Several North Carolina interior design firms recently received past due notices from the state's Department of Revenue for sales taxes they failed to collect on their design and consultation services over the course of several years. Collecting sales tax from their customers on the purchase of furnishings, fabrics, draperies and other items — referred to by most state taxing authorities as “tangible personal property” — was something the designers had done diligently over the years, taking care to invoice those taxable retail sales separately from their design and consultation services.

But the N.C. Department of Revenue's notification that they should have been charging the state's 6.75% sales and use tax on design and consultation services provided to customers has left the designers with tax bills ranging from $8,000 to $200,000. Many say the policy, if left to continue, could put them out of business. In response, several groups have offered their support in lobbying the state legislature on the matter, including the Carolinas chapter of the American Society of Interior Designers, the Interior Design Society, the High Point Chamber of Commerce and the High Point Market Authority.

Thomas Beam, the NCDOR's external communications manager, said the central issue is the definition of sales price, and that although there's been a lot of recent attention given to the definition of interior design services, the law defining sales price has been around for more than 50 years.

In a January High Point Enterprise article, Winston-Salem designer Emmy Williams said it's an interpretation the NCDOR has just begun applying and that the design firms received no warning or notification. “If you had told me in a technical bulletin that interior designers are a special group and you have to charge sales tax, there's not a single one of us that wouldn't have been following the law,” she said.

Beam references a statute adopted in 1957 that says services (such as design consulting) directly related to the sale of tangible personal property are considered part of the sales price of the tangible personal property. “That definition has been applied numerous times over the years, with more frequency in recent months because auditors saw a pattern of non-compliance,” he said.

Confusion about how and when purchases obligate the designer to connect the retail transactions with consulting services is another problem. Furniture/Today Business Editor Larry Thomas covered remarks made by Williams and another designer before the ASID in February 2008. At that time, the designers said they were told by state tax auditors that any time a designer sells a product to a client, not only does the entire consulting fee become subject to sales tax, but so do consulting fees for all past and future work with the same client.

Andy Sabol, director of the sales and use tax division for the NCDOR, said formal guidelines clarifying the application of sales tax policy should be accessible online soon (as soon as it's available, the link will be provided on my Retail Update blog at homeaccentstoday.com). Sabol said those guidelines will include “detailed explanations of why design services are not taxed when retail sales occur after design services are complete, as well as how, in the scope of large design projects or long-term client relationships, only the design services that are directly connected to retail sales are taxable.” The guidelines also stress the importance of keeping good records that reflect design services that are not tied to retail sales.

In the process of reading and writing about the North Carolina designers' dilemma, I began to wonder about the taxation of design services in other states. What I found should come as no surprise — the taxation policies regarding professional design services vary as widely as the profession's licensing rules and regulations. However, the Washington-based nonprofit, Federation of Tax Administrators, attempts to gather and report the sales tax policies of all service groups every few years with its Service Taxation Survey, the most recent being the 2004 version.

According to the FTA's findings, in 2004 the following states were either exempt from collecting sales tax on Interior Design and Decorating Services, or they did not collect sales tax at all: Alaska, Arkansas, Colorado, Connecticut, District of Columbia, Idaho, Illinois, Kentucky, Louisiana, Massachusetts, Missouri, Montana, Nebraska, Nevada, New Hampshire, North Dakota, Oklahoma, Oregon, Rhode Island, South Carolina, Texas, Utah, Vermont, Wyoming. Michigan, listed in 2004 as exempt, expanded its 6% sales tax last December to services, including interior design.

In 2004, the following states charged flat sales tax rates in the amounts indicated for all goods and services: Hawaii, 4%; Iowa, 5%; New Mexico, 5%; New York, 4.25%; West Virginia, 6%. In Delaware, a flat tax rate applied to gross receipts in excess of $50,000 per month. The state of Washington charges a business and occupation tax that varies depending on the business activity.

The rest of the states in the 2004 Survey were designated as “exempt” subject to footnoted remarks such as North Carolina's, which read “Retail sales of tangible personal property by interior designers are subject to the general state tax and applicable local sales tax.” Case in point — everyone reads, interprets and reports things differently.

It's all very confusing and promises to remain so. The moral of the story is to go beyond just staying current on the sales tax issue — make sure you thoroughly understand your local and state taxing authority's application and interpretation.

To comment on this story, please write to me at susan.dickenson@reedbusiness.com or share your thoughts on my blog at HomeAccentsToday.com.