Tax Consideration for Warranty Providers

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State Income Tax Considerations

Businesses dealing in service contracts are generally subject to state income tax in any state in which they have the requisite nexus. It is important to note that while providers of service contracts might only have a physical presence in one state, their connection to other states through licensure, dealers of their warranty products, or contractors (repair centers) fulfilling their warranty obligations could create nexus for the warranty company in other states. Furthermore, the purposeful availment of a state’s marketplace might in and of itself create nexus.

It is also important to note that even though certain service contract providers might be treated as insurance companies for federal income tax purposes, they are typically not deemed to be insurance companies under state law. Therefore, the service contract providers are not typically subject to state premium taxes and as such are not able to avail themselves of the “in lieu of” provisions exempting themselves from state income tax. Service contract providers with nexus in a given state are typically required to file a corporate income tax return using federal taxable income as the starting point for the calculation of state taxable income.

State Sales and Use Tax Considerations

As with state income tax, a service contract provider may potentially have a sales and use tax filing obligation for any state where their warranty products are being sold or repairs being fulfilled. States differ in their treatment of warranty contracts with most falling into one of two categories:

  1. States that subject the warranty contract to sales tax and exempt any subsequent services provided under that contract; and

  2. States that exempt warranty contracts and tax the subsequent services provided under the contract.

Within each of these categories, there are many state-specific nuances and documentation requirements. It is common in this space for the warranty to be provided through a third party, which typically requires the service contract provider to collect and maintain proper exemption documentation on file (e.g., resale certificates). Because multiple levels of sellers can be involved, it is common for parties to assume that the collection of tax is occurring elsewhere, when in actuality, no tax is being captured on the transaction. For the states that fall into the second category above, this can also create a use tax obligation for inputs used in fulfilling the repair.

DHG has helped multiple warranty service providers facing these scenarios navigate this process to become compliant with minimal disruption to their business.  Some of the services that DHG provides in this space include comprehensive diagnostic reviews to determine where gaps may exist, nexus studies to determine which jurisdictions a warranty service provider may have a legal obligation to register and file in, voluntary disclosures to address prior periods where material exposure may exist, registration / compliance services for current and future filing obligations, and audit representation for clients facing audits and inquiries from state revenue agencies.