Service Providers: Determine Today If You Are Obligated to Collect and Remit Sales Tax
A commonly held misbelief is that service providers are exempt from collecting and remitting sales and use taxes. The truth: Only a few states exempt all services, and most states tax some services. That means it’s important to determine if the services you provide are taxable anywhere you have nexus.
The cost of not properly determining taxability can include penalties and interest, on top of the tax obligation. Plus, there are costs associated with figuring out back taxes and dedicating resources to redressing the error. On the other hand, misinterpreting tax law can result in overpaying taxes.
That’s why both “service providers” and “purchasers of service” need to have a reasonable understanding of how and what constitutes nexus in the service industry, in addition to the taxability rules associated with services in the states and localities where they do business.
The issue of which services are taxable is complicated and varies in different states and localities. To demonstrate this, here are some examples of how some states define taxable services for just one of the five main categories of services: Bundled Services — a separately identifiable service that is combined or packaged together with tangible personal property and sold at a single price. Examples include maintenance, service or warranty agreements that combine tangible personal property and services.
This category probably is the most straightforward of the five common service categories, and yet determining whether Bundled Services are taxable can be complicated.
In many states, mandatory maintenance agreements that involve the transfer of both tangible personal property and services are subject to tax. When the contract is optional, though, then often the service portion is not subject to tax — but only if separately stated on the invoice from the tangible personal property.
Some states, including California and Virginia, impose tax on a certain percentage of the transaction if a software agreement is optional, allocating 50 percent to taxable software updates, and 50 percent to the nontaxable service portion. If the value of the tangible personal property represents 51 percent or more, then the entire amount of the maintenance charge is subject to tax in the state of Nevada.
Simple, right? There’s more: A common exception to the rule involves maintenance agreements associated with custom or electronically transferred software. If a state does not impose tax on custom software or electronically transferred canned software, a charge for a maintenance contract associated with the software would likewise be exempt from tax in many states.
Determining whether a service is taxable or not for the other four main services categories is even more complicated, and yet, as complicated as this subject is, you as a service provider need to determine whether you are required to collect and remit sales and use taxes.
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