Do You Charge Sales Tax on Services in California?

California’s sales tax system can be complex, especially when determining if services are taxable. Sales tax is generally imposed on the retail sale of tangible personal property within the state. This tax applies to items that can be seen, weighed, measured, felt, or touched. Businesses must understand California’s sales tax rules to ensure compliance and avoid liabilities.

The General Rule for Services

In California, sales tax applies to the sale of tangible personal property, not to the performance of services. Many common services, such as legal advice, accounting services, medical consultations, and consulting, are not subject to sales tax. The law does not specifically list most services as exempt; instead, they are automatically excluded from the tax base because they do not involve the transfer of tangible personal property.

Service providers are considered the consumers of any tangible personal property they use incidentally in rendering their services. For example, an accountant pays sales tax on office supplies they purchase, but their client does not pay sales tax on the accounting services received.

When Services Are Subject to Sales Tax

While services are generally exempt, sales tax can apply in California when services are closely tied to the creation or transfer of tangible personal property. Businesses must assess their transactions to determine if any part of their service offering falls under these taxable categories.

Services that are an inseparable part of a sale of tangible personal property are taxable. If a service is a required condition of a taxable sale, the entire charge, including the service, is subject to sales tax, even if separately itemized. For instance, if a computer program sale requires a specific training service, the training becomes taxable as part of the software sale.

Charges for fabrication labor are taxable in California. Fabrication involves creating, producing, processing, or assembling tangible personal property. This applies whether the seller or the customer provides the materials. Examples include manufacturing machinery, custom printing, or sizing and engraving a ring.

Installation charges are not taxable if they are separately stated and separate from the sale of tangible personal property. However, if installation labor is considered part of the fabrication of an item, or if the item installed becomes a “fixture” and is sold by the installer, the installation charges are taxable. For instance, when a construction contractor installs a fixture, the sale price of the fixture, which can include fabrication and installation, is taxable.

Labor for repair services is not taxable, but charges for parts used in the repair are taxable. If a repair involves furnishing parts, sales tax applies to the retail selling price of those parts. If a repairer does not separately state the charge for parts, and the retail value of parts and materials is more than 10 percent of the total charge, the repairer is considered a retailer of the parts, and tax applies to the retail selling price of the property.

Services provided in connection with the lease or rental of tangible personal property are taxable. If a service is mandatory or inseparable from the rental of tangible personal property, it is subject to sales tax. For example, if a maintenance agreement is mandatory with the lease of equipment, the charges for that agreement are taxable.

Maintenance agreements and service contracts are taxable depending on their nature. Mandatory warranties or maintenance agreements included in the total selling price of a taxable product are taxable. Optional warranties or service agreements are not taxable if they are purely for labor. However, if an optional software maintenance agreement provides physical products like software updates on a CD, 50 percent of the separate charge for the agreement is taxable.

Navigating Mixed Transactions and Bundled Sales

Transactions that combine both services and tangible personal property are complex for sales tax determination. Businesses must distinguish between taxable and non-taxable components to ensure accurate tax collection. Proper invoicing and understanding the “true object” of a transaction are important.

Separately stating charges for taxable tangible personal property and non-taxable services on invoices is crucial. If a business fails to itemize these charges, the California Department of Tax and Fee Administration (CDTFA) can deem the entire transaction taxable. Clear itemization demonstrates which portions of a transaction are subject to sales tax and which are not.

Bundled transactions involve selling both goods and services together for a single price. The “true object” test determines taxability by assessing whether the purchaser’s primary intent was to acquire the service or the tangible personal property. If the true object of the contract is the service, the transaction is not taxable, even if some tangible personal property is transferred incidentally.

Professional services that involve the incidental transfer of tangible personal property are not taxable. For example, if a lawyer provides legal advice and hands the client a printed report, the report is considered incidental to the legal service, and the entire charge is non-taxable. The key is whether the tangible item is merely a means of delivering the service.

Resale certificates are used when buying tangible personal property that will be incorporated into a taxable service or resold. If a business purchases items for resale, they can provide a resale certificate to the supplier, exempting the purchase from sales tax. The sales tax is then collected when the item is sold to the consumer as part of a taxable transaction.

Compliance and Recordkeeping

If a business determines its services are subject to California sales tax, compliance steps are necessary. Adhering to these requirements ensures proper operation and avoids penalties.

The first step for any business making taxable sales in California is to register with the CDTFA and obtain a seller’s permit. This permit is required for anyone engaged in selling or leasing tangible personal property that would ordinarily be subject to sales tax if sold at retail. Registration can be completed online through the CDTFA website, and there is no fee to obtain the permit, although a security deposit may be required.

Once registered, businesses are responsible for collecting sales tax from their customers on all taxable transactions. The collected sales tax must be reported and remitted to the CDTFA. Filing frequencies for sales and use tax returns are assigned by the CDTFA based on taxable sales, and can be monthly, quarterly, quarterly prepay, or yearly.

Returns are due at the end of the month following the reporting period, though specific due dates vary by filing frequency. Businesses can file their returns and make payments electronically through the CDTFA’s online system. Even if no sales tax is due for a period, a return must be filed.

Maintaining accurate and complete records of sales, purchases, and collected tax is required for businesses holding a California seller’s permit. These records are used for verifying the accuracy of sales and use tax returns and for audit purposes. Businesses should retain records, including invoices and sales journals, for at least four years, or longer if an audit is pending.