Mapping your products in an automated tax system

The taxability of a given product or service can vary from state to state, and in some cases, such as in Colorado, taxability can even vary from city to city. Location isn’t the only complication businesses face when calculating sales tax. Specific products and services can also have special or reduced rates and fees that need to be calculated at the point of sale.

This is why mapping products and services to an appropriate tax category in any automated tax system is both very important and very powerful.

Sales tax is often complicated. Properly mapping products and services in your tax system will ensure that the correct taxability determination, accurate tax rate, and any applicable fees are being calculated for every sales transaction.

The need for mapping products and services to tax categories is most apparent in these major areas:

• Clothing
• Sales Tax Holidays
• Food for Home Consumption
• Meals Tax
• Medical Products
• Items with fees (such as Tires, Batteries, TVs and monitors)
• Computer and Software Products and Services

Clothing

In the US, four states provide general exemptions for clothing, three states provide an exemption as long as the clothing is under a certain dollar amount, and one state taxes luxury clothing at a higher rate. The definition of what qualifies as clothing (clothing accessories, work clothing, protective equipment, etc.) is not uniform from state to state, so an item may qualify for the clothing exemption in one state but not in another.

To further complicate the issue, in 2018 sixteen states had sales tax holidays that provided exemptions for certain articles of clothing for limited periods of time.

Looking at the states with clothing dollar amount thresholds, we see that Connecticut, Massachusetts, New York, and Rhode Island are all subject to different thresholds. The thresholds are $50, $175, $100, and $250, respectively.

These states not only differ in thresholds, but they may also differ in how purchases that are over each unique threshold are treated.

Massachusetts

Massachusetts has a 6.25% sales tax rate for the entire state. For clothing, only the amount over the $175 threshold is subject to sales tax.

• Sales Transaction A: $100 Blouse. No sales tax applies because blouse is under $175.
• Sales Transaction B: $200 Blouse. Sales tax applies only to the portion over the threshold; $25. $200 – $175 = $25 * 6.25% = $1.56 Sales Tax

New York

New York has an 8.875% sales tax rate in NYC and other rates vary depending on the location of sale. For clothing, the entire amount is taxable if the item is over the $110 threshold.

• Sales Transaction A: $100 Blouse. No sales tax applies because the blouse is under $110
• Sales Transaction B: $200 Blouse. Sales tax applies to the entire item price; $200. $200 * 8.875% = $17.75 Sales Tax

If the taxability of clothing seems complex, it gets even more complicated as you look at more and more states. For example, one article of clothing that costs $1200 would be subject to different thresholds Massachusetts, New York, and Rhode Island, as well as taxable at a special rate in Connecticut, while being fully taxable in some states and exempt in others. Clothing rules can be more problematic than you think.

This shouldn’t make you worry. Properly mapping your clothing products to the correct clothing tax category in an automated sales tax system will ensure that the proper taxability determination, rate, and threshold rules are applied across all taxing jurisdictions.

Sales tax holidays

In 2018, seventeen states had sales tax holidays that exempted certain categories from state sales tax for limited periods of time. These categories included items like: back to school supplies, energy star appliances, and hurricane preparedness items.

Sixteen of these sales tax holidays exempted clothing. As a small business owner, you have to keep in mind that the sales tax holiday exemptions have similar intricacies as the year-round exemptions, including the definition of what qualifies as clothing for each holiday and how the thresholds vary from state to state.

For example, Alabama, Arkansas, Connecticut, Iowa, Maryland, Mississippi, Missouri, New Mexico, Oklahoma, Tennessee, Texas, and Virginia exempt clothing up to $100 during their sales tax holidays, while South Carolina has an unlimited exemption, Massachusetts exempts up to $2,500, and Ohio and Wisconsin exempt any clothing item under $75.

• Your automated tax solution will automatically account for these sales tax holiday rules, as long as your products are set up correctly. In other words, in order for an exemption to properly calculate during a sales tax holiday, the item being sold must be properly mapped to the appropriate tax category.

