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. Check on local sales taxes too. Double-check to see if your state collects sales taxes on internet transactions.
Third: Figure out if what you are selling is a product or a service, or a hybrid.
Fourth: Find out if your state requires this product or service to be taxed.
Finally: If you are selling products on the internet, you will need to make sure you have the latest information about your state's internet tax regulations.
Find out If Your State Collects Sales Taxes
Sales taxes are state-driven. Each state has its own rules on transactions involving products and services sold by businesses.
If you are doing business in a state, you have what's called a tax nexus in that state. A business can have a tax nexus if the business has a physical presence in the state, by having property or employees.
A home-based business is a tax nexus because it's located within the state. Each state also has tax nexus definitions for internet sellers.
Most states collect sales taxes. 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.
Sales Taxes on Internet Products and Services
The landscape of internet sales tax is continually changing, and a recent (2018) Supreme Court decision opened the way for more states to charge sales taxes on sales over the internet. As of December 2019, 43 states 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.
Each state has complicated regulations for internet sales tax and these regulations may change. Check with your state sales taxing agency to be sure you are following the law.
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 trends have driven the inclusion of sales taxes on services:
- 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, and states keep adding more services all the time. Experts at the Tax Foundation say all services should be taxed.
All states tax some services, and services like dry cleaning, carpentry work, and barbershops are often taxed, but very few states tax professional services, like doctors and lawyers. Hawaii and New Mexico tax nearly all services.
Is it a Product - or a Service?
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.
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 issue is, consider the state of Connecticut. The state charges sales tax on computer and data processing services, differentiating between employees and independent contractors. In one example, the sale of prewritten software for website creation is taxable at 6% when "tangible personal property" is given to the purchaser, but is not taxable when delivered electronically.
Sales Taxes on Digital Products
Here's another example of the product vs. service dilemma. The discussion about taxing digital products is getting more complicated. Digital products include:
- Digital audiovisual works, like movies, music videos, news shows, entertainment programs, and live events.
- Digital audioworks, like songs, music, audiobooks, speeches, ringtones, and other sound recordings.
- Digital books (fiction and non-fiction.
Software is considered tangible personal property.
Each state may include or exclude certain products from sales taxes based on their own rules, so the taxability of digital products varies greatly by state. Currently, if a state wants to tax digital products, they label as tangible personal property.
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.
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 may be able to get a sales and use tax exemption certificate if your state belongs to the Streamlined Sales Tax Registration System, or go to your state's revenue department for more information.
If a business in your state gives you a sales tax exemption certificate when buying products for resale, you must honor it. Keep a copy of the certificate and check your state's laws on how to deal with these certificates.
How To Find Out What's Taxable in Your State
You can search your state's department of revenue to see if you can find specifics. 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. They also have a list of state sales tax rates, including food and drug exemptions.
Tax Foundation. "A Very Short Primer on Tax Nexus, Apportionment, and Throwback Rule." Accessed Mar. 11, 2020.
Tax Foundation. "Facts & Figures 2020 How Does Your State Compare?" Table 19. State & Local Sales Tax Rates. Pages 19-20. Accessed Mar. 11, 2020.
Tax Foundation. "State Sales Taxes in the Post-Wayfair Era." Download PDF. Accessed Mar. 11, 2020.
Tax Foundation. "Sales Tax Base Broadening: Right-Sizing a State Sales Tax." Accessed Mar. 11, 2020.
Tax Policy Center. "The State of State (and Local) Tax Policy." What Purchases are Subject to the General Sales Tax? Accessed Mar. 11, 2020.
Connecticutt Dept. of Revenue Services. "Sales and Use Taxes on Computer-Related Services and Sales of Tangible Personal Property." Accessed Mar. 11, 2020.
Rice University. Baker Institute for Public Policy. "The Current State of Sales Tax on Digital Products." What are Digital Products? Page 1. Accessed Mar. 11, 2020.
Rice University. Baker Institute for Public Policy. "The Current State of Sales Tax on Digital Products." The Current Landscape of State Tax on Digital Products. Page 3. Accessed Mar. 11, 2020.
Federation of Tax Administrators. "State Sales Tax Rates and Food and Drug Exemptions." Accessed Mar. 11, 2020.