Sales and Use Taxes in California

April 13, 2006

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California assesses a sales tax on the retail sales price of tangible personal property. So, if your business sells tangible personal property in California, a sales or use tax liability will probably be incurred.

Liability for sales tax. California is a state that assesses a sales tax on sellers for the privilege of doing business in California. What this means for those of you who are retailers is that you're going to be required to pay a minimum 6 percent sales tax on all sales you make in California. You may (or may not) collect the sales tax from your customer.

Starting January 1, 2004, all California municipalities may impose a local transactions and use (sales) tax at a rate of up to 2 percent. Previously, only qualifying governmental entities were authorized to impose such a tax and the rate was generally a maximum 1.5 percent.

Beginning July 1, 2004, California will impose an additional temporary state sales and use tax of 0.5 percent to help repay its state deficit financing bonds. At the same time, however, the total rate that may be levied by local governments will be reduced by 0.5 percent. This means that the combined state and local sales and use tax rate in any taxing jurisdiction will remain unchanged.

Liability for use tax. In order to avoid losing tax revenues on sales transactions taking place outside the state, California also imposes a use tax. The use tax is assessed against all persons who store, use, or otherwise consume tangible personal property in California that was purchased out-of-state. California does provide a credit for use tax that is paid to other states, but only up to the amount of the California use tax for which you are responsible.

Sales or use taxes on services. In California, most services may be provided without incurring any sales tax liability. Furthermore, this exclusion from sales tax also extends to any property or equipment that may be included in the price of the service you provide. However, if you're audited, the tax assessor may hit you with additional sales or use tax and interest and penalties for the services provided and any equipment installed if it looks like your customer was not buying your services, but instead was buying the equipment you were including in the cost of your services. To handle this determination, you're going to have to figure out what to look at in determining when the service you're providing is secondary in importance ("incidental") to the installation of the equipment.

To clear up some of the confusion that this determination causes, California uses an analysis called the "true objects test" which is applied to the total transaction. By using the true objects test, you can get a better idea of whether a transaction will be taxable by determining if the service provided or the property acquired was the main purpose, or the true object, of the transaction.

When you provide your patient with dental services as well as an x-ray or gold filling, the client is clearly paying you for the services performed. The actual tangible property received — an x-ray, gold filling or any other stuff you can actually hold in your hand — is incidental to the actual service provide.

On the other hand, if your computer repair business puts in a power supply and fan, a new RS232 cable, a new monitor and upgraded software for your customer, then you're probably going to have to pay sales tax. The computer equipment and software you installed is the object of the sale to the customer, not the actual labor it took you to put in this new equipment.

Sales and use taxes on leased property. In general, all leased and rented property will be subject to sales taxes. The state treats leases and rentals as "continuing sales" and possession by the lessee as a "continuing purchase." The leasing or rental of the following types of tangible personal property, however, will not be treated as a sale or purchase:

motion pictures, including television, films, and tapes (except videocassettes rented for private use)
linen supplies and similar articles by professional cleaners
household furnishings included in a lease of living quarters
mobile transportation equipment
property for which sales or use tax has been paid by the lessor

The following discussions address additional sales and use tax issues that many small business owners face: