The Rise of Sales Tax Applicability on Services

In recent years, there has been a significant shift across states in tax policies concerning the expansion of sales tax to various services. Historically, sales tax functioned narrowly as a consumption tax on tangible personal property. This growth in application is driven by the transition from a manufacturing-reliant economy to one heavily dependent on e-commerce and technological services.

Currently, the 45 sales taxing jurisdictions in the U.S., along with the District of Columbia, undertake diverse approaches to taxing services, which is an area ripe for generating much-needed revenue. Some states impose sales tax on a limited number of services, while others take a more comprehensive approach. At the extreme end, states like Hawaii and New Mexico broadly tax services, often including many professional services, unless specifically exempted. On the other end, states such as California and Colorado tax few services. In California, Silicon Valley, the incubator of the service economy, heavily influences the state’s hesitancy to expand its sales tax base to services.

While no two states laws are the same, generally, when sales tax is imposed on a service, it is specifically enumerated in taxing regulations. The reason for this is that businesses would encounter challenges in taxing services due to varying rules on how states define and categorize specific services. New York, for example, has explicit provisions for taxing information services and detective services.

The domain progressing most rapidly with respect to the imposition of sales tax on services is cloud computing and software-as-a-service (SaaS). Antiquated tax laws are either being reinterpreted or extensively updated to keep up with the technological evolution. Many states are aiming their tax focus on these new services. Remotely accessed software, data processing, and even Artificial Intelligence (AI) services are under the taxing microscope. States like Texas and Utah have recently issued guidance delineating many of these services as taxable.

Businesses providing services across states, especially in cloud computing and the information processing space, must be vigilant in understanding the evolving state tax laws. While there is some inconsistent treatment amongst the states, sales tax on services is quickly advancing its reach. Businesses are therefore advised to stay informed, seek professional guidance, and adapt their strategies to ensure compliance with the diverse state tax regulations. Failure to do so may result in unintended financial consequences.

For further information and guidance on state-specific sales tax rules with respect to technology services, please contact Alan Goldenberg, Principal and Leader of the State and Local Tax and Tax Controversy groups, or your Anchin Relationship Partner.