Which Transactions Are Subject to Sales Tax?
The main target of sales tax laws traditionally was retail sales of tangible personal property. However, more than half the states now tax some types of services. And, nearly all states impose sales tax on leasing exemptions. Each state usually has numerous types of times that are exempt from tax. Most often prescription medication or food is nontaxable or subject to a lower tax rate.
Each state has its own definition for what it considers to be a "retail sale." States generally define the term as broadly as possible. As a general rule, the method of payment has no effect on whether a sale is subject to sales tax. Credit sales, installment sales, lay-away sales, conditional sales, and sales involving trade-ins or other exchanges of property are no less taxable than are sales for cash. All such sales of tangible personal property are presumed to be taxable unless specifically excluded from tax.
What is tangible personal property? Tangible personal property generally is defined as any movable item that has substance and value. In other words, the term refers to items that may be seen, weighed, measured, felt, or touched or that are in any other manner perceptible to the senses. By this definition, sales of real property and of intangibles (such as cash, stocks, and bonds) are not subject to sales tax because they are, respectively, immovable and imperceptible to the senses. However, states can elect to impose sales tax on intangible property as well.
Only sales to ultimate consumer are taxable. By definition, a retail sale is one that is made to the ultimate user or consumer. The fact that tax is due only on sales to the ultimate user or consumer gives rise to two of the principal exemptions from sales tax:
- Resale exemption. This exemption exempts wholesale purchases from sales tax. It applies to sales to persons who will resell the purchased property, either in the same or in an altered form.
- Manufacturing exemption. Most states do not charge sales tax on purchases of raw materials that become an ingredient or component part of property that is being manufactured, processed, assembled, or refined for future sale.
Is the sale of goods or services? In most cases, it's easy to spot a potentially taxable retail sale of tangible personal property. There's not much to dispute when items such as cars, equipment, tools, furnishings, food, or clothing are involved. However, the issue isn't always so clear cut. For example, is the sale of a computer software program a taxable sale of tangible personal property? How about commercial photographers' sales of their prints? Or, consultants providing their advice in written reports?
Although each of these examples involves the transfer of some tangible personal property, you could argue that what's really being purchased and sold (the true object of the transaction) is the expertise of the programmer, photographer, or consultant. Assuming that the underlying services are not themselves taxable, successfully making this true-object argument would insulate the transactions from sales tax.
All of the states recognize this "true object" argument. However, whether the purchaser's intent primarily was to acquire the property or the service is a subjective determination. Furthermore, the states are not always consistent in how they approach their analysis or in the results they reach. Accordingly, if you're regularly going to be faced with this type of problem, either for your purchases or your sales, you should consult your tax professional for guidance on how you should treat those transactions for the state or states where you do business.
Are Services Subject to Sales Tax?
Traditionally, sales taxes have been limited in application to retail sales of tangible personal property. However, given the fiscal problems in most states, it probably shouldn't come as any surprise that many states have started looking to the services industries for additional sources of sales tax revenues. In fact, half the states impose significant amounts of taxes on various services.
In taxing services, the states have pretty much followed a piecemeal approach. Currently, only Hawaii, New Mexico, South Dakota, and West Virginia impose their sales taxes on all services, subject to specified exceptions. The other states specify which services are taxable, with the services that are not so specified remaining exempt.
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