Are Payment Facilitators Subject to Sales Tax? 4 Questions to Consider|
Reading Time: 4 minutes
At a glance:
- The main takeaway: Sales tax guidance is ever-evolving and differs by state, which means payment facilitators need to understand exactly how rules apply to their unique business activities.
- Impact on your business: With the help of an experienced CPA, there are four basic questions you should consider to appropriately determine your sales tax nexus, the aspects of your business that are subject to tax, and more.
- Next steps: Schedule a meeting with Aprio’s State and Local Tax (SALT) team to understand your sales tax liability.
The full story:
Interpreting the tax code can be a feat for any business owner — but there is another level of tax complexity to sift through if your business accepts credit and debit card payments. Here are four questions all payment facilitators should consider when assessing whether they are subject to sales tax.
1. Where does your business have sales tax nexus?
At its most basic level, sales tax nexus occurs when your company and business activities have a connection to a particular state. All states in the U.S. provide different definitions of nexus, which can become increasingly complicated if you do business in multiple states.
As a payment facilitator, you likely have sales tax nexus in each state in which you own hardware or have employees. For instance, if you provide your customers with hardware as part of your payment processing services, it’s possible that the state in which you’re operating may view the entire charge as taxable. If your business owns tangible personal property that you provide to customers as part of your services, you likely will be subject to sales tax nexus in each state in which that tangible personal property is located.
Depending on the quantity of the property you own in a particular state, you could argue that the amount is minimal and does not rise to an appropriate level to create sales tax nexus. However, states’ definition of what’s considered “minimal” is generally not clear, which means your situation would need to be analyzed carefully and compared to all available guidance.
In states that view your physical presence as “minimal,” you may still have economic nexus if you meet certain thresholds (typically at least $100,000 in revenue or at least 200 transactions, such as the number of invoices, the number of times your company is paid, etc.).
2. Are your payment processing revenues subject to sales tax?
Most states subject sales of tangible personal property to sales tax, unless exempted. On the other hand, when it comes to services, most states typically only tax those that are specifically enumerated by statute; therefore, payment processing services would be subject to sales tax in those states that specifically identify such services as taxable.
Currently, no state expressly provides that payment processing services are taxable. Nonetheless, there is the possibility that a state may group payment processing services under another category of services that it does subject to sales tax, such as data processing services.
To date, there are four states that generally impose sales tax on services unless specifically exempt: Hawaii, New Mexico, South Dakota and West Virginia. Therefore, unless an exemption applies, your business’s payment processing revenues are likely taxable in these states, if you do business in them.
3. What exactly qualifies as “data processing services”?
Data processing services include:
- Processing another person’s data, including all processes incident to the processing of data, such as keypunching; keystroke verification; and rearranging or sorting previously documented data for the purpose of data entry or automatically processing and changing the medium on which data is sorted — whether these processes are done by the same person or several persons.
- Providing access to computer equipment for the purpose of processing data, or examining or acquiring data stored in or accessible to the computer equipment.
Besides the states mentioned above, there are four states that tax data processing services: Connecticut, the District of Columbia, Ohio and Texas. Connecticut and Texas uphold guidance stating that credit card processing services fit within their definitions of data processing services. Meanwhile, Ohio provides guidance that credit card processing services are not considered a data processing service, and the District of Columbia has not issued specific guidance on the matter.
4. What other potential sales tax risks does my business face?
If your company provides hardware in connection with the sale of payment processing services, a state could take the position that the taxable hardware makes the entire transaction taxable. Second, the states that tax software-as-a-service (SaaS) revenue could also decide that since the customer receives the right to use some features of a tool or software program you provide, the entire transaction is taxable.
Both risks tie back to the “true object of the transaction” analysis. States generally apply this rule when an otherwise nontaxable service includes providing a customer with some sort of tangible personal property or a taxable service (which are inseparable from the nontaxable service).
Consider this example to understand the rule in context: A lawyer is hired to draft a will and provides the will (i.e., tangible personal property) to their client. The prevailing view is that the lawyer was paid to provide a nontaxable service, even though the client also received tangible personal property.
Similarly, in states that tax SaaS revenue, the true object analysis should also be applied, and some states have noted this in their rules. For instance, Tennessee recognizes that certain nontaxable services involve the use of software — sometimes by the customer — when the object of the transaction is the nontaxable service.
Ultimately, true object analyses are subjective, and states may take different views of the same facts and circumstances. Your business should request a letter ruling from the state(s) in which you do business to clarify how its sales tax rules would apply to your services.
- Aprio State and Local Tax Consulting
- Aprio State Tax Nexus Services
- Sales Tax Economic Nexus Compliance Map
The bottom line
Do you need help making sense of your sales tax liability in the states in which you do business? Contact Aprio’s State and Local Tax (SALT) team today.
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.