Decoding product taxability: A comprehensive guide for retailers
by September 25, 2025
As a retailer, understanding product taxability is crucial for maintaining compliance, building customer trust, and avoiding costly mistakes. The complexities surrounding sales tax product taxability can be daunting, so we asked an expert from our parent company, Stripe, to help simplify these concepts. Alyssa Dusterhoff is an indirect tax technology lead at Stripe, a licensed lawyer with a JD specializing in tax. She focuses on developing tax technology solutions and overseeing the logic and rules that drive the Stripe Tax product.
In this guide, we’ll provide you with the knowledge you need to navigate this challenging aspect of retail operations to help you maintain compliance.
What is product taxability?
Product taxability refers to how a good or service is treated for indirect tax purposes. Some products are fully taxable, others are exempt, and some fall into special categories with alternative rates or reduced tax bases. Getting this right is essential for accurate tax compliance, and the implications of misclassification can be significant.
Incorrect product taxability can lead to either undercollection or overcollection of tax. If you undercollect, you might find yourself having to cover the tax liability out of pocket, potentially including interest and penalties. Overcollection, on the other hand, can create an administrative headache as you work to obtain refunds and reimburse customers. Additionally, overcollecting tax can damage customer relationships and potentially expose your business to legal action, including class action lawsuits that could attract unwanted media attention.
The complexity of product taxability becomes even more apparent when we consider sales tax holidays. These temporary exemptions, often applied to specific categories like back-to-school supplies or hurricane preparation items, require retailers to be especially vigilant. Tax authorities typically provide detailed guidance on eligible products, but interpreting and implementing these rules accurately can be challenging.
Adding to this complexity is the fact that taxability rules vary significantly between jurisdictions. Each state, and sometimes even local authorities, can define which products are subject to tax, exempt, or subject to special treatment. This patchwork of regulations means that a product taxable in one state might be exempt in another, requiring retailers to maintain a nuanced understanding of the tax landscape in each area where they operate.
What determines product taxability?
The type of product you’re selling plays a crucial role in determining its taxability. Tangible personal property—physical goods that can be touched or moved—is generally subject to sales tax. Whereas real property (land and buildings) and intangible property (like copyrights) are commonly excluded from sales tax. However, the rise of digital products has complicated matters. Some states treat digital goods like their physical counterparts, while others have expanded their definition of tangible personal property to explicitly include certain digital products.
Services present another layer of complexity. While many people assume services are universally nontaxable the reality is far more nuanced. Only a couple of states tax all services by default, others tax only specific types of services, and still others exclude most services from taxation. Many states apply tax on services to tangible personal property, such as assembly, repair, and cleaning. Whereas personal services, like massage or tattoo services, and services to immovable property, like lawn care and cleaning, are less frequently taxed. Finally, professional services, like legal, medical, engineering, and consulting, are rarely taxed.
The method of delivery—whether in-person or electronic—can also impact taxability. Another common misunderstanding about product taxability is that if a good or service is entirely digital or accessed remotely, it isn’t taxable or isn’t taxable at the location of the customer. As technology has evolved, many states have updated their tax codes–originally written in the early 1900s–to explicitly tax digital products or to expand the definition of tangible personal property to include these services.
Additionally, with the growth of e-commerce, all states have adopted economic nexus laws, meaning they can require out-of-state sellers to collect tax on sales to customers in their state once a threshold is reached.
The intended use of a product can also influence how it is taxed. For example, items purchased for resale are almost always exempt from sales tax. Similarly, sales to non-profit organizations or government entities are commonly exempt. Use-based or customer-based exemptions usually require proper documentation such as exemption certificates.
Common product taxability mistakes for retailers
A common mistake retailers make is incorrectly taxing bundled transactions or mixed transactions. A bundled transaction or mixed transaction is when a retailer charges one non-itemized price when there is more than one distinct or identifiable good or service included in the transaction.
Bundling presents major challenges for tax compliance. Accurate tax calculation requires applying the right rates and tax treatment rules – which vary depending on the products or services in the transaction. This process, referred to as tax product classification, involves assigning a product tax code (PTC) to the products or services offered for sale by the retailer.
Product classification is a crucial part of integrating with tax compliance software. The rules for taxing a bundle with items that are not separately stated vary by jurisdiction (within the US and across different countries). However, these rules commonly follow the concept that if a taxable element is included in the bundle (or represents more than a small component of the bundle), then the entire bundle is taxable. Alternatively, if items within the bundle are subject to various rates, the entire bundle is taxable at the highest rate that applies to any item in the bundle.
One approach to this problem is to separate the products or services within the bundle into unique products with individual PTC assignments. This will result in a more precise tax calculation, potentially lowering out of pocket expenses for customers and reducing tax liability. Another common approach is to assign the product tax code that represents the majority value of the bundle or the true object of the bundle. Tax advisors can help evaluate the tax liability risk based on your business’s unique offerings and tax footprint.
Here’s a real-life example: Peloton, the at-home fitness equipment manufacturer, illustrates the potential pitfalls of misunderstanding product taxability. The company faced lawsuits in multiple states for applying tax on digital membership subscriptions to streaming and downloaded cycling classes, highlighting the complexities surrounding the taxability of digital products and services. By assigning digital membership subscriptions as taxable in three states, Peloton incorrectly collected sales tax from customers in those states.
Navigating product taxability: Strategies for retailers to ensure compliance and streamline operations
Given these challenges, how can retailers effectively navigate the world of product taxability?
- A regular review of your product offerings is essential: Assess your inventory for taxability, leveraging resources like TaxJar’s blog and API documentation to guide your evaluations.
- Staying updated on changes in tax law is equally crucial: Tax regulations are not static; they evolve over time, sometimes rapidly. Commit to ongoing education, monitoring changes at both local and state levels through tax authority websites, industry publications, and professional advisors.
- Don’t underestimate the power of technology in managing product taxability: Sales tax automation tools can significantly simplify compliance, reduce the risk of errors, and save valuable time and resources. These solutions can help you stay on top of changing regulations and ensure accurate tax collection across various jurisdictions. For example, TaxJar’s AI-powered product classification tool evaluates all of your products and suggests the right tax code for each and every one.
Understanding sales tax product taxability is a complex but essential task for retailers. By taking a proactive approach to assessing your product taxability and leveraging available resources and technology, you can navigate this intricate landscape with confidence. Remember, staying informed and utilizing the right tools not only ensures compliance but also contributes to building trust with your customers and protecting your business from potential legal and financial risks.
Are you ready to simplify your sales tax compliance journey? Consider signing up for a free TaxJar trial or reaching out to the sales team. See how TaxJar can transform the challenge of sales tax management into a seamless part of your business operations.
