By Peter Bunio and Graham Wicas
Whether buying gifts for family or steel for a factory, electronic commerce has made remote purchasing commonplace. The ease of buying goods and having them delivered has increased awareness of freight and shipping charges. The taxability of freight goes by many names such as shipping, transportation, or delivery charges, and has generated attention because of the confusion it causes.
The taxability of freight is determined by many factors including: if freight is taxable in the state, if the good is taxable, if the freight is separately stated, who provides transportation for the good, and the seller’s shipping terms. While these factors are straight-forward individually, misinterpretation of their application can cause problems for businesses.
In some states freight is taxable and in others it is not. If the sale is taxed then the freight is taxed in states that tax freight. Imagine that a grocery store wants to buy three tons of potatoes from Big Spuds Potatoes. Would the freight charges to deliver these potatoes be taxable? It depends on the particular state’s rule regarding the taxability of potatoes. Some states do not tax specific categories of products, such as food. In addition to the category of the product, the intended use of the product affects whether it is taxed. In some states a computer for home use is taxable but if the computer is being used by the Federal Government or for the research and development of products it is not taxed. Therefore, if the potatoes are considered a taxable good, the freight, shipping, or delivery charges are taxable.
Big Spuds Potatoes is about to ship the three-ton order but they have a decision to make regarding the second factor for taxability of freight: should the freight charges for the three tons of potatoes be separately stated on the invoice? Based on the previous answers you might have already guessed the answer—it depends on the state. Showing freight charges separately from other charges on an invoice can ensure that it is exempt in certain states. Yet some states always tax freight even if separately stated.
It is important for Big Spuds Potatoes to determine this distinction in their state because sellers sometimes combine the freight and handling charges (e.g. “S&H.”) Since most states charge tax on handling, combining freight and handling renders both taxable while listing them separately makes one non-taxable in certain states.
The fourth factor that affects the taxability of the freight is who provides the delivery for the three tons of potatoes from Big Spuds Potatoes to the grocery store. Whether shipping is a necessary part of the sales transaction can affect whether it is taxable. When Big Spuds Potatoes, or any seller, sends freight by common carrier or the mail, it is less clear whether doing so is a necessary part of the sales transaction. If the grocery store were to use their own trucks to transport the three tons of potatoes, doing so would indicate that shipping is a necessary part of the sales transactions and make the freight taxable in many states.
Lastly, the shipping terms of seller, in this case Big Spud Potatoes, has implications for the taxability of the freight and who pays for it. Also, did the seller charge more for freight? Shipping terms refer to the legal stipulation in the purchase agreement of the good. When the grocery store purchased all those potatoes they entered into a legal agreement in which the shipping terms for Big Spuds Potatoes were stipulated.
There are two main shipping term distinctions that typically impact the taxability of freight. The first is Free On Board (FOB) origin. In this example, the title and legal ownership of the freight was transferred as soon as those three tons of potatoes were purchased. In the case of FOB origin shipping terms, freight is typically exempt from tax in many states.
Most sellers tend to have FOB origin shipping terms because it defers liability to the buyer. Imagine that the truck from Big Spuds Potatoes is traveling down the highway when a squirrel sprints into the road. An animal lover, the driver slams on the brakes to spare the creature’s life. The truck swerves and flips over, littering the road with three tons of bouncing potatoes. Thankfully the driver and squirrel are okay. Fortunately for the grocery store, Big Spud Potatoes is not required to replace the potatoes lost in the accident because the FOB origin shipping terms made them the property of the grocery store as soon as they were purchased. It should be noted that most companies realise it is bad business not to replace lost or damaged orders but FOB origin shipping terms provide a hedge against liability.
The other shipping term, Free On Board destination, entails that title is not transferred until the buyer receives the goods. Freight is usually taxable in the case of FOB destination. If the shipping terms had been FOB destination in our previous example, then Big Spuds Potatoes would have had to replace the order because the three tons of potatoes strewn about the highway are still their property.
The replacement order of potatoes successfully arrived at the grocery store. On this journey from purchase to store, it is evident that many factors influence whether freight is taxable. For each factor, there are often exceptions based on the tax rules of particular states. Consult your state tax code for specific answers.