Technology exemptions are some of the most easily overlooked exemptions because they are not well advertised and changing by the day. In an attempt to keep up with the vast technological advances of the 21st century, old sales tax schemes are forced to evolve and adapt if they want to keep these technologies within their tax base. While some states have acted quickly to capture these items, slow moving states have left otherwise taxable transactions exempt because they can’t keep their laws current with the technology. Meanwhile, some of the more advanced states have identified new technologies they want to encourage production of in their state. Such states have done this by enacting narrow tax exemptions within broad technology-focused tax statutes.
If you are treating your technology purchases and sales the same in each state in which you do business, you likely are missing out on various sales tax exemptions that could save you thousands or more! This article will broadly discuss the varying approaches to taxing technology taken by five large states: California, Florida, Illinois, New York, and Texas. The resulting conclusion is that states have dramatically different approaches to taxing emerging technologies, leaving great opportunities for refunds for the savvy taxpayer.
California exempts from sales and use tax custom software and computer services. This includes custom-ordered modifications to existing and prewritten software. Exemptions for computer services generally do not apply when the service is performed as part of the sale of tangible personal property. Therefore, in cases where computer software is sold with the hardware, the exemption does not apply.
In California, computer generated output is taxable when the true object of the contract is for the output itself rather than the services rendered. This could apply when purchasing graphics. Are you buying the end graphic or the service of creating a graphic? Such distinctions are important for sales and use tax purposes.
Intangible personal property that is transferred with tangible personal property in connection with a technology transfer agreement is exempt only when separately stated and a reasonable price allocation exists. Often, businesses will put a low value on the taxable portion and a high value on the nontaxable to reduce overall sales tax on a transaction. California is trying to prevent that. However, it is difficult for a state agency to decide what an appropriate price is for intangible personal property versus tangible personal property sold by the business. Finally, SaaS (software as a service), IaaS (infrastructure as a service), and PaaS (platform as a service) are currently not taxable in California without the transfer of tangible personal property.
Florida perhaps offers the best opportunities for savings and refunds in the technology sector. Florida broadly exempts software, including both canned or custom software. However, the catch is that the software must be downloaded or otherwise transferred without a tangible medium, such as a CD-ROM. SaaS, IaaS, and PaaS are similarly not taxable either. Therefore, Florida is, for the time being, uninterested in current and new technologies when it comes to software. This could result in a large refund for businesses that unilaterally pay tax on their software technology purchases on the basis that they are taxable in most states.
However, taxpayers are often caught off guard in Florida, with its broad exemptions for software in its various forms, when they are assessed tax on computer maintenance contracts. While maintenance contracts that include parts are clearly taxable in most states as the sale of tangible personal property, Florida also taxes labor only contracts because Florida explicitly imposes sales tax broadly on service warranties.
The taxation of software is more complex in Illinois. Generally, canned software is taxable while custom software is not. However, there are specific exemptions that can save businesses substantial sums. Of note, custom and canned software used to operate exempt machinery and equipment used in manufacturing are exempt as well.
Illinois taxpayers further provide exemptions for SaaS, IaaS, and PaaS which are currently not taxable. In addition, those maintenance contracts that are taxable in Florida are generally not taxable in Illinois. Therefore, Illinois, a state which is known for its aggressive tax scheme, still offers exemptions in the technology sector that can result in huge savings or refund opportunities for those doing business within the state.
New York has a more aggressive technology tax scheme. SaaS, IaaS, and PaaS are all generally taxable. However, like Illinois, narrow exemptions apply that can save those affected a substantial amount. Interestingly, even tangible personal property relating to technology may be exempt in certain scenarios. For example, computer hardware, associated parts, and embedded software is exempt when used or consumed directly and predominantly in designing and developing computer software for sale. Therefore, while those in the business of selling software will likely need to pay tax on the sales side, there may be hidden savings for them on their purchases.
In addition, computer equipment used directly in production qualifies for the manufacturing exemption. New York also exempts separately stated custom modification or enhancement. Other services, such as training, consulting, instruction, troubleshooting, installing, programming, systems analysis, repairing, maintaining, and services are exempted only when separately stated and reasonably priced.
Similarly to Illinois and New York, Texas has a more advanced technology tax scheme. Within that scheme, narrow exemptions exist that are easy for the average taxpayer to miss. For example, Texas offers several exemptions for computer hardware. Computer hardware and software used to assist blind or deaf persons may be considered exempt medical equipment. In addition, computer hardware and software are considered exempt when used in connection with a qualified data center project.
In addition to exemptions for hardware, software exemption or refund opportunities exist as well. Specifically, software that becomes part of computerized control units or electronic control room equipment that is used to power, supply, support, or control equipment that is essential to manufacturing operations may be exempt. Furthermore, software sold to internet hosting provider may qualify as an exempt sale for resale. Finally, customizable software is generally exempt. Meanwhile, SaaS itself is generally taxable.
Charges for installing or configuring software may be exempt from sales and use tax when the service provider is not the seller of the software. Therefore, oddly, if the company that sells you the software also sells you an installation or configuring package, it is likely taxable. Meanwhile, if you purchase the install and configuring from a separate company, it is likely exempt.
States take odd approaches when applying their preexisting and new sales and use tax laws to emerging technologies and especially software. Taxpayers operating in multiple states should pay close attention to not only their sales, but also their purchases, the taxability of which may vary dramatically from state to state. If you believe you have been assessed sales tax improperly, or have overpaid tax in error, consult a sales tax professional to see what challenge or refund opportunities are available. Most options require quick action, so make sure to contact your sales tax attorney prior to any deadlines on the notices you receive or as soon as you realize tax has been paid in error to maximize savings.
Jeanette Moffa is an attorney who concentrates on state and local taxes at Moffa, Sutton, & Donnini, P.A. She is an executive council member of the American Bar Association Tax Section State and Local Tax Committee and the Florida Bar Tax Section. Ms. Moffa is an author of both the CCH’s Expert Treatise Library: Sales and Use Tax as well the ABA’s Sales and Use Tax Deskbook. In addition, her regular columns on state and local tax issues can be found in State Tax Notes and Actionline, a publication from the Florida Bar’s Real Property, Probate, and Trust Law Section. She also serves as assistant editor to the Sales and Use Tax Deskbook and Actionline. Ms. Moffa is a regular speaker at the American Bar Association Tax Section conferences, the Institute of Professionals in Taxation, the Florida Bar Tax Section, the Florida Bar Real Property, Probate, and Trust Law Section, and the FICPA. In her free time, she teaches as an adjunct professor at Broward College.
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