Food for home consumption

The majority of US states impose special rules on food. Most states exempt food for home consumption from sales tax entirely. Arkansas, Illinois, Missouri, Tennessee, Utah, and Virginia have special reduced rates for food for home consumption. Arizona and Louisiana exempt food at the state level but tax it at the general rate at the local level (some exemptions/reduced rates apply).

While individual states are ultimately responsible for defining the exact scope of special sales tax rules related to food and beverages, food for home consumption is generally accepted to include staple grocery items and foods which are not prepared prior to purchase and are not meant to be consumed on-premises. Candy and soft drinks can be included or excluded in this definition, depending on the state.

Many states, including Member States of the Streamlined Sales Tax Agreement, exclude prepared food, dietary supplements, and alcoholic beverages from the definition of eligible food for home consumption.

Example: A liter of soda is fully taxable in Minnesota and Illinois, while fully exempt in Massachusetts.

Example 2: A loaf of bread is exempt in Minnesota, taxable at a reduced rate in Illinois, and exempt in Massachusetts.

Again, properly mapping food items to the correct tax category will ensure that the proper taxability decision and reduced or full rates are applied across all jurisdictions.

Meals tax

While most states provide an exemption for food for home consumption, food intended to be consumed on-site in places such as in a sit-down restaurant or when ordering take-out is generally taxable. Some states tax this type of food at the general rate, while others have special rates, called a Meals Tax.

Many local jurisdictions also impose a meals tax, even in states that have no other local taxes, such as Massachusetts or in states with no state sales tax, such as New Hampshire.

In an automated sales tax system, these rules will seamlessly be applied to your transactions once you have mapped all of your products and services accurately.

Medical products

Medical products is another area where states enact special tax rules. Many states provide a sales tax exemption for prescription drugs. The definition of what qualifies as a prescription drug, just like clothing and food, can differ from state to state.

For example, some states such as Missouri, exclude over-the-counter prescription drugs from their exemption. Other states such as Texas, exempt all drugs, regardless if they are or are not given under a prescription.

Why mapping is important in this area is because some states have a very broad definition of what qualifies as a “drug.” States are also increasingly providing exemptions for other medical items, such as feminine hygiene products.

Properly mapping a medical product to the most specific tax category in your automated tax system will ensure that the proper taxability determination is being applied across all jurisdictions and that your customers are getting all of the exemptions that the states have to offer.

Fees

Products that are not exempt in any jurisdiction and are not covered by any sales tax holidays may still need to be mapped in your automated tax system to ensure not only a comprehensive collection of all relevant taxes but also of all applicable fees.

States may impose fees on items such as lead-acid batteries, tires, electronic items, bottled water, soda or alcohol containers, and E-911 charges.

Mapping to the proper tax category for these types of items will ensure that the proper taxability, as well as any applicable fees, are calculated by your automated system.

Software and software services

The treatment of software and related services differ significantly from state to state. Prewritten software provided in tangible format is taxable in every jurisdiction with a sales tax. The treatment of software transmitted electronically, on the other hand, varies from state to state and can vary for a variety of reasons, including whether the software is custom, prewritten, transferred with tangible personal property, or comes with upgrade, updates, or technical support services.

The treatment of Software as a Service (SaaS) and other software related services also varies widely from state to state.

Similar to clothing, food, and medical items, not only does the sales tax treatment differ for SaaS, but the definition of what qualifies as SaaS and other software related services differs by state. This is another reason why it is critical to pick the most specific tax category that matches the products your business sells.

Software-related services may also be subject to special rates, such as the 1% Connecticut rate for computer and data processing services, or in Texas, where data processing services are only taxable at 80% of the base.

Automated Tax systems provide a significant number of software and software services tax categories where the underlying taxability is maintained across all jurisdictions and helps your business ensure the proper calculation of rates and taxability.

Automate your efforts

Given the many variables and complexities around sales tax product and services categorizations, the solution is probably not DIY. When set up properly using a comprehensive software like QuickBooks Online, you can take all of your compliance issues and turn them into an automated process that seamlessly and effortlessly calculates the right tax, at the right rate, for every transaction.