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Are Nontaxable Consulting Services Taxable Employment Services?

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Employment (or temp) services are taxable in Ohio under R.C. 5739.01(B)(3)(l). But as the following story shows, the difference between taxable employment services and nontaxable consulting services sometimes isn’t always clear.

Patricia had been at her new job for a few weeks as the controller of a small IT consulting firm when she received a call from a new customer asking why sales tax hadn't been charged on their first invoice. Patricia politely explained that Nerd Squad was an IT consulting firm, and consulting services weren’t taxable under Ohio law. The customer's reply surprised her—namely that all other IT companies that had provided services in the past had always charged sales tax. Now second guessing herself, Patricia said she’d investigate and get back to the customer.

The first thing Patricia did was double check Ohio law. Sure enough, R.C. 5739.01(B) didn’t list consulting services a taxable service, and R.C. 5739.01(Y)(2) indicated professional services weren’t taxable.

The next thing she did was talk to the VP who sold the services to fully understand the project specifics. Patricia learned that the customer (Nexus Corp) was migrating data and software from their old system to a new offsite data center and needed help with the migration. Nerd Squad had assigned a consultant named Mahesh to the project, who’d been with the company 20 years and had participated in several migrations. According to the contract, Mahesh was to serve as project manager, as Nexus’s IT director was on long-term medical leave. He would work onsite according to the customer’s normal work hours and policies and achieve certain milestones as of certain dates with the migration to complete in six months. If significant issues arose, Mahesh was to report them to the VP of Operations who would direct Mahesh on how to proceed.

Patricia called the customer back and relayed her knowledge and in reponse received a question.

"But isn’t this a contract for taxable employment or temp placement services?"

That sounded ridiculous to Patricia (“It’s not like we’re placing a temp,” she thought), but to be safe she called the sales tax consultant she met at last year’s Ohio tax conference.

What the expert said - and the questions you need to ask:

Ohio is one of the few states that taxes employment or temporary placement services. The taxable services are described in R.C. 5739.01(JJ) and Information Release ST 1992-08. To constitute taxable employment services the individual performing the services must be paid by the supplier (or other third party) but be under the “supervision or control” of the customer.

Generally, when the individual performing the services is serving in a non-managerial position, the customer will be supervising or controlling the worker, and the services are taxable. In that instance, the individual serves merely as a supplement to the customer’s workforce rather than as an expert with specialized knowledge and skills beyond that of the customer’s employees.

When the person performing the services is at the manager level or above, however, the supervision or control issue become murkier. In this instance, there’s more of an appearance that the individual has been selected for their special knowledge or expertise and is acting independent of the customer. The individual may be taking direction from the customer, however, and the issue is whether this direction constitutes “control or supervision.”

Answering the following questions can help determine whether the individual is under the supervision or control of the customer:

  • 1) Does the individual have specialized knowledge or skills above and beyond those of the customer’s employees?
  • 2) Has the individual (or rather the company in general) been retained to complete a specific task or project or answer a specific question?
  • 3) If the customer is providing direction to the individual, is the direction provided as a result of a management decision, meaning a decision of such importance that the company, rather than a consultant, should make it?
  • 4) Who bears liability if the services are deficient?

Keep in mind, if the contract says one thing and the parties’ conduct indicates something else, the parties’ conduct will control. That said, however, it’s important that the contract be clear on who is supervising or controlling. Be sure the contract sets that out. Name the supervisor if there is one, and be sure the supervisor checks in on the project regularly. If deliverables or milestones are involved, be sure to describe them, and describe who bears liability if the services or deliverables are deficient.

One final item of importance. If the services are believed not to be taxable employment services, the service provider should obtain an exemption certificate from the customer stating that services are consulting services or those of an independent contractor and referencing R.C. 5739.01(JJ)(1). R.C. 5739.03(B)(1)(a) now requires a vendor to obtain an exemption certificate if the customer claims that any one of R.C. 5739.01(JJ)’s exceptions applies.

With this information, Patricia went back to the VP and asked few more questions, reviewed the contract, and called the customer, who was very impressed with Patricia’s knowledge and analysis.

They both agreed that the services were not taxable employment services. Mahesh had knowledge and skills above and beyond that of Nexus Corp’s employees (because its IT director was out), Nerd Squad had been hired to complete a specific task (oversee and complete the data and software migration) and while Mahesh was required to work onsite according to Nexus’ work hours and policies and take direction from the VP of Operations as significant issues arose, those “directions” resulted from decisions that would ordinarily made by a company’s management and not a consultant. Finally, the contract provided that Mahesh was under the supervision and control of Nerd Squad and that Nerd Squad would bear liability if the migration failed or was not completed on time.

Nexus Corp promptly executed an exemption certificate, and Patricia put it in her files.

About the Author: Steve’s Ohio tax experience began in 2006 at the Ohio General Assembly where he drafted the State’s tax legislation. Steve quickly became a expert on Ohio’s manufacturing, restaurant, oil and gas, R&D, and other sales tax exemptions and on the taxability of data processing, cloud computing, employment, and other services. In 2011, Steve joined Big 4 firm pwc and gained experience on a national level. Steve also worked for a global software development company where he was responsible for sales, use & other tax compliance.
Comments or questions may be submitted to this sales tax specialist by using the on-page "Comment" feature which follows a post, subject to disclaimer on page. You may also send a question or request directly to Steve by using the orange REQUEST link on his Firm Profile page.

Other recent “Ohio (OH)” posts by Steve Estelle, Esq.:

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