What Is Service Tax and How Does It Work?

A service tax is a consumption tax applied by state or local governments on specific services a business provides to its customers. Unlike federal income taxes, there is no single, uniform service tax across the United States. Its application is entirely dependent on the laws of the specific jurisdiction where the service is sold or delivered. As the U.S. economy has shifted from manufacturing to services, more states have begun to tax various services to generate revenue.

This means a business could be required to collect tax on a service in one state, while the exact same service is not taxable in another. The rules are highly localized, making it important for business owners to understand the specific requirements where they operate.

Identifying a Service Tax Obligation

A business’s requirement to collect service tax hinges on two factors: having a connection, or “nexus,” with a state and whether the specific service is considered taxable by that state. Nexus is the link that allows a state to impose its tax laws on a business. This connection can be established through a physical presence, such as having an office, employees, or inventory within the state.

A business can also establish nexus economically. Following the 2018 Supreme Court decision in South Dakota v. Wayfair, states can require businesses to collect sales tax even without a physical presence. This economic nexus is triggered when a business exceeds a state’s specific threshold. While many states use a $100,000 sales threshold, a significant number have eliminated a separate transaction count. The requirements vary widely, with some states setting the sales threshold as high as $500,000.

Even if nexus exists, the service itself must be designated as taxable by the state. States maintain lists of taxable services, which can often be found on their Department of Revenue websites. These can include a wide range of activities, from professional services like consulting and design to personal services like landscaping or pet grooming. For example, a graphic designer with a client in another state must determine if they have economic nexus and then check that state’s regulations to see if graphic design services are taxable before collecting tax.

Registering to Collect Service Tax

Before a business can legally collect service tax, it must register with the appropriate state tax agency to obtain a sales and use tax permit. The registration process is handled online through the state’s Department of Revenue or Taxation website.

To complete the application, a business owner should gather key documents and information beforehand. This includes:
The business’s legal name and any “Doing Business As” (DBA) name
Physical address
Federal Employer Identification Number (EIN)
Names, addresses, and Social Security numbers of the business owners, partners, or corporate officers
Business structure (e.g., sole proprietorship, LLC, corporation)
The date business commenced in that state
A North American Industry Classification System (NAICS) code that best describes their business activity

Some states may charge a small registration fee, while in others it is free.

The Process of Collection and Remittance

Correctly calculate and add the service tax to customer invoices, listing it as a separate line item for transparency and clear record-keeping.

It is a standard practice to segregate the tax funds collected from the business’s operating revenue. These funds are held in trust for the state and should not be used for business expenses. Failing to remit collected taxes can lead to significant penalties.

The state will assign a filing frequency—typically monthly, quarterly, or annually—based on the business’s estimated sales volume. When it is time to file, the business owner logs into the state’s online tax portal. The process involves entering the total gross sales and total taxable service revenue for the reporting period into the state’s electronic form. After verifying the amounts calculated by the system, the payment is submitted electronically. The state then provides a confirmation receipt, which should be saved as part of the business’s tax records.