Can You Charge Sales Tax on a Service?

Sales tax is a consumption tax imposed by state and local governments on the sale of goods and certain services. It is collected by the seller and remitted to the taxing authority. The taxability of services is complex, varying significantly by jurisdiction.

The General Rule for Service Taxation

Unlike tangible personal property, services are generally not taxed at the federal level. Sales tax is state-governed, with each state setting its own rules. Historically, most states exempted services, focusing on physical goods. Thus, a service is typically exempt unless explicitly stated otherwise by state law.

While five states lack a statewide sales tax, others, including the District of Columbia, have their own systems. Local governments may add sales taxes, leading to varying rates. Some states tax services by default unless exempted, while most tax only specifically enumerated services. This decentralized approach means taxability varies by jurisdiction, requiring businesses to understand local rules.

When Services Become Subject to Sales Tax

The taxability of services varies by state, but common scenarios exist where services become subject to sales tax.

Enumerated Services

Many states specifically list certain services as taxable. Examples include services related to real property, such as landscaping, lawn care, and cleaning. Other taxed services include pest control, certain repair services, or personal services like tanning or massage.

Services Related to Tangible Personal Property

Services incidental to the sale or repair of tangible personal property are often taxable. This includes installation charges for taxable goods. Repair and maintenance services for items like appliances or vehicles are also often taxable. Extended warranties or service contracts on products may also be subject to sales tax.

Digital Products and Services

Many states have expanded sales tax laws to include digital products and services. These include streamed content (music, video), software as a service (SaaS), digital downloads (e-books, software), and cloud computing services. Taxability often depends on whether the digital product is considered a tangible equivalent or a service, with states adopting different classifications.

Services Resulting in Tangible Personal Property

When a service directly results in a tangible item, the transaction may be taxable. Examples include custom printing services, photography services providing physical prints, or fabrication services transforming raw materials into a new item.

Key Preparations for Service Providers

Before collecting sales tax, service providers must take several steps to ensure compliance, including understanding taxability and administrative requirements.

Determining Nexus

Determining “nexus” is the first step, signifying a sufficient connection to a state that obligates sales tax collection. Physical presence nexus is established by a physical location, employees, or inventory in a state. Economic nexus requires collection if a business meets certain sales revenue or transaction volume thresholds, even without a physical footprint. Many states set economic nexus thresholds around $100,000 in sales or 200 transactions annually.

Researching State-Specific Rules

After identifying nexus, service providers must research if their services are taxable in those states. Consulting official state tax agency websites provides detailed guidance. Seeking advice from sales tax professionals can also clarify complex situations and ensure accurate interpretation of state laws.

Sales Tax Registration

If a service is determined to be taxable and nexus exists, the business must register with the relevant state tax authority. This registration process is necessary to obtain a sales tax permit or license, which legally authorizes the business to collect and remit sales tax. The information typically required for registration includes the business name, address, federal Employer Identification Number (EIN), and details about the business structure. It is generally advised to register before beginning to collect any sales tax.

Understanding Sourcing Rules

Service providers must also understand sales tax “sourcing rules,” which dictate where a sale is considered to have occurred for tax purposes. Sourcing rules determine which jurisdiction’s sales tax rate applies. Most states use destination-based sourcing, meaning the sales tax is based on the location where the customer receives the service or where the benefit of the service is consumed. A smaller number of states use origin-based sourcing, where the tax rate is determined by the seller’s location. For remote sales into a state where nexus exists, destination-based sourcing is commonly applied.

Identifying Exemptions

Businesses should also identify common sales tax exemptions that may apply to their services. For instance, a resale exemption may apply if a service is purchased by another business for the purpose of being resold to an end customer. Sales made to certain non-profit organizations or government entities are also frequently exempt from sales tax. When an exemption applies, it is important to obtain and retain valid exemption certificates from customers to substantiate why sales tax was not collected, as these are important for audit purposes.

Collecting and Remitting Sales Tax

After completing the necessary preparations, service providers must implement procedures for collecting sales tax and remitting it to the appropriate authorities. This involves ongoing mechanics of charging customers, filing returns, and making payments.

Collection Mechanics

Sales tax must be properly charged to customers at the point of sale. This typically involves showing the sales tax as a separate line item on invoices or receipts provided to the customer. This transparency ensures that the customer understands the amount being collected for tax purposes. The sales tax collected is considered a “trust tax,” meaning the seller holds these funds in trust for the taxing authority until they are remitted.

Filing Sales Tax Returns

Businesses are required to file sales tax returns with each state where they are registered to collect sales tax. The frequency of filing, such as monthly, quarterly, or annually, is determined by the state and is often based on the volume of sales tax collected. Higher sales volumes generally necessitate more frequent filing. Even if no sales tax was collected during a reporting period, a “zero return” may still need to be filed to maintain compliance.

Remittance Methods

The collected sales tax must be remitted to the state by the specified due dates. Most states offer online portals for electronic filing and payment, which is often the preferred or required method. Electronic funds transfer (EFT) or Automated Clearing House (ACH) payments are common methods for remitting funds. Due dates for filing and remittance vary by state, but they are commonly set for the 20th day of the month following the reporting period.

Record-Keeping Requirements

Maintaining accurate and detailed records of all sales tax activities is important for audit purposes. Businesses should keep records of all sales transactions, including invoices and receipts, indicating the amount of tax collected. Documentation related to tax-exempt sales, such as valid exemption certificates, must also be retained. Most states require these records to be kept for a minimum of three to four years, but longer retention periods may be necessary if an audit is ongoing or anticipated.