How product taxability and classification fit into your tax compliance automation strategy

Product taxability is perplexing. Sales and use tax rules aren’t consistent across jurisdictions or even within categories. 

Consider food, for example. Certain jurisdictions tax groceries at a reduced rate, while in others, food for home consumption is fully exempt. Food can also be subject to local sales taxes but not state sales tax, or vice versa. 

Even what is considered food isn’t as straightforward as you might think. Some goods that you may think are food, such as candy and soda, might not be considered as such because of their lack of nutritional value. Sometimes they’re even taxed at a higher rate.

Taxability rules are complicated and rarely consistent. Product definitions can be very specific. In the 24 states that are members of the Streamlined Sales and Use Tax Agreement (SST), products that contain flour don’t meet the definition of “candy.” So a Reese’s Peanut Butter Cup, which doesn’t contain flour, may be taxed differently than a Twix bar, which does. And even though SST states adhere to the same definition of “candy,” they don’t all tax it the same way.

The taxability of digital products is another area that can make your head spin, in part because states have different definitions for digital goods in their statutes. Which digital products are taxable varies as well. Depending on the state, there may or may not be sales tax on digital photographs, and taxability rules for software can vary depending on how it’s delivered.

Understanding when to collect and remit sales tax on services isn’t easy, either. Some states tax most services. Others tax very few or none at all. Many fit somewhere in between.

Some states have sales tax holidays that can change the taxability of products for a weekend, week, or longer. During sales tax holidays, consumers get a break from paying tax on eligible purchases of normally taxable products like clothing, school supplies, and emergency preparedness items.

Even if you know how the goods and services you sell are taxed today, rules can change tomorrow. There were 85,836 taxability updates in the U.S. and Canada in 2023, and 98,910 U.S. sales tax holiday rule updates.

Understanding the taxability of what you sell is crucial to tax compliance. But keeping track of which goods and services are taxable, which are exempt, and where they are exempt is virtually impossible without the right technology. 

Many businesses automate tax compliance with software that calculates sales tax and applies sales tax exemptions based on regularly updated tax rates and rules.

If you’re only using a sales tax rate calculator or uploading tax rate tables to your point-of-sale system, you’re likely missing a crucial compliance step. You’re also likely spending more time than necessary trying to manually assign product taxability to your sales transactions. Tax rate tables alone don’t account for product-specific tax rules.

The right software should identify what’s being sold and which rates apply in a particular jurisdiction. Avalara AvaTax has regularly updated tax content for more than 30,000 jurisdictions, including 190+ countries worldwide.

Sales and use tax compliance is trickier if your business sells complex products or services or frequently adds new items to your product catalog. Combining a solution that uses artificial intelligence with experts that provide assisted item classification services can mean less work for your team and more time to focus on other business priorities.

You can help improve customer experience with automated product classification built into your tax calculation solution. By calculating tax more accurately and including all charges at the point of sale, your customers know exactly how much they’ll be billed and will be less likely to abandon their shopping carts.

The type of customers you sell to can also affect product taxability. Purchases by government agencies, charities, and businesses that buy your products for resale are generally sales tax exempt. 

An automated solution like Avalara Exemption Certificate Management (ECM) makes it easier to manage high volumes of tax-exempt transactions and helps prevent exempt customers from being charged sales tax. ECM includes a built-in tax exemption reference library that lets you know whether an item is tax exempt or not. The solution automatically collects certificates and validates them to help ensure your business has accurate records during audits.

There may be times when you want to conduct your own product taxability research. You can spend less time looking up rates and regulations relevant to your business and industry with a self-help tool like Avalara Tax Research. Avalara Tax Research helps you quickly find answers and gives you direct access to tax researchers.

By now you’ve likely come to realize, between exemptions and the myriad rates and rules, how much product taxability can complicate your compliance. But with the right software, you can be confident that you’re taxing products more accurately by increasing the likelihood of classifying them correctly in the first place. Connect with the team at Avalara today to learn more about how our solutions can help you tackle taxability and improve compliance.