The fight against sales taxes on professional services goes on

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While West Virginia was the first state to enact a sales tax in 1921, the majority of states instituted sales taxes in the 1930s. At the time, tangible personal property comprised the sales tax base, and only later did some states add services. As the tax base of retail sales in the economy has shrunk while professional services has grown, a number of states have attempted to implement a sales tax on professional services.

Transactions involving professional services are different from over-the-counter sales. Yet that hasn’t stopped a number of states from imposing, or seeking to impose, sales taxes on these services, including services by CPAs and accountants. “Currently, three states — Hawaii, New Mexico and South Dakota — tax all services,” observed Scott Peterson, vice president of U.S. tax policy and government affairs at Avalara. “Other states tax some services, but not all services. Iowa, Connecticut and West Virginia tax a lot of services, but they don’t tax accountants and lawyers. California and Maryland have been attempting to do this.”

“For a business like dry cleaning and car repair services, it’s not too difficult to charge sales tax. But if you’re providing services remotely, it’s a different animal,” he added. “Professional services are very often not over the counter, and generate more complex issues, such as where is the point of the transaction sourced?”

New fronts

Recently, CPAs in California and Maryland have been wrestling with the possibility that their services would be subject to sales tax. Maryland CPAs (and other professionals there) recently won, for the time being, their battle to stave off a professional services tax, while California is still mustering troops for the skirmish ahead.

The Maryland proposal, House Bill 1628, was geared to attract taxpayers by dropping the existing sales tax from 6 percent to 5 percent, while expanding it to apply to professional services, including CPAs, attorneys, architects, real estate agents and even landscapers. However, largely as a result of a campaign waged by Maryland CPAs and other professions, a House subcommittee unanimously voted down the proposal.

“This year’s battle to defeat sales tax on professional services was one of the most intense in my 23 years at the Maryland Association of CPAs,” said Tom Hood, CEO of the association. “The secret to our success came from our proactive grassroots approach that involved the record number of CPAs at our CPA Day in Annapolis, our support from CPA firms all across Maryland with 100 percent membership, and the ultimate grassroots program we have that matches every member to their legislative districts and representatives.”

“It was an epic battle to defeat bad legislation,” he said. “But it’s not the first time the issue has been before the legislature. It came up in the 2007-08 legislative session, and it’s returned every couple of years since then. But it was different this year because of the Kirwan Commission recommendations.”

The Kirwan Commission, officially named the Commission on Innovation and Excellence in Education, made extensive recommendations for improving Maryland’s public schools, which would cost billions of dollars over a 10-year period. “It’s recommendations are not mandatory, but the legislature is really keen to get it going,” Hood said. “They think they have funding for the first three years, but will need additional funding down the road to meet the goals.”

Despite the unanimous, bipartisan vote to kill the measure, Hood anticipates further attempts to place a sales tax on professional services.”We will need to keep our guard up,” he said. “A big argument the opposition makes is that this new service-based economy means that the revenue base has shifted from manufacturing to services. Therefore, they argue that they have to tax services because that’s where a growing part of the economy is headed.”

On the other coast

The battleground now shifts to California, where California Society of CPAs CEO Anthony Pugliese is marshalling his troops in opposition to pending Senate Bill 522, the state’s latest attempt to tax professional services.

“A tax on professional services will be an issue whenever there’s a revenue shortfall,” Pugliese predicted. “It’s an evergreen topic — they’ll be coming back after it year after year. The state characterizes it as a way to smooth out revenue and create less volatility. Our concern with that logic is that it’s not well-vetted in terms of its effect on the economy, in particular the end consumer. Everyone will have to pay for this — it’s another impediment to being successful for a business in California.”

Not only would a professional services tax have a negative effect on an already challenged business climate, it would place much of the tax burden on consumers across the state, Pugliese observed. He cited a recent study that found that a 5 percent sales tax would translate to an effective tax rate of 6.1 percent to 8.1 percent to the consumer. “Think of all the services that go into the development of the products and services that a consumer would purchase,” he said, noting that the compounding effect of a sales tax on professional services would create a pyramid where the same product is taxed multiple times as it moves to the end consumer.

For example, Pugliese estimated that the taxes on architecture, engineering, legal and accounting services required by a homebuilder to construct a housing development would add more than $16,500 to the price of a new home.

One of the consequences of such a tax would be the loss of clients to other states as clients seek professional services on a remote basis, Pugliese indicated. “It would discourage the use of professionals in California,” he said. “If clients migrated their service needs to Nevada, Arizona or Oregon, it would hurt the consumer as well as the CPA.”

Pugliese said that CalCPA has allied with other professional groups to educate policymakers on the negative impact of a services tax. Like MACPA, CalCPA used its CPA Day to speak to state legislators and government officials.

“We explained that a professional services tax would not just add something that would increase revenue, but it would discourage the use of other things that create revenue. Simply the shift in the use of services to another state means that California would not be collecting as much payroll tax — it creates a shortfall somewhere else.”

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Sales tax MACPA CalCPA Tom Hood