As a freelance professional, the burden for ensuring you are in compliance with all tax regulations falls squarely on your shoulders. One area of taxation that is often misunderstood by those who are self-employed are the rules applying to sales tax and use tax. Sales tax generally applies to retail sales of certain tangible personal property and services. Use tax is usually applicable to purchases of tangible personal property and services that are made outside of the state in which they will be ultimately used.
Here are some facts about sales tax and use tax to help you determine how you should handle these obligations as they apply to your freelance business.
Fact #1: Sales and use tax regulations vary by state.
Every state has different requirements for sales tax and use tax. For example, in New York State the assumption should be that goods being sold are taxable unless they are specifically exempt in the state’s regulations.
If you sell physical goods and ship them to someone in your same state, then you have to collect (charge the buyer) sales tax and pay that tax to your state. However, if you ship these goods to another state where you do not have a tax nexus (see the explanation of tax nexus below) you do not have to collect sales tax on sales where goods are delivered to an out-of-state address. For professional services, it is generally safe to assume that your sales are tax-exempt unless your state’s regulations rule otherwise, but it is still a good idea to double check and become familiar with the sales tax regulations of the state(s) in which you do business.
Fact #2: Freelancers should determine their tax nexus and responsibilities.
From a tax perspective, nexus means that your business has established a presence in an area. Your nexus may be based on your business presence in a state, however, in some states you have to register by county or city. You can have a direct presence by having a store location in a state, hold inventory within a state, or by living or working in a particular jurisdiction. You can also have a presence through a representative in a particular area. You may also be considered as having a tax nexus if you have affiliates in a state that you work with to sell your goods.
Fact #3: The type of product or service you offer matters when it comes to sales tax.
For many freelance professionals, especially those working in the programming and website development industry, the line between what is considered a tangible good and what is considered a service for the purpose of charging sales tax can be quite fuzzy, unless you are a tax professional.
As a rule of thumb, digital work that produces a tangible output such as pre-programmed, non-customizable software is usually taxable. Work such as website development that produces downloadable electronic files or the ability to download files may be subject to sales tax (again, depending on the state in which the sale is being made), but website maintenance would generally be considered a service on which sales tax would not apply. Conversely, providing maintenance services for computer hardware in some jurisdictions (such as New York) is taxable. Freelancers should consult with a tax professional regarding how sales tax should be applied to their specific product and service offerings.
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Fact #4: Freelancers may need a sales tax permit.
Most states require you to register for a sales tax permit or license for your business if you intend to engage in the sale of goods or services which require you to collect sales tax and/or use tax.
The permit allows you to charge sales tax on your customers’ purchases so you can collect the necessary amount for which you will owe when completing a sales tax return. To register for a sales tax permit, you typically file an application through the department of taxation in your state. After you file the application and are approved, the state issues your business a certificate including a sales tax identification number.
Fact #5: A sales tax exemption certificate may help freelancers relieve their resale tax burden.
A sales tax exemption certificate can exempt you from having to pay sales tax on an item that you are going to resell. To obtain a certificate, a purchaser must first apply for and be granted one by their home state’s tax authority and provide the required information to sellers they are purchasing resale items from. The seller can then sell property or services to the purchaser without charging sales tax. However, this type of certificate is generally used when the end good is sold and subject to sales tax. There are very specific rules as to when sales tax exemption certificates can be used.
You should also keep in mind that when it comes to sales tax exemption certificates there are usually very specific regulations about what type of purchaser may use the certificate. In addition, most sellers must have a valid Certificate of Authority in order to accept an exemption certificate. A properly completed exemption certificate accepted in good faith protects the seller from liability for the sales tax not collected from the purchaser. Each state will have its own rules about the use of sales tax exemption certificates. For example, in New York, sales tax exemption certificates of other states or countries are not valid to claim exemption from state and local sales taxes.
Fact #6: Use tax returns are applicable to freelancers, businesses and consumers.
Use tax is owed when someone buys a good that is taxable outside of the state where the item will be used and either sales tax was not collected by the retailer in the selling state or the rate of sales tax is lower than the sales tax in the home state. For example, if Joe, a New York-based freelancer buys a hard drive from a company that does not have a tax nexus in New York and the company ships the item to Joe, the item will be taxable in New York and Joe will owe use tax on it. Another example: Jane, who lives in New York, buys a computer in New Jersey, and is subject to the state’s sales tax which is lower than that of New York State. Jane owes a use tax equivalent to the difference between the tax rates of New Jersey and New York.
The requirement to pay use tax applies to freelancers, consumers and businesses. States such as New York allow individuals, in lieu of filing a use tax return, to pay use tax based on a percentage of their personal income. However, this only applies to their personal, non-business purchases and, theoretically, an individual who is a freelance professional would still be subject to filing a use tax return for business purchases.
Fact#7: Freelancers who charge sales tax must file a sales tax return.
Like use tax returns, freelance professionals (as well as individuals, sole proprietors, and LLCs) who collect sales tax must file sales tax returns with their state’s tax authority. The reporting times and frequency vary by each state. It is advisable to check with a tax professional familiar with your local tax regulations for guidance on this area.
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Jonathan Medows is a New York City based CPA who specializes in taxes and business issues for consultants across the country. His website, www.cpaforfreelancers.com, has a resource section with how-to articles and information for freelancers.