Washington Advises on Tax Treatment of Alarm Monitoring Services

As changes in technology intersect with changing sales tax rules, businesses may find themselves subject to new or different sales tax compliance obligations.

By Tina M. Chunn, SALT Senior Manager

As technological progress continues at its rapid pace, two trends are occurring that impact sales tax.  First, many services are becoming more automated and require less human interaction and many products are becoming more digitized.  Second, states are recognizing this and are enacting sales tax laws in an effort to capture these services/products within their taxable bases.  Thus, many states have enacted rules that tax “digital goods,” “digital audio/visual works,” and/or “digital automated services.”  Alarm monitoring is one such service that may require further review to determine the proper tax treatment in each state.

Washington recently issued an advisory stating that alarm monitoring services are presumed to be a digital automated service and are subject to the retailing classification under the state’s business and occupational tax, which also make such service subject to sales tax.[1]  Previously, Washington had advised that the alarm monitoring services may be treated as a digital automated service if it met the definition with an automated component and did not have primary human effort.[2]  This new advisory continues to allow for the use of primary human effort as an exclusion, but the taxation as a digital automated service is now presumed to meet the definition of digital automated service otherwise.

Alarm monitoring services are used to monitor homes and businesses for break-ins, events, fires, etc. using computers, software and telecommunications.  Typically, this service involves a combination of human effort with the automation tools provided through computers, software and telecommunications.  For purposes of this advisory, an alarm monitoring service provider includes the sale of alarm monitoring services directly to the end user, or sale of alarm monitoring services to a third party, who then resells the services to the end user.

Washington rules provided that digital automated services are any service that transferred electronically that uses one or more software applications.  As such, alarm monitoring services would meet this broad definition of digital automated services.

Under Washington’s rules, one of the exclusions to the definition of digital automated services is for services that require “primarily human effort.”[3]  Specifically, the exclusion applies to any service that primarily involves human effort by the seller and the human effort originated after the customer requested the service.  Generally, a time factor and cost factor are used to determine if a service requires “primarily human effort.” The time factor is calculated by dividing the time spent to perform the human effort portion for customers by the total time spent performing the service. The cost factor is calculated by dividing the direct costs incurred to perform the human effort portion for customers by the total direct costs incurred to perform the service. Direct costs of the human effort component include salaries, employee benefits and similar direct costs. Direct costs of the automated component include the cost of software, computers, hosting services and other similar direct costs.  If the average of the time factor and cost factor is more than 50 percent (i.e., time factor percent plus cost factor percent divided by 2), then the service is considered conducted through primarily human effort and is not treated as a digital automated service.

As we see these technological trends continue (both the increase in automation and the expansion of taxable product and service classifications), it will be important to re-evaluate how certain services are taxed.  We have already seen this with digital books, videos, and music, and this will continue to be an area of consideration for services, as states continue to review how these types of services are taxed.

Aprio’s SALT Team has experience analyzing these types of transactions and understanding the potential tax treatment under these new classifications.  Our guidance will help to ensure that your business remains in compliance with state sales tax rules and does not incur unexpected exposure and penalties.  We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Tina Chunn at tina.chunn@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the February 2019 SALT Newsletter.

[1] Washington Excise Tax Advisory, No. 3189.2018, December 21, 2018.

[2] Washington Excise Tax Advisory, No.  3189.2014, March 7, 2014 (replaced by the new advisory).  Prior to the state’s enactment of “digital automated services” as a taxable service, alarm monitoring would likely have been classified under the state’s business and occupation tax as “services and other activities,” but would not have been subject to sales tax.

[3] WAC 458-20-15503(303(a).

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.