Taxation of services

Understanding the taxability of your company’s products or services is one of the key steps to complying with sales and use tax laws. In many situations, your “products” can be easy to classify: They’re usually tangible (in fact, a key sales tax definition is “tangible personal property”) and you charge sales tax on property unless it falls into an exemption category. 

“Services” are not tangible and can be an entirely different animal in terms of taxability. Services continue to pop up among states’ lawmakers as a potential new source of sales tax revenue.  

Complex and ongoing question 

One paper cited by the Tax Foundation maintains that the reason most states don’t tax services is a simple “historical accident” and that consumed services should be taxed just as completely as commodities and goods (though not B2B services). 

“Consumption of many personal services, such as cosmetic and beauty services, fitness, pet grooming, veterinary services and landscaping, among others, skews towards the higher end of the income scale. Including personal services would increase tax neutrality, while providing for increased revenue, allowing the state to reduce the overall tax rate,” the Foundation paper reads. 

Recent developments 

Many states have recently mentioned taxing services; it cropped up notably in West Virginia’s 2021 State of the State address. States also continue to debate taxing digital advertising services, especially in the wake of  Maryland enacting the nation’s first digital advertising tax. (The U.S. has no uniform sales tax on digital items, though periodically there are attempts to firm up guidelines – just as there are periodically attempts by states to tax services.) 

Two states took action last year regarding easing sales tax on specific services: Ohio repealed the state sales tax on employment services; and Texas Gov. Greg Abbott signed legislation that excludes some payment processing services from tax.  

Elsewhere among state legislation still in progress, the intent is to intensify taxation of services: 

• Indiana has introduced a bill that extends (among other tax proposals unrelated to services) the state sales tax to all services beginning next Jan. 1, excluding government services. “Service” is defined by any activity engaged in for another person, if the person purchases the service as the end user of the service for consideration (though not a service rendered by an employee). The bill excludes B2B transactions. Right now, services are generally non-taxable in Indiana. 

• Nebraska will reconsider a carried-over 2021 bill to extend sales tax to services and, effective this October, lower the state sales tax rate back to 5% with later adjustments possible. The bill presumes services to be taxable unless with a specific exemption and that “service” is distinguished from the sale or lease of tangible personal property.” As in Indiana, employee services wouldn’t be subject to the tax. 

• In April 2021, the Connecticut General Assembly introduced a bill to impose a new tax on digital advertising services, the rate varying from 2.5% to 10% of the annual gross revenues derived from digital advertising services in Connecticut, depending on the taxpayer’s global annual gross revenues. 

Expect more states and tax jurisdictions to explore taxing services as America moves even further toward a service-based economy. 

(To learn more, see our white paper/ebook Intricacies of Sales Tax Taxability Across Various Industries.) 

TaxConnex is an outsourced sales tax department for businesses looking to solve the sales tax puzzle. By relying on years of expertise and having dedicated practitioners to provide support and answer questions, TaxConnex can help your business stay on top of your taxability and ensure your are maintaining compliance in the states where you have an obligation. Get in touch to learn how we can help you!