Services – The New Sales Tax Target
The new year comes with new attempts to expand the sales tax base. Services are on the dart board!
Cities, counties and states need funds to maintain and enhance their infrastructures and provide much needed services to their citizens. One area that has been a hotbed over the past years is the inclusion of services to sales tax bases. Traditionally, services have not been subject to sales tax since no tangible personal property is provided. However, our business model has changed from a production model to a service provider model. Today, more and more business is in the service sector and the possible sales tax revenues from those businesses are appealing to taxing authorities to increase revenues.
Some states have already included many services into their sales taxability matrices. Hawaii, New Mexico, West Virginia and South Dakota tax most, if not all, services. Still some states have tried to pass legislation to tax various services, only to receive backlash so harsh, they had to repeal or remove the attempts.
2017 will most likely see more attempts to expand the definition of services, as well as inclusion into taxability matrices.
Services generally fall into five main categories. How a state defines each category can determine how that state determines taxing or trying to tax that category. The five main service categories are Services to Tangible Personal Property, Services to Real Property, Business/Professional Services, Personal Services and Bundled Services. Each definition within these categories can affect if the services provided could become subject to sales tax or not.
Services to Tangible Personal Property:
These include services to tangible personal property (“TPP”), which include repairs, installation, maintenance, inspection and upkeep of TPP. Generally, most states will not tax these services if separately stated on the invoice. The TPP is taxable therefore the theory could be that the service provided is secondary to the purchase of the TPP.
Services to Real Property:
This category becomes trickier. These are the trade services such as electrical, plumbing, heating and air conditioning, painting, brickwork and roofing. Most of the time, these services will fall under a construction tax category and depending on the state and how the invoice is presented will determine the taxability or who is liable for the tax. Many states tax the materials and not the actual “service/labor”, others will tax the prime contractor or the subcontractor. This is a category that is subject to taxability expansion over the year(s). Arizona is currently trying to figure out its new construction tax classification by expanding the tax base through new definitions of prime and sub contractors.
Accounting, advertising, consulting, computer, security, medical, engineering, data processing and staffing services are some of the components in this category. Many states already tax many business/professional services: Connecticut, Washington DC, Hawaii, Iowa, New Mexico, New York, Ohio, South Dakota, Texas and West Virginia. Some states differentiate business service from professional service by requiring specific educational, licensing or certification designations. In today’s world, these can be done remotely creating a problem for sourcing the actual taxable service. The consumer rarely receives any type of substantial TPP of material value.
The services comprising this category generally are based on personal consumption to an individual and not a business. Services included here include photography, hair salons and barber shops, tanning, cleaning, landscaping, hunting and fishing guides, bookkeeping and dance lessons. Personal services seem to attract attempts at taxation, yet have managed to keep out of the taxable base in almost all states. States receive major push back when attempts are made to inclusion into the tax base; although, some states such as Iowa taxes many personal service businesses.
This category includes contracts or invoices that include taxable and nontaxable items together at a single price, sometimes called lump sum contracts. Most common are warranty and maintenance contracts. There is no distinction between retail and labor or service on the invoice. Generally, this becomes 100% taxable since it is all-inclusive, although some states will only charge partial tax to the bundled/lump sum to account for tax previously paid on materials by the contractor.
Some of the new and broader based services getting subject to sales taxes are interesting. With the popularity of fitness and wellness services comes inclusion into sales tax base. A hot debate has been around for Yoga instruction. Depending on where the instruction is held, the purpose of instruction, and the state may determine whether or not it is taxable. Fitness and health facilities generally are subject to sales tax in many states. That may explain why membership fees are high.
On-line travel services are another hot bed under scrutiny for inclusion into sales tax bases. Many states are going after on-line travel service companies to subject booking service fees to sales tax. Montana won its battle in charging sales tax on hotel and car rental booking fees to on-line travel companies. The real issue is the difference between the rate charged by the on-line travel service and the commercial rate by the hotel or car agency. The difference is the amount currently not subject to sales tax by most states, but that may be changing very soon.
The bottom line: Most think services are considered a labor endeavor and therefore not subject to sales tax. That is no longer true. With the amount of on-line and remote business transactions today, it is logical that tax authorities want to tax those services as their revenues from manufacturing and tangible products deteriorate.
Stay tuned and alert to see the changes. The cost of that next hair cut could be increased to include sales tax.
Laura Hoffman is an Indirect Tax Specialist living in Las Vegas, Nevada. Laura retired from a multi-state natural gas distribution company after specializing in sales & use taxes, franchise fees, business licensing, property taxes, excise and utility taxes for over 15 years.