Scott Peterson, Director of Government Relations at Avalara, helps us understand that whole sales tax collection piece when selling your services online. Your decision and strategy depend on several variables, so we would recommend listening to the show to make sure you are tax-compliant.
We chatted about:
- The differences between sales taxes on products and sales taxes on services
- How to figure out as a business owner whether your services are subject to sales tax
- Whether a single state sales tax rate covers all the services provided in a specific state
- What happens if a service is associated with equipment or a product that needs to be taxed
- The initial steps a business should take to get their sales tax on services in full compliance
How is sales tax on services different from sales tax on products?
Now, from my own experience, I know that I’ve dealt with clients in the past, I’ve done coaching and consulting, and I know when it comes to sales tax and services, it’s one of those areas where people who sell online may get the most confused. I’m guessing a lot of people who also offer services think that their products, or that people that have products, just need to be taxed. Let’s dive into these questions and clarify that for everyone. I’m going to start with this very first one, Scott. What makes sales tax on services different than sales tax on products?
Scott Peterson: The first thing is that taxing products is very common, and it’s almost uniform. Every state that has a sales tax, is it 45 states and the District of Columbia, plus Guam and Puerto Rico and Canada and a few other places, they all tax tangible personal property, and they’re usually pretty aligned in how they define what they tax. They’re pretty much aligned in what they don’t tax. Services is an entirely different thing. almost every state taxes some services, but there are very few states that tax all services. You have this tremendous variety in what’s taxed and how it’s taxed, including definitions.
States, they are just now becoming comfortable with modern computer software services. Software as a service, which is what Avalara does, we’re a software as a service. We don’t sell people software, we sell people a subscription to software. They don’t get our software. They don’t even get a license to our software. They get the opportunity to pay us to use our software to accomplish something. That’s a service. For the longest time, states couldn’t understand how software could go from being something that you got on a CD and you put into the slot in your computer and you download it on your computer. It was a resident on your computer, to something that sits on a server in Seattle that’s being accessed millions of times every second by people all over the world. That concept took states awhile to get their hands around. Very few states had an actual law, so they had to rely on the laws they had in effect at the time and none of them applied to this kind of stuff. It took states a long time to figure out what to do.
It’s complicated: states tax sellers differently
There’s some things that states are really good at taxing, some services, amusement service. States are very competent, and very consistent, in how they tax concert tickets. Concerts have been around for a long time. People have been selling tickets to concerts for a long time. Up until Ticketmaster was invented, and Ticketmaster created this thing called a service charge, it was a relatively simple thing. You’d be surprised, I was surprised how long it took states to adapt to the simple change of going to the ticket office at your local concert hall and buying a ticket, to buying that same identical ticket on Ticketmaster, and Ticketmaster keeping a portion of that ticket price. Took states a long time to figure out, “Okay, so who’s the seller? I think we know who the buyer is, but who’s the seller and are they selling something that’s taxable? Is the whole thing, that Ticketmaster charge is taxable because part of that’s a service fee?
The way, frankly I think the difference between tangible personal property, between products and service, is the ever increasing number and variety of services. The never changing sales tax law. The almost universal desire by a state to think that everything that’s created tomorrow is going to fit into their laws they passed 75 years ago. If you’re out there, somebody selling services to somebody, you’ve got a pretty good chance that the state has no idea what your service really is, and they’re going to be relying on laws that are radically older than your service. It’s something simple as, I talked about Ticketmaster, photographers.
State of Iowa treats a photographer as a service provider. They are in the business of taking pictures. State of South Dakota, right next door, sees photographers as people who are selling products, they’re selling pictures. States that touch, they share a border, they both tax them, well that’s not true. South Dakota taxes them much more broadly. Iowa taxes just part of the service. If you’re a photographer who’s doing business in both South Dakota and Iowa, your sales tax is instantly more complicated than you ever imagined it could be, because in one state you’re selling tangible personal property, in the other state you’re selling a service. One state’s taxing everything and the other state’s taxing bits and pieces of it.
