Iowa businesses enjoy some of the most generous sales tax exemptions for computer hardware and software in the nation. However, until recently, outdated definitions in Iowa’s statutes and regulations have made it difficult for both taxpayers and auditors to draw the line between taxable and exempt purchases.
Recent statutory changes and guidance issued by the Iowa Department of Revenue will help bring Iowa’s sales tax rules for both hardware and software into the 21st century.
Since 1985, most for-profit businesses in Iowa have been eligible to purchase computer hardware exempt from tax. The computer hardware exemption has been interpreted to include obvious computer hardware items such as laptops, desktops, monitors and printers. Computer software that is downloaded onto a user’s machine has historically been considered exempt, whereas software received on a disk is taxable.
But what about networked multifunction printer/scanner/fax machines, wireless routers and hotspots, firewall equipment, smartphones and tablets? On the software side, what is the tax treatment of Software as a Service and cloud-based information services? These are products and services that didn’t exist in 1985 and, until recently, the only guidance provided by the state included out-of-date examples such as plotters, card readers, tape punchers and digitizers.
In recognition of this problem, a bill was passed during the 2019 legislative session requiring the Department of Revenue to initiate and coordinate the Taxation and Exemption of Computers Task Force, consisting of representatives from the Department, business, manufacturing and taxpayer associations.
The purpose was to review the definition of “computer,” as used throughout portions of the Iowa Code and regulations. As a result of the Task Force efforts, the legislature enacted a tax bill in 2020 that modernized definitions and specifically expanded the exemption to include not only computers but also “computer peripherals” when used by manufacturers, insurance companies, financial institutions and commercial enterprises, among others.
Computer peripherals are defined as ancillary devices connected to a computer digitally, by cable or by other medium, used to put information into or get information out of a computer.
On Jan. 15, 2021, the Iowa Department of Revenue released guidance in the form of a non-exhaustive list of taxable and exempt computer hardware items. The guidance addresses the taxability of the hardware purchases listed above as well as many others. The department also acknowledged that refund claims will be accepted if taxpayers have paid tax on the purchase of a qualifying exempt item.
On the software side, the Iowa Legislature enacted changes that were effective in early 2019 that expanded the imposition of Iowa sales tax to include purchases of Software as a Service, as well as certain downloaded or streamed products. Since very few software transactions include the receipt of a compact disc, thumb drive or any tangible media or the downloading of software onto a specific server or computer, the changes were an attempt by the legislature to address current transactions.
In addition to imposing the sales tax on purchases of Software as a Service, the legislature also enacted a “commercial enterprise” exemption that provides most for-profit business an exemption from the tax on Software as a Service. The net result is that most for-profit businesses do not pay sales tax, while individuals and nonprofit organizations are required to pay sales tax.
Iowa taxpayers might be overpaying sales tax on computer hardware and software purchases that are exempt in Iowa. The new guidance impacts businesses in all industries, except for nonprofit companies and certain professional services and occupations.
It is recommended Iowa businesses review invoices for purchases of computers, computer peripherals and software to ensure sales tax is accurately charged. Taxpayers who identify overpayments can apply to the department for a refund for up to three years after the date of purchase. Iowa businesses that are uncertain whether they are impacted by the recent Iowa Department of Revenue guidance or have questions should speak to their tax advisers.