Sales Taxes on Services: A Struggle Before COVID-19

Efforts by states to enact sales taxes on traditional services—landscaping, accounting, dry-cleaning, legal advice, etc.—have been an “uphill battle” for years. That said, future efforts to tax services may encounter far less friction as states scramble to address budget shortfalls in the wake of COVID-19. As such, it is important to understand the factors that have stymied most state legislatures’ attempts to apply sales taxes to services.

“Imposing sales taxes on services has its detractors,” writes Roxanne Bland, a former Multistate Tax Commission member, in a recent Tax Notes State article. “Among other things, some argue that taxing services discriminates against small businesses that cannot perform the needed services in-house, unlike a larger company. A state wishing to tax services might discover that doing so is not as simple as it seems. Imposing tax on an activity previously untaxed requires a new tax structure that must be built from the ground up. Further, there are questions of what services, if any, should be exempt from tax.”

Even when a state clears those hurdles, other obstacles lurk. Lobbying efforts can derail proposed legislation. Bills calling for sales taxes on services that seem likely to sail to approval also can get upended by political outcry, as West Virginia’s legislature discovered in 2017.

Bland, now a contributing editor with Tax Notes State, assesses the pros and cons of this type of tax reform. The arguments against include:

• Extending sales tax to professional services would have a discriminatory impact on small B2B firms: Larger companies can afford to employ a wide range of in-house expertise that small companies tend to outsource to outside vendors. Small businesses may not be able to afford the extra cost of a tax on their externally sourced professional services.
• Lack of uniformity in state laws could hinder economic growth: Companies could avoid setting up shop in states that tax their services, suppressing economic activity in those states. States also might take significantly different approaches to exempting certain types of services from being taxed.
• Administrative headaches: In another article on states’ struggles to tax services, Stateline’s Elaine Povich notes that snow removal is not taxable in Pennsylvania (one of a few handful of states that taxes some services), but that the removal of snow from gutters and downspouts is taxable since it qualifies as Building Cleaning and Building Maintenance Services. “Taxing drain repair services or landscaping services is one matter,” Bland reports, “but for multistate customers and service providers, it is not easy to pinpoint where the taxable service took place — that is, when, where, and how the services were used.”

Additionally, Povich notes that taxes on many services are regressive given that they can have an outsized impact on lower-income taxpayers. In 2017, Povich reported that 23 state legislatures “considered proposals to impose taxes on at least some services. But so far, none have made it into law intact—and most die outright.”

Despite that track record, however, state legislatures may have far better odds of applying sales taxes to services in the coming 12 months, as Vertex Principal Economist and Tax Policy Advisor George Salis explains in his post.