Another thing that makes it complicated is a thing called sourcing. Sourcing is a legal term that describes that point of sale, effectively, where you have an obligation to collect a sales tax. There’s two types of it. There’s a thing called destination sourcing. Destination sourcing is tax based upon where your customer takes receipt of your product or your service. The alternative is origin sourcing. Origin sourcing, for products it’s taxed where the sale occurred, which is generally your store. For services it’s taxed where the service is performed.
When state tax systems conflict with each other
Bob Dunn: That actually maybe answers one of my questions, and maybe you can clarify if I’m on the right track here. If a single state’s sales tax, if you’re wondering if it actually covers all your services provided in that particular state, what you’re just talking about can really affect that, right?
Scott Peterson: Absolutely. Not only from the perspective of a person who’s selling a service, but from the perspective of a person buying the service. Let’s say your laptop needs to be repaired and you send that off to wherever the manufacturer tells you to send that. That happens to be a state that taxes the repair of laptops, but they do it based on origin sourcing, so it’s going to be taxed based on where the repair was made. They’re going to send it back to you. You’re going to send it, they’re going to repair it, they’re going to send it back to you, and they’re going to charge you sales tax.
You live in a state that doesn’t tax the repair of laptops, or worse, you live in a state that taxes the repair of laptops based upon where you take receipt of that. You live in a state that uses destination sourcing to tax the repair of laptops, and you have it repaired in a state that uses origin sourcing and they tax the repair of laptops, both states are going to say that’s a taxable transaction. You’re going to have to argue with them about which state gets the first right to tax you.
How does a business owner know whether their service is taxable?
Bob Dunn: Yeah, that was another question I have. You might have touched on this a little bit. Maybe it’s common sense now, that since there’s so many variations that people can come up again, how does a business owner know whether their services are taxable?
Scott Peterson: The most common way is that the Department of Revenue calls them and says, “Hey, I see you’ve been selling services in my state and you don’t have a sales tax license, let’s talk.” Of course that’s the worst way to find this out. The best way, this is a very complicated area, as we’ve been discussing. You can do the research on your own. Every state has a website. Some of them are better than others. On those websites you’ll find out, there will be something somewhere on that website that says what services that state taxes and what you have to do. You need to do this both from a buyer’s perspective and a seller’s perspective.
If you’re running a business in a state, you need to know what services your state taxes, and when you’re out there buying services to operate your business, software or marketing or anything that you might buy to operate your business, you need to know whether that other state has taxes. Because if you buy it from a state that doesn’t tax it, but you use it in your state and your state does tax it, your state’s going to expect you to remit the tax on your own. Likewise, if you’re selling a service to someone, wherever you sell that, that state’s going to presume that you’re taxable until you prove otherwise.
You can do the research on your own. You can hire someone to do it for you, and there’s a lot of accountants and attorneys that make a living doing this. You can use somebody like Avalara. This is part of our expertise. Actually that comes with Avalara. One of the things, and frankly this is one of the most critical areas that we help businesses with, is we’ve already done all that research. We know which services are taxable in every state, and why and how and what the rate is, just like we’ve done with all kinds of products. A business that uses us, they never have to wonder whether services are taxable, what they sell is taxable or what they buy is taxable, because we always know. Otherwise, it’s really complicated.
There’s a couple organizations that sell legal research. You can maybe make your own research quicker if you subscribe to one of them, but there are very few good ways of doing it, short of paying someone. If you use Avalara, like I said, it comes with the service.
Bob Dunn: Doesn’t sound like a do-it-yourself project to me. That’s for sure.
Scott Peterson: No, trust me. We probably have 35 people that are doing this all the time, including me. I’m often helping our teams do research, legal research on areas that are new or oddly complicated. I’ve known lots of people inside the state governments around the country, so I have the ability to quickly get a question answered, but often it takes literally having to be on the phone with the Department of Revenue, explaining what you do, how you do it and who your customers are, before you can get an answer.
