What Products and Services are Subject to Sales Tax?

Sales Tax on Products and Services
Sales Tax on Products and Services. Talaj/Getty Images

What States Collect Sales Taxes? 

Sales taxes are state-driven. That is, sales taxes are imposed by states on transactions involving products and services sold by businesses who have a sales tax presence (called a nexus) in that state.

Most states collect sales taxes on products on services. Five states - Alaska, Delaware, Montana, New Hampshire, and Oregon - do not collect statewide sales taxes. Of these, Alaska and Montana allow localities to charge sales taxes.

(From the Tax Foundation). 

When Must I Charge Sales Taxes? 

One of the elements in determining whether you must charge sales taxes is whether your state is an origin-based or destination-based state. Most states have destination-based sales taxes, meaning that the sales tax is applicable when the product is picked up or used. States that have origin-based sales taxes, require merchants to charge sales tax at the point where the sales is completed (usually the merchant's location.  Learn more about whether your state is origin-based or destination-based. 

A Short History of Sales Taxes on Products and Services

Since the 1930s, U.S. states have been collecting sales taxes. In the beginning, sales taxes were only collected on products (tangible personal property). Two major factors have driven the inclusion of services in state sales taxes: 

  •  More and more businesses are service-oriented, and
  • States have begun to realize they could capitalize on what was previously lost revenue by taxing services. 

    States started putting sales taxes on services in 2007, but these were business-to-business sales taxes, and were usually repealed. In 2014, Washington, D.C., started a yoga tax. To make it easy, those of you doing business in Hawaii, New Mexico, and South Dakota, note that ALL services are subject to sales tax.


    Product or Service, and The "True Objects Test"

    As the distinction between products and services blurs, it's more and more difficult to determine which is which for sales tax purposes. And states are all over the place, each enacting laws that seem logical, but might be different from other states. 

    One test that some states are using is called the "True Objects Test." This test, as BizFilings notes, depends on the purpose of a service. For example, if your CPA prepares your tax return, is that a service or a product? What's the true or basic purpose of the service? In another example, if you pay for a company to install a computer system in your office, with thousands of dollars of computers, connectors, routers, etc., that sounds like a product. 

    Just to show you an example of how complex this product/service thing is, see this page from the state of Connecticut's website about sales taxes on computer equipment and tangible personal property. Connecticut charges sales tax on computer and data processing related personal services performed by employees, differentiating between employees and independent contractors.


    What Products and Services are Subject to Sales Tax?

    States vary greatly on the products and services they tax. For example, most states do not charge sales tax on food sales, but a few (Arkansas, Virginia, West Virginia, and Tennessee) do charge sales tax on food.

    Prescription drugs are exempt from sales taxes in almost every state, while most states charge sales tax on non-prescription drugs, and Illinois levies a 1% tax on non-prescription drugs. Most states charge sales tax on most products sold in the state, but sales taxes on services vary widely. Use this PDF file to see sales tax rates for each state.

    How Do I Find Out What's Taxable in My State? 

    You can try to guess, and you can search your state's department of revenue to see if you can find specifics. But laws change and websites might not be updated frequently. If you are registered to collect sales tax in your state, you should be able to receive updates. Or, better yet, make a phone call. The Federation of Tax Authorities (FTA) has a list of all state revenue departments and state taxing authorities. 


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