Is There Tax on Services? When and Where It Applies

The question of whether services are subject to tax is more intricate than it appears, particularly when compared to the taxation of tangible goods. Unlike physical products, the tax treatment of services is not uniform across all transactions or locations. The taxability of a service depends heavily on its specific nature and the jurisdiction where it is provided or consumed. This article explores consumption taxes, such as sales tax, as they apply to services, rather than income tax on service providers.

The Concept of Service Taxation

Historically, sales tax primarily applied to the sale of tangible personal property, which refers to physical items that can be touched and moved. The economy was largely manufacturing-based when many state sales tax laws were first implemented in the 1930s, making it simpler to tax physical goods. Services were often not subject to sales tax due to the difficulty in defining, tracking, and localizing them for taxation purposes.

This traditional distinction between goods and services for tax purposes has evolved significantly as the United States economy has shifted towards a service-based model. Many services that were once exempt are now subject to sales tax in various jurisdictions. The expansion of service taxation is driven by states seeking to broaden their tax bases and adapt to modern economic realities.

A “taxable service” refers to specific services that state laws designate as subject to sales tax. Unlike a physical product, a service for tax purposes involves the performance of an activity that typically does not result in the transfer of tangible personal property as its primary object. The definition of what constitutes a taxable service varies, but it broadly encompasses activities performed for a fee.

Legislators can expand the taxation of services by including additional service categories within existing sales tax frameworks. When a transaction involves both a product and a service, the “true object test” is sometimes used to determine taxability. This test assesses whether the main reason for the sale is the product or the service; if the product is the primary reason, the entire transaction may be taxed, but if the service is the main reason, it might not be taxed unless otherwise specified.

Varying Taxability Across Jurisdictions and Service Categories

The taxability of services varies throughout the United States, as tax rules are primarily determined at state and local levels.

Five states do not impose a general statewide sales tax on goods or services:
Alaska
Delaware
Montana
New Hampshire
Oregon

In contrast, four states tax services by default, with exceptions for services specifically exempted by law:
Hawaii
New Mexico
South Dakota
West Virginia

The remaining states do not tax services by default but specifically enumerate which services are taxable.

Common categories of services frequently subject to sales tax include:
Telecommunications
Certain utility services
Repair and maintenance services
Services applied to tangible personal property, such as car repairs or carpentry
Landscaping
Cleaning services
Digital services, like Software as a Service (SaaS) in some areas

Conversely, many states exempt services that are considered essential or professional in nature.
Medical services
Educational services
Professional services provided by accountants, attorneys, or doctors

These exemptions highlight the diverse approaches states take in balancing revenue generation with the public’s access to certain services.

The concept of “bundled services” further complicates taxability when goods and services are combined in a single transaction for one non-itemized price. If a bundled transaction includes a taxable item, the entire transaction may become taxable. Some states apply a “de minimis” rule, where if the taxable portion of a bundled transaction is a small percentage of the total cost, the entire transaction might be considered non-taxable. However, if the taxable portion exceeds this threshold, the entire bundle could be subject to tax.

Application and Compliance for Service Taxation

The responsibility for collecting and remitting service taxes falls upon the service provider. Businesses that sell taxable services are required to register with the appropriate state tax authorities to obtain a sales tax permit. This registration authorizes the business to collect sales tax from customers.

Determining the “situs” or specific location where a service is considered performed or consumed is important for sales tax purposes, especially for remote or digital services. States typically use either a “benefit received” rule, taxing a service if its benefit is enjoyed in their jurisdiction, or a “service performed” rule, taxing where the service physically takes place. This determination dictates which state’s tax rates apply.

Nexus is central to compliance, defining a business’s connection to a state that obligates it to collect and remit sales tax. Nexus can be established through physical presence (e.g., an office or employees) or economic activity (e.g., exceeding a sales revenue or transaction count threshold). Since the South Dakota v. Wayfair, Inc. decision, economic nexus has become a key factor for remote sellers of services.

Collected taxes are reported and remitted to the state, usually monthly, quarterly, or annually. Maintaining accurate records of all sales, including tax collected and any exemptions, is essential for compliance. For consumers, the sales tax on services is typically added as a separate line item on the invoice.