What Products and Services are Subject to Sales Tax?
New to collecting sales taxes? One of the first pieces of the puzzle is whether your products or services are taxable? As with all things sales-tax-related, it depends on your state. Here's a suggested checklist of questions you'll need to answer to find out.
First: Find out if your state has sales taxes. Double-check to see if your state collects sales taxes on internet transactions.
Second: Second, find out if your state collects sales taxes based on origin or destination.
Third: Figure out if what you are selling is a product or a service, or a hybrid.
Fourth: If you are selling products on the internet, you will need to make sure you have the latest information about your state
Finally: Find out if your state requires this product or service to be taxed.
Find out If Your State Collects Sales Taxes
Sales taxes are state-driven. That is, sales taxes are imposed by states on transactions involving products and services sold by businesses who have a sales tax presence (called a tax nexus) in that state. Your home business is a tax nexus because it's located within the state.
Most states collect sales taxes on products on services. Five states - Alaska, Delaware, Montana, New Hampshire, and Oregon - do not collect statewide sales taxes. Of these, Alaska and Montana allow localities to charge sales taxes. (From the Tax Foundation).
The laws on what products and services are constantly changing; this article gives you an overview and some general information about sales taxes on services and new technology, like digital products.
Sales Taxes on Internet Products and Services
The landscape of internet sales tax is continually changing. A recent (2018) Supreme Court decision opened the way for more states to charge sales taxes on sales over the internet. As of December 2018, 24 states now collect sales tax on internet transactions. Most only collect the tax on sellers who have more than 200 internet transactions or $100,000 in sales each year.
The number of states collecting sales tax on internet transactions is continually changing. Check with your state sales taxing agency to be sure.
Origin-based vs. Destination-based Sales Taxes
One of the elements in determining whether you must charge sales taxes is whether your state is an origin-based or destination-based state. Most states have destination-based sales taxes, meaning that the sales tax is applicable when the product is picked up or used. States that have origin-based sales taxes, require merchants to charge sales tax at the point where the sale is completed (usually the merchant's location. Learn more about whether your state is origin-based or destination-based.
Sales Taxes on Services
Since the 1930s, U.S. states have been collecting sales taxes. In the beginning, sales taxes were only collected on products (tangible personal property). Two major factors have driven the inclusion of services in state sales taxes:
- More and more businesses are service-oriented, and
- States have begun to realize they could capitalize on what was previously lost revenue by taxing services.
States started putting sales taxes on services in 2007, but these were business-to-business sales taxes and were usually repealed. States keep adding more services all the time, and some argue that all services should be taxed. Services of professionals (accounting, lawyers, medical professions) construction are usually not taxed, but personal services (like hair salons, barbers, lawn care, cleaning services) are often taxed.
Note: If you are doing business in Hawaii, New Mexico, and South Dakota, note that ALL services are subject to sales tax.
Product or Service and The "True Objects Test"
As the distinction between products and services blurs, it's more and more difficult to determine which is which for sales tax purposes. And states are all over the place, each enacting laws that seem logical but might be different from other states.
One test that some states are using is called the "True Objects Test." This test, as BizFilings notes, depends on the purpose of a specific service. For example, if your CPA prepares your income tax return, is that a service or a product? What's the true or basic purpose of the service? In another example, if you pay for a company to install a computer system in your office, with thousands of dollars of computers, connectors, routers, etc., that sounds like a product.
Just to show you an example of how complex this product/service thing is, see this page from the state of Connecticut's website about sales taxes on computer equipment and tangible personal property. Connecticut charges sales tax on computer and data processing related personal services performed by employees, differentiating between employees and independent contractors.
Sales Taxes on Digital Products
The world is going digital, and the discussion about taxing digital products is getting more complicated. Digital products include downloaded products like "movies, books and eBooks, music, ringtones, photographs and magazine and newspaper subscriptions" For example, a subscription to your favorite music service is a digital product.
Many states now tax digital downloads. Tonya Moreno at The Balance says, "Several states have adopted the Streamlined Sales Tax Governing Board definition, providing some uniformity to this complex issue. Tonya's article about state taxes and digital downloads lists each state and how it handles these digital products. The article was updated in late 2016; check with your state about whether its sales tax laws have changed since then.
Products Exempt From Sales Taxes - In Most States
States vary greatly on the products and services they tax. For example, most states do not charge sales tax on food sales, but a few (Arkansas, Virginia, West Virginia, and Tennessee) do charge sales tax on food.
Prescription drugs are exempt from sales taxes in almost every state, while most states charge sales tax on non-prescription drugs, and Illinois levies a 1% tax on non-prescription drugs. Most states charge sales tax on most products sold in the state, but sales taxes on services vary widely. Use this PDF file to see sales tax rates for each state.
Sales Taxes on Products for Resale
The U.S. doesn't have an indirect tax (like a VAT tax) on which taxes are imposed at all stages of the production process. If your business produces products, component parts for resale, or if you buy materials that you make into products for resale, you may not have to pay sales tax on these purchases.
You may be able to get a sales tax certificate or a seller's certificate (same thing) which exempts your business from sales tax for purchases that will be turned into products for resale. The sales tax certificate doesn't apply to products that you buy for use within your company, like copy paper and office equipment. It also has nothing to do with sales taxes you collect from customers. You can apply for this sales tax certificate through your state taxing authority.
How To Find Out What's Taxable in Your State
You can try to guess, and you can search your state's department of revenue to see if you can find specifics. But laws change and websites might not be updated frequently. If you are registered to collect sales tax in your state, you should be able to receive updates. Or, better yet, make a phone call.
The Federation of Tax Authorities (FTA) has a list of all state revenue departments and state taxing authorities.