Sales Tax Slice: Taxing Tax Compliance?

In case you missed it, tax day was extended by a few extra days this year to April 18 because of the celebration of Emancipation Day in Washington, DC. The extension probably didn’t mean much to the good little boys and girls who dutifully prepared and filed their personal income taxes well before the deadline. But for those who put off the task to the very last moment, having the few extra days was a welcome bonus. (I’m not fessing up to which class of filers I fall into, but, I happened to be well aware of the extended due date.) 

With tax season winding down, I started to ponder the tax policy implications of sales tax on tax preparation software and services. Given how complicated the process is for most people to prepare their income tax returns, is it reasonable to suggest that policy makers consider minimizing the tax burden on the purchase of tools that help with tax compliance?

In days of yore (any time before the ‘90s), individuals used to complete their tax returns using pen, paper, and an abacus. Thank goodness the personal computer has bestowed upon the American taxpayer the opportunity to spend hours in the warm glow of a computer monitor tearing their hair out minutes before midnight every April 15th (or 18th this year). The off-the-shelf tax preparation software most of us buy is considered prewritten or canned software, and generally is subject to sales and use tax. In states like Alabama, software that has been customized to a particular user is exempt from tax. Your favorite tax preparation product likely has not been programmed just for you. Even if it were, some jurisdictions, like Hawaii, Mississippi, Nebraska, Washington, DC, and now Louisiana (at least temporarily) would collect tax on sales of your custom software, too.

The manner by which you access income tax preparation software also will determine whether you incur a sales tax liability. Florida does not impose sales tax on canned software that is electronically downloaded. A state like California, in contrast, taxes prewritten software regardless of whether it’s provided on a tangible medium, such as a CD, or is delivered electronically. Many taxpayers now prepare and file their returns by accessing the vendor’s server online—never downloading the software to their own machines. Remotely accessed software is exempt from sales tax in a state like Idaho, but is taxable in Utah, for example. 

Engaging an accountant or other tax professional to do your taxes, might allow you to escape sales tax, since many states exempt personal and professional services from sales tax. If you have an “I got this” kind of attitude, you may decide to purchase a book or two to help you deduct, divide, and itemize. If you buy a book in tangible form, you’re likely to pay tax on your purchase. (Remember, even if you buy the book online, you may still owe use tax in your state when it’s delivered to you, if the seller has not collected sales tax.) A digital download to your Kindle or iPad of the same book will be a tax-free purchase in states like Arkansas, Oklahoma and Rhode Island, while the digital book is considered taxable just like its tangible equivalent in a state like Texas.

It does sting a little to contemplate that one’s attempt to comply with the income tax will often result in a sales tax liability. There may be some solace in knowing that the IRS allows you to take a deduction for tax preparation software and services expenses (including the sales tax), if you itemize your deductions, and your miscellaneous expenses exceed more than 2% of your Adjusted Gross Income. Unfortunately, most filers usually don’t reach the threshold. Sigh.  

Continue the discussion on Bloomberg BNA’s State Tax Group on LinkedIn: Should income tax preparation software and services be exempt from sales tax as a matter of sound public policy?

Take a free trial to Premier State Tax Library , a comprehensive research service that delivers deep, unique analysis, and time-saving practice tools to help practitioners make well-informed decisions.

By René Y. Blocker