What to do when a service is necessary with equipment or a product that needs to be taxed
Bob Dunn: I thought I was, my mind was boggled when I talked with Jake in the first podcast, and now it just even goes deeper. What happens if a service is associated with equipment, or a product, that needs to be taxed?
Scott Peterson: The good news is, this is one of the areas where it’s more likely to be taxed than not. One of the areas where the states are relatively consistent in taxing services are services associated with the sale of a product. Like I said, they’re relatively consistent, they’re not completely consistent by a long way. Actually North Carolina, just last year, expanded their sales tax to repair services and installation services. Installation is a relatively commonly taxed service.
You buy a television and it comes with installation, $500 for a TV and $75 to do the installation. Most states with tax the $75 along with the $500. Some states don’t, and it can be very complicated. Some states do it only if it’s the person selling the TV. You buy a TV and you hire the retailer to install it, it’s subject to sales tax. If you hire an independent person who’s not selling the TV, it’s not subject to sales tax. You the consumer are sitting there thinking, “Geez, do I really want to have somebody that doesn’t sell the TV install it? Aren’t they the experts?” Generally speaking, services that are associated, associated is not the right word, a necessary to complete a sale, those are generally taxable around the country.
It’s like shipping and handling. It’s pretty hard to disassociate shipping and handling from the sale of a product, and so you see most states tax shipping and handling, because in their mind it’s part of a sale of a product. It effectively is, hand in glove, the sale of the product. Get much outside that though and it’s really complicated. In the construction business, the installation of a piece of equipment at a construction site is often exempt, even though the piece of equipment’s taxable. It’s just really complicated. It’s immensely variable.
For somebody that’s in the business of making money helping people understand sales tax, variability is a good thing. It’s not so good if you’re somebody out there trying to do this on your own.
Steps to getting your sales tax ducks in order
Bob Dunn: My last question might be a little in-depth as far as asking you to give me a few steps. What would you consider the initial steps a business should take to get their sales tax on services in line? Get all their ducks in order.
1. Figure out where you’re at
Scott Peterson: First, where do they have a legal requirement to collect? A thing called nexus, nexus is a legal word for where you have physical presence. That is the first thing that someone needs to understand about themselves before they do anything else. The way the law is written today, California can’t require someone to collect sales tax on anything if that person doesn’t have a physical presence of some sort in California. States are getting crazy in the way they’re defining physical presence and there’s half a dozen major national court cases going on right now on that very issue. Before you have any idea, you have to know where you’re at.
You figure out where you’re at. If you have a store in Vermont and you’re operating only out of Vermont, you never go to another state and everything is done online and through common carriers, well then you need to know what Vermont needs to know.
2. Figure out where you’re selling
Once you’ve figured out where you’re at, then you figure out what you’re selling. That can be a little bit complicated if you’re selling something that can be misunderstood by Department of Revenue. Software as a service, sometimes software as a service isn’t software as a service. Sometimes it’s software, and it’s not a service. Sometimes it’s a service that’s used as software. The difference between software as a service and service that uses software, is a yes or no when it comes to tax ability.
West Virginia does not tax software as a service, but if you’re selling a taxable service in West Virginia, it doesn’t make any difference if you’re doing that online, it’s still a taxable service. Even though you’re selling, you think you’re selling software as a service in West Virginia. West Virginia’s going to say, “No, you’re selling a service and you just happen to use software to perform that service.” That’s a yes or no. In one situation you’re completely exempt and you don’t have to worry about anything. In the other you’re completely taxable and you hope you find this out before you’ve made your first sale.
3. Go to the states to figure out how they tax services (hint: don’t use zip codes)
First of all, find out where you’re located. Once you find out where you’re located, make sure that you, because that determines what sales taxes you have to collect, what state you have to collect sales tax in, excuse me, that’s a better way of saying it. Once you know what states you have to collect sales tax in, then you go to that state and you determine, somehow, some way, what the state does with your service. Do they tax it? Do they exempt it? Is there some variable rate? Do you get a lower rate? Once you’ve figured out what states you’re doing business in, and whether or not those states tax or exempt what you sell. If they tax it, then you have to figure out what the rate is.
