Sales tax is a major revenue source for many states, including California, which is why its legislature has been looking for additional ways to collect fees under the ‘sales tax’ umbrella.

For years, State Senator Bob Hertzberg has been trying to extend the state’s reach by imposing sales tax on services. Although 2015’s Senate Bill 8 didn’t pass, there’s another bill recently heard in the Senate Governance and Finance Committee: Senate Bill 993 (SB 993).

How Senate Bill 993 Affects Sales Tax

While SB 993 might help increase California’s revenue, it comes at quite a cost. This legislation would create a new sales tax on services like legal and accounting, further complicating an already intricate state tax code.

CalCPA makes several key points against this new sales tax legislation:

1. Ultimately, The Sales Tax Burden Will Fall To Consumers

In order to compensate for the additional expense, businesses will increase their rates. This will happen in companies across the board – not just those providing legal or accounting services. Here are a couple of examples from CalCPA:

• Consumers might not be taxed on the food they buy, but the cost of produce at the grocery store will likely increase since the grocery store overhead has gone up to include more costly accounting and tax services…or a small business that elects to have a retirement plan for its employees is required by law to meet certain audit requirements, which requires the use of an external CPA.

Or they may need an audit or review as part of their application for a bank loan. Either the business absorbs the added tax on the service they are required to get, passes the cost to their consumers or elects to no longer offer a retirement plan to employees or opt to not pursue a planned expansion.

2. It Doesn’t Actually Broaden The Tax Base

Although SB 993 claims one of its goals is to, “Broaden the tax base to decrease reliance of state revenue streams on the ups and downs of the economy,” instead it only increases the sales tax for most businesses in the state. Because the bill is targeting B2B services, when the economy slows down most organizations are going to be less likely to invest in their growth by working with accountants, lawyers and other consultants.

3. It Further Convolutes Multi-State Tax Issues

While this could potentially create a larger headache to sort out regarding nexus and multistate issues, depending on the level of services needed (and therefore the size of the tax burden), it may be worth the additional complexity for some companies to hire businesses out of state for certain services. As CalCPA points out:

• How would a business with a large plant in California and an out-of-state headquarters calculate their services tax obligation if they use a CPA firm for management consulting at their headquarters? If all the benefit of the services is for the business’ management purposes, is there still an obligation to pay a services tax in California?

If so, how will it be calculated? These types of issues are common and will lead to over or under collecting of taxes and the subsequent refund, appeals and legal challenges.

4. It Puts California Companies At A Disadvantage

SB 993 states that the sales tax on services would only apply to those, “Purchased by a business for benefit for use in California.” In an already challenging business climate, this puts in-state businesses at yet another disadvantage and could potentially drive more companies from the state.

5. It Will Hurt Small And Medium Businesses

Although there is a small business exemption in SB 993, it is only applicable to very small companies. In fact, many self-employed businesses operate under very tight margins, despite exceeding the $100,000 threshold included in the bill. Because these companies wouldn’t be able to bring some of the services in-house (like larger organizations could), many would likely try to do it themselves or look for less credible options, opening them up to incredibly costly mistakes and noncompliance issues they can’t afford.

In addition, the legislation isn’t clear regarding exemptions. CalCPA brings up questions like:

• What happens if a service provider mistakenly collects or does not collect a tax?
• If a recipient of a service is exempt, how would they prove that they do not need to pay the tax?
• How will the provider know if a user of their service is exempt?
• What happens if a “small business” crosses the exemption threshold and it had not been collecting or paying the tax?

Have questions? Contact Monika Miles.