Sales Tax Guide For Business Owners: Part 3

By Author: Mary Rose Somera
Total Articles: 94
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This year, my kids came home with a game called ‘Wall Ball.’ A mix of racquetball and handball, this game is simple enough… until you play it. Each child has a different set of understanding of the rules, how the rules are interpreted, and what is allowed. My second grader loves a move where he ducks under the ball called a rainbow, but the side of the wall is out-of-bounds. My sixth grader outlaws these rainbows but likes having the ‘sides’ as in-play.

Each state operates in a somewhat similar way with its sales tax rules. What may be taxable in one state, is moot in another. In article number two, we described nexus (Effectively we outline: “Do you have to adhere to another state’s sale tax laws?”) In article 3, we will cover how to think and act like we are part of another state.

Exception States

As a business expands across the nation, being aware of the rules is key. One easy knockout is identifying the states that do not impose a sales tax, regardless of what is sold. Oregon, Alaska, Montana, Delaware, and New Hampshire do not impose a sales tax at a STATE level.

For various ...
... reasons, states may generate revenue from other sources. In Oregon, a sales tax legislation has been proposed many times, only to be ritually rejected by the residents due to a cultural mistrust of government and its ability to manage finances.

Please note there are still caveats. Often, many small businesses do not reach Alaska, though there is a wrinkle in the ‘Great State’ worth noting. The actual state of Alaska does not collect sales tax as it broadly leverages revenue from its oil extraction business. HOWEVER, Alaska’s many municipalities and its 19 ‘buroughs’ apply sales tax, acting as their own stand-alone entities. We would advise that any business that anticipates expanding into “AK” should think ahead on how to administrate for these local regulations.

General Rule of Thumb

While there are rules that are highly unique for each state, there is a key, common thread to most states for sales tax application: “Tangible Products” If something is physically delivered to a customer, then the odds are that a sales tax should be applied if nexus is present. A simple way of thinking about this is if you have to put something in a box, it is likely taxable.

Exceptions to the “Rule of Thumb”

Many states exempt various tangible products. Certain goods have essential characteristics where states implement policies that ease the burden of purchase. For instance, food and medicine is ubiquitous for all people, rich or poor. However, the percentage of income that goes to these essential goods for lower income households is disproportionate when compared to higher income groups. Accordingly, most states have implemented legislation that exempts groceries and prescription medications.

The list does vary. Some states – like Pennsylvania – have expanded the policy to exclude clothing, textbooks, and fuel for heating. Whereas a few states (Alabama, Mississippi, and South Dakota) tax groceries at the full state tax rate.

It is worth commenting on shipping and handling charges on the tangible goods. Broadly, if the tangible product is taxable, any shipping fees passed along to the consumer should also be taxed. Some states do allow for a separate line item for shipping which may allow for a full or partial exemption of sales tax application.

Non-Tangible Product (Service)

Historically, services are exempt from sales tax. However, as the US economy has shifted from manufacturing-heavy to services-oriented structure over the last century. The sales tax code becomes reflective of the economy; thus, we see many states tax certain services.

One area that services generally are taxable is if the service pertains to tangible personal property. Improvements to property, such as an addition to a home or an auto repair, have many states requiring sales tax remittance. Likewise, many states apply taxes to services on property, such as land scaping or janitorial services.

A couple of areas that are worth highlighting on opposite ends of the spectrum are professional services and software-related services. With the growth of virtual capabilities, professional services from lawyers and accountants can be rendered from anywhere in the US. Broadly, these types of services are not taxable, but for a couple of isolated states (South Dakota and New Mexico).

Software is much more involved in analysis. Software that is canned and packaged with media (think Turbo Tax CD), this largely becomes viewed as a tangible product and taxable. However, with software being offered more and more ‘in-the-cloud’ (aka SaaS or cloud computing), there is wide interpretation of taxability. Each state has unique and changing views on this subject.

Facts & Circumstances – Full Disclosure

Lastly, we would note that sales tax interpretation is complex and ever-changing. Each business is unique with its nature, footprint, and manner by which the product or service is delivered. We recommend that research is done to understand each state’s nexus & tax application.

Further, we would recommend that professionals are enlisted who keep up on current trends and case law to understand how to apply out-of-state sales tax. The rules can be complex and subject to interpretation. As well, the rules DO change frequently. A practical example is that the state of Maryland just adopted sales tax for SaaS sales effective March of 2021.

In our next article, we will discuss some aspects of compliance and governance.

I am Aaron Jaeger, leader of Credo’s CFO practice, CredoCFO. My approach is to work as an extension of your executive team to help you meet distinct goals and create—as we say at Credo—Results That Matter.

Whether you are in hyper-growth mode, launching a new product, or considering your exit strategy, CredoCFO offers fully customized financial strategies to achieve your objective.

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