” states, on the other hand, tax the provision of a service even if the result of the service is delivered outside the state. These states take the position that the service is conducted in their state and the first use of any property used in providing the service occurred in their state and therefore it should be taxed.
Personal services, like getting a haircut or getting your suit dry cleaned, as a category of services are generally taxed where the services are performed. It makes sense as any property used for these types of services (like a pair of scissors or dry-cleaning equipment) is likely permanently used in-state.
Digging into state definitions of key concepts like tangible personal property will help you understand what products and services the state imposes tax on from the start.
For example, in New York, a company was subject to sales tax on pet sitting services because pets are considered tangible personal property, and the services provided by the company were the taxable “maintenance and servicing of tangible personal property.”
In this case, the company separately stating the pet sitting services didn’t impact the taxability since maintenance of tangible property is a taxable service in New York. Your first instinct might not have been to classify pets as tangible personal property! That’s why checking state definitions is critical to apply the correct definitions to your business situation.
Checking state definitions was essential in a different service scenario for a provider of portable toilets and related services in Missouri. The company advertised itself as a portable toilet rental company and argued that its entire business is a service and not taxable. However, the state didn’t see it that way and held that the company’s offerings were taxable as the rental of tangible personal property and not exempt as a waste removal service. Research broadly as to how your service should be classified so you don’t end up in a messy situation.
Small changes to your business processes like invoice and contract set-up and going just a little bit deeper into state rules can have a huge pay off for your company. You don’t want to collect and pay unnecessary sales tax on services that are exempt, and on the flip side, you don’t want to realize down the line you should have paid tax on one of your services and owe back taxes plus interest and penalty.