Can You Charge Sales Tax on a Service?

Sales tax is generally imposed on the sale of goods and services, with rates varying by location. It is a state and local tax, not a federal one, used to fund public services.

Understanding Service Taxation

Sales tax traditionally applies to tangible goods. As the U.S. economy has shifted towards services, many states have expanded their sales tax base to include certain services. This expansion helps states generate additional revenue and adapt to the changing economic landscape.

There is no uniform federal sales tax on services in the U.S.; instead, taxability is determined at the state and often local levels. This means whether a service is subject to sales tax can vary considerably. Some states tax services by default with specific exemptions, while others only tax certain enumerated services. Five states (Alaska, Delaware, Montana, New Hampshire, and Oregon) do not impose a general statewide sales tax on either goods or services.

Factors Determining Service Taxability

Determining whether a service is subject to sales tax involves several key factors, which vary by jurisdiction. Businesses must consider their connection to a state, the inherent nature of the service provided, and how services are treated when bundled with goods. The location where the service is performed or received also plays a role in applying the correct tax laws.

Sales Tax Nexus

Sales tax nexus refers to the sufficient connection a business has with a state that requires it to collect and remit sales tax. Nexus can be established through a physical presence, such as having an office, employees, or inventory in a state. It can also be created through economic nexus, where a business exceeds a certain threshold of sales revenue or transaction volume within a state, even without a physical presence. Many states set economic nexus thresholds at $100,000 in sales or 200 transactions over a 12-month period, though some, like Texas and California, have higher thresholds, such as $500,000. If a business meets these thresholds, it is obligated to register and collect sales tax in that state.

Nature of the Service

The nature of the service significantly influences its taxability. States categorize services differently; some are explicitly listed as taxable, while others may be taxed if considered incidental to the sale of tangible personal property. The “true object” test is a common analytical tool used by states to determine the primary purpose of a transaction involving both goods and services. This test seeks to understand what the customer truly intends to acquire: is it primarily the service, with any tangible goods being incidental, or is it the tangible good, with the service being secondary? If the true object is the transfer of tangible personal property, the entire transaction may be taxable; conversely, if the main purpose is a non-taxable service, the transaction might not be taxed, even if some tangible items are included.

Bundled Transactions

Bundled transactions involve the retail sale of two or more distinct products or services for a single, non-itemized price. If a bundled transaction includes a taxable product or service, the entire bundled price could become taxable. Many states apply de minimis rules where if the taxable portion is a very small percentage of the total price (often 10% or less), the entire transaction may be considered non-taxable. However, if the taxable portion exceeds this threshold, the whole transaction may become subject to tax.

Service Location

The location of the service also impacts which state’s tax laws apply. Taxability can depend on where the service is performed or where the customer receives the benefit of the service. These jurisdictional rules help determine the specific sales tax rates and regulations that a business must follow.

Common Taxable and Exempt Services

While service taxability varies significantly by state, certain types are commonly taxed, while others are frequently exempt. Understanding these categories helps businesses anticipate potential sales tax obligations. Specific state laws dictate the exact tax treatment.

Commonly Taxed Services

Commonly taxed services often include those related to tangible personal property or real estate. These include:
Repair and installation services for goods
Cleaning services for personal and real property
Landscaping services
Digital services, such as streaming and Software as a Service (SaaS)
Telecommunications services
Certain advertising services
Amusement or recreation services, like event admissions

Commonly Exempt Services

Many professional services are commonly exempt from sales tax. These include services provided by licensed professionals, such as:
Legal services
Accounting services
Medical services
Architectural services
Educational services
Financial services
Certain personal care services, like childcare or pet care

Real estate services are generally not subject to sales tax. Businesses should always verify the specific tax laws in each state where they operate.

Compliance Obligations for Service Providers

If a service provider determines their services are taxable, they must fulfill several compliance obligations to remain in good standing with tax authorities. These responsibilities are procedural and ensure proper collection and remittance of sales tax. The steps involve registration, collection, remittance, and diligent record-keeping.

Registration

The first step is to register with the relevant state tax authorities to obtain a sales tax permit or license. This permit authorizes a business to collect sales tax from customers. Registration is required once a business establishes nexus in a state, whether physical or economic. Most states provide online registration portals, and some offer simplified registration through systems like the Streamlined Sales Tax Registration System for member states.

Collection

Once registered, businesses are obligated to collect sales tax from customers at the point of sale. This means adding the applicable sales tax to the price of the taxable service. The collected tax must be accurately calculated based on the varying rates for the service location.

Remittance

After collecting taxes, providers must remit these funds to the appropriate state and local tax agencies. States typically set specific filing frequencies, such as monthly, quarterly, or annually, often based on the volume of sales tax collected. Returns must be filed even if no tax was collected, and payments are due with the return by the specified deadline.

Record-Keeping

Maintaining accurate records is a fundamental compliance requirement. Businesses must keep detailed records of all sales, taxes collected, and any claimed exemptions. These records, including sales slips, invoices, and exemption certificates, should generally be preserved for at least three to seven years, depending on state requirements. Proper record-keeping is essential for verifying sales tax returns and preventing issues during audits. Failure to comply with sales tax obligations can result in significant financial penalties, interest charges, and in some cases, criminal liabilities.