When should I collect sales tax on my services?

Personal services like hair-cutting, ear piercing, and tattooing are often taxed. So are other kinds of services performed for people or businesses.

So when should a company or freelancer collect sales tax for their services? Like so many other things in the realm of sales tax, whether a specific service is taxed depends, upon both the state you’re in and on the specific service in question.

And as our economy shifts from one based on the production, sale, and consumption of goods to one centered more on providing professional and personal services, it’s easy to foresee that more states will seek to extend their tax bases by adding sales tax on more kinds of service.

Here is an overview of current laws regarding sales tax on services.

We’ve covered this topic before, but in general, there are six broad categories of services that can be subject to sales tax, depending on the state:

• Services performed on tangible personal property — For example, improvements or repairs to something like a car or an appliance.
  
• Services performed on real property — Work done on buildings or land; janitorial services are often taxed under this category as well as landscape services.
  
• Personal services — Grooming services (for humans and sometimes for pets), tanning, and similar services fall into this category.
  
• Amusement and recreation — Many states add an admission tax for events (think concerts, professional sports, live theater) and for activities at places like amusement parks.
  

There are two more categories that often get confused, but are very much distinct under tax law:

• Business services — These are services that businesses sometimes contract out, like after-hours telephone answering or credit reporting, and they’re often taxed.
  
• Professional services — Legal work, medical care, accounting, and other services provided by specialists accredited in their fields often are not taxed.
  

This can be confusing. For example, if you outsource your payroll processing to a third party, is that a (typically taxable) business service or a (typically non-taxed) accounting service? We’ll provide some examples below, but once again, it depends on the state.

There are five states that do not levy a general sales tax on anything: New Hampshire, Oregon, Montana, Alaska and Delaware. In most cases, that means there is no sales tax on services in those states.

However, Alaska does allow cities and boroughs to levy a sales tax on sales, rents, or services  made, collected or performed within their boundaries. There are more than 100 local governments in Alaska that do so, and each is allowed to make specific tax exemptions on specific products sold or services provided within their jurisdiction.

In addition, there are a handful of statewide exemptions to local sales tax on services, a particularly interesting one is that “a borough may not levy or collect a sales tax” on “the provision of services relating to an orbital space facility, space propulsion system, or space vehicle, satellite, or station of any kind possessing space flight capacity, including the components of them.” 

In Alaska — unless you’re literally a rocket scientist — it’s best check with your local authorities or a trusted third party to determine whether the service you provide is subject to tax. 

For the most part, Hawaii, New Mexico, South Dakota, and West Virginia tax all services unless a specific exception applies.

In West Virginia, for example, most services are taxed, but day care services are exempt; so are personal services “such as barbering, hairstyling, manicuring and massaging.” The state also exempts from taxes the “construction, alteration, repair, improvement or decoration of real property, but only when the work performed results in a ‘capital improvement’ to the real property.”

South Dakota exempts a number of categories of services, including health services, educational services, social services, and agricultural services.

Hawaii is unusual in that it doesn’t have a sales tax, but rather a General Excise Tax (GET) levied on all businesses that provide products and services. As a result, services provided to a nonprofit organization are not tax exempt, as they are in many states; that’s because the tax is on the service provider, not the organization paying for the service.

In Hawaii, different types of services are taxed at different rates: Retail services, provided to a consumer, are taxed at 4% or 4.5%, depending on the county; while wholesale services, provided to a business, are taxed at 0.5%.

Out-of-state companies that provide services within Hawaii are subject to the state’s GET.

California, Colorado, Georgia, and Michigan tend to tax very few services.

For example, Georgia only taxes the sale of accommodations, in-state transportation of individuals (meaning limos or taxis), sales of admissions, and charges for participation in games and amusement activities. Also, if a service is needed to complete the sale of taxable personal property — like a delivery charge — any fee charged for the delivery also is taxable.

Colorado taxes telephone and certain utility services. Rooms and accommodations and food for immediate consumption also fall under the state’s services tax. No other services are taxed.

California only taxes services in two situations:

The first is when the service is tied to the sale of a taxable good. For example, if your machine shop buys a new 5-axis CNC machining center, and the delivery, installation, and calibration of the machine is included in the purchase price, then you’d pay sales tax on those services.

Second, fabrication or manufacturing services also are taxed. Sometimes, the California Society of CPAs notes, the line between the two is blurred. For example, the alteration of a new garment is taxable, but the alteration of used clothing is exempt.

So if you buy a new suit and take it to a tailor, then the tailor must collect sales tax on the labor involved in the alteration. But if you wear the suit and then decide the jacket needs to be taken in or the sleeves let out, then the tailor wouldn’t charge sales tax on their labor, because that’s considered a repair or restoration service, which makes it exempt, according to the CPA society.

Government labor economists lump business and professional services into one category of employment. However, for tax purposes, they’re distinct.

In a broad sense, professional services are those performed by accredited specialists: doctors, lawyers, accountants. Business services are more general in nature: janitorial services, for example, or telephone answering services.

Sometimes the distinctions can be murky. Connecticut, for example, taxes business analysis, management consulting, and public relations services.

Elsewhere, the District of Columbia taxes a range of third-party data processing services, including payroll and business accounting, the input of inventory control data, the computation and preparation of checks, and the preparation of W-2 forms. And Texas taxes 80% of the cost of check preparation, accounts payable or receivable preparation, web hosting, and other data services. (The other 20% is exempt.)

Kentucky’s Legislature this year extended sales tax to a wide range of business and personal services, which will take effect January 1, 2023.

On the business services front, sales taxes now apply to companies providing everything from web design, development, and hosting services, to marketing, telemarketing, parking, public opinion surveys, executive recruiting, and certain types of software.

Personal services now subject to sales tax range from personal training; massages and cosmetic surgery (unless they’re deemed medically necessary); renting spaces for weddings, parties, or banquets; and body modifications, including piercings and tattoos.

It was all part of a contentious tax overhaul that includes a gradual reduction in Kentucky’s individual state income tax. 

Kentucky is far from the only state considering adding sales tax to services. As we noted in this post back in January, legislators in several states introduced such measures, including:

• Indiana Senate Bill 372, which would have extended the state sales tax to most services while reducing individual income taxes and phasing out the corporate sale tax. It never got out of committee.
  
• Nebraska Legislature Bill 422, which would have extended the sales tax to all services except “business inputs” while also reducing the state sales tax. It was introduced in the 2021 session, carried over into 2022, but then action on the bill was indefinitely postponed.
  

If you want a closer look at states that impose tax obligations on businesses that provide services, check out our state-by-state guide to economic nexus laws.