Texas is one of the 47 states that does not charge sales tax on professional services. Therefor many consultants providing web related services such as marketing, design, programming and digital strategy believe their services are not subject to sales tax. However, Texas has some fairly unique data processing and information services statutes that the state Comptroller is interpreting in the broadest possible manor to effectively make any professional service related to the web subject to sales tax.
It is true, if you do traditional marketing such as advertising and PR, your services would not be subject to sales tax. Custom programming for a purely desktop or mobile platform is not a taxable service. But as soon as you do any part of those of those same services using the web in any way, you now are now likely subject to sales tax.
This means that if you do online marketing like social media or search engine optimization, you should be charging sales tax. If you design or develop websites you should be charging sales tax. If you are programming web applications or developing applications that integrate with web services or web related technologies such as HTML5, CSS or JavaScript, you should be charging sales tax.
Background
Services in general in the state of Texas are not subject to sales tax. There are 17 classifications of services that the Texas has specified as taxable.
In 1988, Texas enacted rule 3.330 which made data processing a taxable service. This rule makes taxable the processing of information for the purpose of compiling and producing records of transactions, maintaining information, and entering and retrieving information. It specifically includes word processing, payroll and business accounting, and computerized data and information storage or manipulation.
You are exempt from the data processing rule if you provide certain professional services, such as accounting, legal and engineering (software engineering is apparently not considered a professional service by the state of Texas), and are mearly using the computer as a tool to provide your expertise.
This law was created several years before the world wide web. Since the creation of the rudimentary HTML documents that comprised early websites were similar to word processing, the creation of web pages fell under this rule.
By the mid to late ninties, the web had already moved well beyond basic informational HMTL web documents. There were concerns that the Comptroler was using the data processing rule to tax advertising and other professional services that were not traditionally meant to taxed.
Other states had enacted laws that isolated online marketing and web development services from taxation. Texas was concerned that Texas companies would have a competitive disadvantage if these services continued to be taxed.
In late 1997, a subcommittee was convened to analyze the data processing rule and to try to separate data processing from professional services related to the web. Their conclusion was that it was impossible to do. The subcommittee found that the data processing and information services rules were intrinsically flawed.
…the Group found that the existing statutory definitions for both data processing services and information services were so subject to such a wide range of interpretations that they were wholly inadequate in evaluating Internet activities. Therefore, the Group concluded that under the existing statutory language, there is no way to distinguish between services that were intended to be taxable (e.g. storage of data by word processing) and those intended to be nontaxable (e.g. storage of data by storing an advertisement on the Internet). Considering the negative economic development and retention-of-jobs ramifications of applying the tax across the board, the Group recommends that the sales and use tax on data processing services and information services be repealed.
Citing numerous concerns over the negative impact this would have on the competitiveness of Texas business, quality of websites, retentions of web professionals and the Texas economy in general they recommend the law be repealed.
The state decided against the recommendation and kept the rule. Acknowledging the issues raised, they did offer a concession of only taxing 80% of the total charges.
In general, web related service professionals only have to charge sales tax on 80% of their total charges. One notable exception is graphic design which is taxed at 100% of total charges.
Tax Exempt Services
There are some web related professional services that are exempt from sales tax. In general, services that are purely consulting such as training, analysis and providing advice are exempt from taxes. In order for these services to be exempt, they must be offered as a stand alone service and not connected to the actually delivery of a website, web based application or online marketing service.
Services Bundling
In Texas, businesses are generally able to separate services and only charge taxes on those items that are subject to tax. If you do not adequately bifurcate non-taxable services in your invoicing and processes they will be considered bundled with the taxable ones.
If non-taxable services are bundled with taxable items and the percentage of the non-taxable items are greater than 5%, the total charge for all services becomes subject to sales tax.
While vendors of tangable goods and traditional services can effectivly unbundle their sales, the complex interconnected nature of web services complicates bundling taxation issues considerably. In otherwords, it is exceptional difficult for providers of web services to determine which services are non-taxable and can be unbundled.
Use Tax
Most people believe that they only need to pay sales tax when a vendor charges sales tax during a purchase. In the State of Texas you are required to pay sales tax on any taxable item even if the vendor does not charge you tax. This is called a use tax. Use taxes apply to both personal and business purchases.
The most common example is that if you buy something from Amazon, you are not typically charged sales tax. However if that item is taxable in Texas, which most tangible goods are, you are supposed to calculate the sales tax for your jurisdiction and submit it to the state.
This is true for taxable services also. For example if you hire someone to construct a wall in your office, a taxable service, and they don’t charge you sales tax you are supposed to calculate the tax and submit it yourself to the state.
Businesses that operate in multiple states don’t have to pay use tax on the full amount of the purchase to the State of Texas. They are only required to pay the percentage of the benefit they derive in the state.
Exempt clients
As a web related professional service provider, you do not have to charge sales tax to all clients. There are three categories of clients that you do not have to charge sales tax:
- Tax-exempt organizations
- Out of state customers or those with multi-state exemptions
- Service provided for resale
Several types of organizations such as government and qualified non-profits are exempt from sales tax and as such you do not need to charge them taxes. Any customer that operates in multiple states will likely claim multi state exception. In both these cases, if the client provides you a valid exemption certificate, you do not need to charge them sales tax. Any client who derives no value from your services in the State of Texas is also exempt from Texas sales tax.
If the services you provide are intended for resale by your client, you also don’t have to charge sales tax as long as you are provided a valid resale certificate from your client. An example might be if you are building a web application that the client intends to sell in a software as a service (SAAS) model. SAAS is a taxable service in Texas, therefor your services should qualify for resale status.
The current state
Most web related professional service providers we have surveyed don’t curently charge sales tax. We have found there are largely three reason for this:
- Many large consultancies have constructed their service offerings in special ways to get around the taxable services or minimize what is taxable.
- Consultants have been told by the state they are not subject to tax or have been given conflicting information
- Most consultants assume that they are professional services and as such are not subject to sales tax
Despite the ambiguous nature of the laws and contradictory information from state officials, if you provide any services that incorporate the web, you will be held accountable for back and future taxes if audited. Additionally it looks like the state has started aggressively auditing providers of these services.
Errata
This information has been compiled though research and numerous conversations with Texas auditors and sales tax consultants. The laws are vague. Even by the state own findings the laws are “subject to such a wide range of interpretations that they were wholly inadequate in evaluating Internet activities”.
In the surveys we have conducted with web related professional service providers many report they have been told different things at different times by the state.
photo by The Doctr