That can be a function, in many states that have local governments that have a sales tax, so you have to be able to know at an address level, what the sales tax rate is. You can’t rely on zip codes. A five digit zip code is going to be wrong way too many times for anyone to withstand an audit based on five digit zip codes. Even nine zip codes. Nine digit zip codes can be wrong oddly often. It’s amazing how many zip codes, if you live on a border of a state, you would be surprised at how often your post office is in the next state. Even a little bit it drives us nuts, but it drives retailers really crazy, because they’ll sell something to somebody and that address will be, the nine digit zip code will be for Kentucky, but the address is for Tennessee. It just drives computers nuts. You have to do this at an address level. You have to ignore what the post office says, go down to the address. Because the sales tax rate can be radically different.
You know where you’re doing business. You know what you sell. You know whether or not those states tax are exempt, what you sell. You’ve figured out what the tax rate is at each of the addresses. Where you have physical presence, you have to have a license. Figure out where you’re physically located at. Is the thing that you’re selling taxable? Get yourself a sales tax license everywhere where it’s taxable. Figure out what the rate is at the address level. Then try to understand how the return and remittance process differs between states. Most states are electronically doing all the returns and the payments, so you’ll go to the state. Once you get a sales tax license, they’ll give you the information to be able to log in and create an account on their website, which you use to file your sales tax return and to make your payments.
Every state is unique
Then you have to figure out how in the world the sales tax return in West Virginia can be so different than the sales tax return in Pennsylvania. You have to have staff, you have to have people that know how to do that. It’s oddly complicated. For something the states think is relatively simple, is not simple at all. Then you have to remember that every state thinks they’re unique, and almost in every case they are. They think that it’s your obligation as a retailer to know everything.
Bob Dunn: Yeah. Well I think just what you’ve gone over, and the reason we wanted to go into this was to help clarify all those gray areas for people that are doing services, and should they be putting sales tax on there? Obviously yes, they can go through a lot to try to figure it out themselves, but as I’ve often recommended to people when I’m talking to them is, you’re likely better to get somebody to help you.
Scott Peterson: I haven’t figured out a way, honestly, and I’ve talked to a lot of retailers in my life. I’ve never found one that could make money doing sales tax. All it ever did was get in the way.
Bob Dunn: Yeah. I know that with a lot, especially online with people I’ve dealt with. It’s sales tax and shipping are the two things that really bog them down. It takes away from everything else they need to be doing. It’s good there are services like Avalara out there. That’s all I can say.
Scott Peterson: Some day Congress will pass a law or the Supreme Court will change their mind on opinion, and everybody’s going to have to collect sales tax everywhere. At that point in time, there’s no rational reason anyone would want to have this burden all over the United States. We’re different here in the US, because we have these individual states that are sovereign and they have the right to make decisions. If you’re making sales in Europe, this isn’t that complicated over there because the first question that I said people need to understand is where they’re doing business. That’s irrelevant in Europe. If you’re making sales in Europe, you’re making sales. You don’t get to make sales over there and not collect their value-added tax.
Bob Dunn: Right. At least they know where they’re at, right?
Scott Peterson: Yes. They can skip the first question and they can go on right to the second, what’s the rate?
Bob Dunn: Well I think that pretty much does it as far as this. You’ve really explained it in a way that, I think people will know, this is not easy. This isn’t something that is always, like I said, a do it yourself project. The more you sell, the more outward you go and where you sell, especially online, throws in all those variables. I think we’ll wind it up because you’ve given us the steps and you’ve given us some good insights. I just really want to thank you for taking the time to share this with us, because I know this gives my listeners a lot to chew on.
Scott Peterson: Well thank you. I appreciate your interest in helping retailers. I’ve been helping retailers, in a variety of different roles, for a long time and it’s nice to talk to somebody who’s also doing the same thing.