Service providers are often heavily targeted groups for Texas sales and use tax audits because of the many issues that make mistakes easy when it comes to reporting and collecting. Factors that can complicate your Texas sales tax obligations may include navigating difficult rules and guidance from the Comptroller’s Office, providing both taxable and nontaxable services, and managing use tax obligations for items purchased to perform your services. Our Texas sales tax professionals regularly help businesses and contractors overcome their challenges when faced with an audit or assessment concerning their services. In this article, we discuss the different services subject to sales tax in Texas, the problems that can increase your audit risk, and when the help of a professional may make sense.
The Broad Categories of Taxable Services within Sales Tax Code Section 151.0101
Texas sales tax applies to several different categories of services under the definition of “taxable service” within Tax Code Section 151.0101. The Tax Code further gives exclusive jurisdiction to the Texas Comptroller to determine the applicability and interpretation of the taxable services categories, which can be found in applicable administrative rules and publications from the Texas Comptroller’s Office. The taxable services in Texas include the following:
- Amusement services. See Rule 3.298.
- Cable television services. See Rule 3.313.
- Personal services. See Rule 3.317.
- Motor vehicle parking and storage services. See Rule 3.315.
- Repairing, maintaining, restoring, or remodeling services of tangible personal property
- Telecommunications services. See Rule 3.344 and Publication 94-132 (10/2002).
- Credit reporting services. See Rule 3.343 and Publication 94-106 (01/2001).
- Debt collection services. See Publication 94-106 (01/2001).
- Insurance services. See Rule 3.355.
- Information services. See Rule 3.342 and Publication 94-109 (05/2024).
- Real property services. See Rule 3.356.
- Data processing services See Publication 94-127 (03/2022).
- Real property repair and remodeling. See Rule 3.357 and Publication 94-116 (03/2007).
- Security services. See Rule 3.333 and Publication 94-119 (11/2021).
- Telephone answering services.
- Internet access services (unless separately stated). See Rule 3.366.
- Electricity transmission services. See Rule 3.295.
If your or your client’s business provides any of the above-listed services, then you likely collect and remit sales tax from your customers. However, nuances within the rules governing the listed services can quickly change your work from taxable to non-taxable. For example, Texas distinguishes taxable data processing services, such as A/P or A/R preparation, from professional services that simply use a computer as a tool to perform nontaxable work like the preparation of a financial report. It’s important to carefully consider the applicable rules for your business and consult with a sales tax professional to avoid overpayment of tax during an audit or assessment.
Texas Sales Tax May Also Apply to Labor Charges in the Manufacturing, Processing, or Production of Property
Beyond the services explicitly listed as taxable under the Texas Tax Code, sales tax may also be due on labor charges for fabricating or processing tangible personal property. Examples of this taxable labor include charges for tailoring, woodworking, producing artwork, catering, and the assembly of property (e.g., toys, furniture, and other equipment). Texas sales tax applies to these charges even when the customer supplies the raw materials or equipment involved in the project.
The Texas Sales and Use Tax Obligations of Service Providers
Service providers often have more challenging compliance obligations when it comes to their sales and use tax reporting. Depending on the nature of their business, they may have obligations as both a consumer and retailer–meaning they must pay Texas sales tax to suppliers on the items they use in their business while also collecting sales tax from customers for their services. This contrasts with retailers of tangible personal property who generally purchase inventory without tax using a resale exemption certificate and later collect tax after a final sale to an end-user or customer. Some businesses may also find that they do both, providing taxable services and selling property that requires proper accounting to ensure accurate collection and reporting of sales and use tax.
Texas Sales Tax Exceptions and Exemptions Could Apply to Your Service Business
Service businesses may also benefit from different exceptions and exemptions that could apply to their transactions. These exemptions could exist depending on the type of service provided or the nature of the customer. For example, Texas sales tax does not apply to residential real property contractor services while services to repair, remodel, or upgrade nonresidential real property are taxable. However, Texas also exempts nonresidential real property services to repair property damaged in a natural disaster declared by the President of the United States or the Governor of Texas.
Service providers may also not need to collect Texas sales tax on transactions involving exempt organizations. Generally, these are services provided to government agencies and qualifying nonprofit organizations with a letter from the Comptroller confirming their exempt status. Service providers must obtain a properly completed exemption form from the organization to substantiate that Texas sales tax is not due on the transaction.
Common Texas Sales Tax Mistakes for Service Businesses That Could Lead to an Audit
Businesses that provide taxable services in Texas often face a variety of issues that could result in under-reporting and under-collecting. If any of the following issues apply to you or your client’s company, an audit from the Texas Comptroller could lead to expensive tax liabilities that also include amounts for accrued interest and penalties.
- Not collecting a Texas sales tax exemption form from customers
- Purchasing taxable materials used to provide services with a resale certificate
- Not collecting sales tax on fabrication labor
- Improperly using a manufacturing exemption for taxable fabrication labor
- Misapplying Texas’ Tax Code and Administrative Rules that subject your services to sales tax