Charging sales tax on services

Sales tax is a main source of state and local revenue, funding a wide array of basic government and social services. When collections drop, governments sometimes fill revenue gaps by broadening sales tax to more services.

As more states expand taxability to services, the potential for sales tax calculation errors and audit risk rises. This paper gives some “rules of the road” for companies of all sizes to consider, especially those selling the following services:

• Debt collection
• Financial services
• Professional services
• Credit reporting services
• Construction contractors
• Maintenance services

Sales tax laws can apply to out-of-state sellers.

Most states now require certain out-of-state sellers to register with the tax authority then collect and remit sales tax. What's challenging is figuring out which states require which businesses to do do so. That depends on nexus — the connection between a business and a state that triggers a sales tax collection obligation.

Having a phyiscal presence in a state always triggers nexus, but thanks to the United States Supreme Court decision in South Dakota v. Wayfair, Inc. (June 21, 2018), nexus can also be created by economic activity alone (economic nexus). As of June 2020, 43 states and the District of Columbia require out-of-state businesses with a certain volume of sales or number of transactions in the state to collect and remit sales tax.

Determining nexus is the first step toward sales tax compliance.

Sometimes a service is taxable because an associated product is taxable.

Many businesses that provide customer support, installation, or warranty services in conjunction with the sale of a physical good need to hire an army of accountants to determine what's taxable and what's exempt. If you sell service contracts separately or in tandem with sales of tangible goods, you may be liable to collect sales tax.

While Hawaii, New Mexico, and South Dakota generally tax all sales of services, many other states tax some services but not others. The challenge for businesses is determining which services are taxable in states where they have nexus i.e., an obligation to collect sales tax). 

Taxable services in Texas include:

• Appliance repair
• Construction related services
• Data processing services
• Debt collection services
• Dog grooming
• Furniture refurbishing or upholstering
• Information technology services
• Jewelry repair or cleaning
• Shoe shining repair

In some states, businesses must charge sales tax on services provided in conjunction with sales of physical goods.

The true object test can help determine taxability.

When a sale includes both a product and a service, some states use a true object test to determine the taxability of the transaction. If the main purpose of the transaction (the true object) is the sale of taxable property or equipment, the entire transaction is subject to sales tax. If the main purpose of the transaction is instead the sale of an exempt service, the entire transaction is generally exempt.

Combined sales of products and services are more common in some industries than others, notably the construction, manufacturing, and medical industries. For example, an insulin monitor often accompanies the sale of diabetes treatment. In this case, the product is secondary to the service, and taxability is based on the real object of the transaction — the service provided.

Navigating sales tax rules and regulations is challenging and syphons resources from more profitable activities. Automating sales tax compliance helps businesses stay on the road toward success.