The question as to whether labor is taxable creates much confusion, particularly in manufacturing settings. The issue is best framed through the example of the manufacturing process for baseball bats.
Say you are manufacturing a baseball bat. In order to manufacture a baseball bat, you must buy the lumber and cut down a tree. Then, you must take the tree trunk, cut it into baseball bat size pieces, and shape that into a baseball bat. Afterward, you have to add the finishing touches to the baseball bat so that it is ready for final sale through a retail store or distributor.
As demonstrated, the supply chain can quickly become complicated but at each step in the manufacturing process, there is value added to the product. When there is value added at a step in the process, the transaction in that step is generally taxable unless a resale certificate is presented.
The big misconception with respect to which steps in the manufacturing process are taxable is that labor — or in this example, the chopping and molding of the wood to make it into a baseball bat — cannot be taxed. However, states can and do tax certain types of labor.
In this chapter, we will look at the different types of labor and how they are taxed. We will also talk about delivery labor and situations where it is subject to tax.
If you own a business that uses a lot of labor and are not sure what is taxable, call me. I can help you determine whether or not the labor is taxable. It is better to know up front than face a sales tax audit down the road.
What Types of Labor are Taxable?
In many states, California being one of them, fabrication labor is considered a taxable labor. When you manufacture something or give creative input into a process, that labor may be taxable.
For example, if you sell blueprints, the service that you charge for the architect’s creation of the idea for the blueprint will be considered taxable labor. The same is true for the design of other items such as construction signs.
Where there is a component added to a product that would increase its value, that labor will be considered taxable. Thus, when it comes to determining how much sales tax to remit, the selling price of the product will be the number by which the states determine how much liability a business owes. The states will not discount the taxing price by the amount of the labor costs. (Professionals in Taxation, Sales and Use Taxation Ed. 2, §8.04, 5.)
Manufacturing labor is labor that involves cutting, resizing, and altering a product in any way. (Duffy v. State Bd. of Equalization, 152 Cal. App. 3d 1156, 199 Cal. Rptr. 886 (1984).) a case in which the court held that the alteration of “new” clothing (clothing that had not been previously worn but was purchased from someone other than the tailor) was taxable labor.
Just remember, if you alter an item and the alteration creates a step in the production chain or results in a new item, that will more than likely be viewed as taxable labor as there has been value added.
Assembly labor involves putting together an item that is separated into its component parts. This type of labor is not considered taxable in every jurisdiction. (Institute for Professionals in Taxation, Sales and Use Taxation Ed. 2. §14.03, 232.) However, in California, assembly labor is taxable.
The exceptions for taxable labor are repair and installation labor. Repair labor is defined by the CDTFA as “work performed on a product to repair or restore it to its intended use.” Installation labor and assembly labor can be particularly tricky to distinguish from one another.
Knowing the difference is absolutely key to determining whether you must remit taxes for that labor. However, determining whether a type of labor constitutes installation or assembly is ultimately dependent on whether the labor constitutes a step necessary for the creation of the final product.
According to the CDTFA, delivery labor is not taxable if it meets all of the following provisions:
- The item is shipped directly to the purchaser by common carrier, contract carrier or US mail
- The invoice separately itemized the delivery, shipping or postage charge
- The charge on the invoice does not exceed the actual cost for delivery to the customer. If no records are retained to show the actual cost of delivery, the labor will be deemed taxable.
Apart from labor that meets all of the above mentioned criteria, any other type of delivery labor will be considered either fully or partially taxable. Determining what delivery labor can get especially complicated depending on the industry of the company and the products sold.
However, the determination as to what delivery labor is will be informed by how the company invoices the labor. For a full and detailed chart of the taxability of various subtypes of delivery labor, visit the CDTFA’s Publication 100, Shipping and Delivery page and read the contents under the “Applying Sales Tax” tab.
When it comes to delivery labor, there is one bright-line rule to remember. Charges for delivery through common carriers will generally be tax exempt. However, if you are not delivering through a common carrier, you will have to determine whether the labor is taxable and if so, whether you are charging the appropriate amount of tax.
Determining Taxable Labor
Whether or not labor in California is taxable is determined by how much value is added to the final product at each stage of its development. The main exception is in the case of a reseller situation.
Labor taxation can also be added to services and intellectual property, such as our example with the architect and blueprints. Alterations and certain types of repairs or installations can also be taxed.
Lastly, while most categories of delivery labor are not taxed, in certain situations, it can be. As most companies ship through the USPS or common carriers, they will not have to pay taxes on shipping.
If you are uncertain about where a particular type of labor is taxable, reach out to me. I have successfully helped numerous small businesses determine if the labor they employ is taxable. I can help yours, too.