The application of the sale of a warranty or service contract in relation to the types of agreements now available to consumers has become increasingly difficult. What appears to be a straightforward statute can become quite difficult to interpret when attempting to determine what is tax exempt. The taxing of a warranty contract that is not separately stated, or of a warranty that is part of the sale of the product, is viewed as benefits associated with the sale. A warranty or service contract that is separately identifiable and is an optional purchase would in some states qualify under a statutory exemption from tax.

Definitions: Warranty contracts provide for repair service only in the event of a future malfunction of an item of tangible personal property. Maintenance contracts provide for service to be performed on an item of tangible personal property at a future time. This service is rendered to sustain or support safe, efficient, continuous operation, or to keep an item in good working order by preventing its decline, failure, lapse or deterioration. This service is not contingent upon the malfunctioning of the tangible personal property covered under the contract. Repair contracts provide for service to be performed on an item of tangible personal property which is broken, damaged, defective or malfunctioning. The repair service is to mend or restore such property to working order or operating condition. Labor is a service. Many states provide exemption from tax on labor charges if shown separate from any parts sold as part of the same transaction.

Analysis: In determining whether a contract is taxable, you should research the statutes of the state(s) where the contract(s) will be performed. The true object of the contract must be established. If the true object of a contract is to acquire tangible personal property (e.g. software upgrades or machine repair parts) then the total charge for the contract could become taxable, even though certain (nontaxable labor) services are also provided. If the true object is to acquire services (e.g. labor, telephone assistance), then the total charges might escape taxation. States that have statutes which include the taxation of labor (e.g. repair, installation) performed on tangible personal property usually hold that labor performed under contract, even if separately stated and optional, meets the statutory provision to make the entire contract taxable. You should also determine whether the tangible personal property covered under contract was purchased tax-exempt (e.g. manufacturing equipment, resale). This could cause the repair charge to be exempt from tax. Both state and local statutes should be researched to determine the extent of this exemption. We work closely with our clients to structure their contracts to minimize the amount of applicable taxes.

Feel free to call or e-mail us to discuss any tax issues you may have.

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