Navigating Sales Tax as a Service Business

Companies that sell physical goods are accustomed to charging sales tax in most states. But what about businesses that provide services, like healthcare, real estate, or entertainment? Depending on the location and type of service, these transactions may also be subject to sales tax.

Sales tax was originally collected on tangible personal property (TPP), with rates varying by state and county. In general, all physical items sold except food and medical devices are subject to sales tax. But as the United States has evolved from a purely goods-based economy to one that offers services, sales tax has also changed. Many states now impose sales tax on services to boost state tax revenue. 

You might think sales tax doesn’t apply to you as a service provider and not a business that sells physical items. However, businesses need to know the ins and outs of sales tax on services so they can properly collect and remit sales tax and avoid costly penalties. 

In this article, we’ll dive into taxability on services and how to determine if your company should collect sales tax. 

Basics of Sales Tax on Services  

In its most basic form, taxable services are just that: services that need to include sales tax. Services are generally anything that isn’t a tangible good.

Sales tax on services differs from sales tax on goods because there tends to be more ambiguity and variation on taxable services. Most states that collect sales tax follow the same basic guidelines for taxing physical goods. But states agree less often on taxing services. A car or book purchased in most states will require sales tax (although the rate will differ). However, depending on the state, a haircut or concert ticket may or may not require sales tax. And for states that collect tax on services, the rates will also differ.

There tend to be many misconceptions because sales tax on services is a changing area. Here are three common service-based sales tax myths:

1. Services are never taxed. Services are often taxed, but not all services are taxed and the rate and category of sales tax varies based on each state. 
2. A service-based business needs to collect sales tax in all states. Just like sales tax on physical goods, companies have to establish nexus to determine if they need to collect sales tax. Sales tax is required in all states that tax services and where a business has nexus. 
3. States are more lenient on sales tax for service providers. Sales tax is sales tax no matter what was purchased to collect it. Sales tax on services may require more questions and definitions from states, but it is still a requirement in many states that can come with steep punishments if not collected correctly. 

6 Categories of Taxable Services 

What services are typically taxed? There are a wide variety of services, but most taxable services fall into six areas:

1. Business services. These services include financial and consulting services, advertising, and computer services. These services are geared toward helping businesses thrive, not necessarily the people who run them.
2. Professional services. These services are often performed by accountants, engineers, attorneys, or medical professionals. They are typically to acquire knowledge or expertise and are the least-taxed service area. 
3. Personal services. This category includes services people use for grooming and self-development, including childcare, pet care, education, and beauty treatments. 
4. Tangible Personal Property (TPP) services. These services are typically performed to improve or repair personal property, such as equipment installation, automotive repair, or tailoring.
5. Real property services. These services are performed on buildings and land, such as cleaning, painting, construction, pest control, and landscaping. 
6. Amusement and recreation. This includes recreational events, sporting events, live theater, and amusement parks. 

Professional and personal services are the categories most commonly exempt from sales tax, unless a state specifically includes specific services. For example, most services in Utah, including haircuts and legal and accounting services, aren’t taxed. However, sporting events and other recreation services are taxed in the state.

The reason for these exceptions is that taxability varies by state. Just like states can choose whether to collect sales tax on physical goods and the rate to charge, they can also decide what services are taxable. There isn’t a federal sales tax, so sales tax varies by state. Those variations are especially noticeable on services.

In total, 45 states collect sales tax. Five states (Alaska, Delaware, Montana, New Hampshire, and Oregon) don’t collect any kind of sales tax. Four states (Hawaii, New Mexico, South Dakota, and West Virginia) tax services by default and then specify exceptions. In those states, assume that the service is taxed unless the state has stated otherwise.

The remaining 41 states are the opposite: services aren’t taxed by default, but the states can make exceptions for services that should collect sales tax. In those states, assume that the service isn’t taxed unless the state has stated otherwise. 

Do You Need To Pay Sales Tax?

With all of that variation, how can companies know if they need to collect sales tax? It starts by determining nexus, either through a physical presence (locations, employees, contractors) in a state or an economic presence (thresholds for revenue and transactions in a state). If your business meets either of those criteria for its services in a state, it has an established nexus and needs to register and pay sales tax.

However, with the many variations of sales tax on services, simply understanding nexus isn’t enough. Businesses must also understand whether their service is taxable. 

To determine if you need to collect sales tax, consider the following:

• Do you have nexus in that state? For services, nexus is often determined by an economic threshold. If you’ve made sales, have customers in that state, or have physical locations, you must pay sales tax.
• Is your service taxable in that state? Each state has its own definitions of what services are taxable. Check with your local tax agency for details and definitions.
• Are you following current legislation? Sales tax legislation changes regularly, especially around services. Just because you did or didn’t have to pay sales tax before doesn’t mean it is still true. The rate can also change. It’s important to stay up to date on sales tax legislation to properly collect and remit sales tax. 

Calculating and Collecting Sales Tax on Services

Before you collect sales tax, ensure you are properly registered with the state tax authorities. Whether they sell services or products, businesses must register for a sales tax permit in every state in which they have nexus. 

One of the biggest challenges for calculating sales tax for services is understanding the correct rate and which services apply. Service-based businesses can benefit from working with a sales tax professional to walk them through the steps and ensure they are calculating, collecting, and remitting sales tax properly. 

Sales Tax Compliance for Service Companies 

If a company establishes nexus in a state, it needs to file and maintain a sales tax license, allowing it to do business and collect sales tax. Most states require businesses to file sales tax returns monthly. In some states, the frequency is determined by the amount of sales tax collected — companies that don’t collect as much sales tax may only need to file quarterly or annually. Companies that don’t pay sales tax properly can be punished with fines and penalties, plus added interest on the late payment amount. 

The key to successfully filing sales tax returns is to keep accurate records of every transaction and collection. Digital tools and point of sale systems can help companies keep accurate records and properly calculate and collect sales tax.

3 Unique Services Considerations 

Service businesses often have unique circumstances for collecting and remitting sales tax. 

One example is when businesses bundle services and goods, such as a salon selling a haircut and physical hair tools or a handyman company selling painting services and supplies. In these bundled situations, the entire purchase price may be taxable unless certain conditions exist. Again, rules vary by state, but the general rule of thumb is that if the exempt services are less than half of the total purchase price, the entire bundle is taxable. Tax rates for bundled transactions vary by state.

Some service providers may be out of state, such as a landscaping company that is based in one state but performs services in another state. In these instances, it’s a matter of if nexus is met. Physical nexus likely isn’t applicable without a business location in the state, but the services may push the business past the economic threshold and require the business to file a sales tax registration in the state and pay sales tax. However, if the service is below the threshold, the business likely doesn't have to pay sales tax. 

One growing and evolving sales tax area is digital services and software as a service or SaaS. In most states, SaaS services aren’t taxable if other services aren’t taxable. That means that if a state doesn't require sales tax on things like real estate services and spa treatments, SaaS will likely not require sales tax. However, SaaS will likely require sales tax in states that tax more services. Again, businesses must understand each state’s requirements or work with a sales tax professional to ensure they follow the correct processes.

Need help with your service-based taxes? The dedicated team at Peisner Johnson specializes in providing comprehensive sales tax services. Our in-depth knowledge and strategic approach help you navigate the intricate landscape of sales tax regulations, ensuring compliance and peace of mind. Contact us to learn how we can support your business.