ISSUE BRIEF

Prepared by AIA Oklahoma

A Component of the American Institute of Architects with over 500 member architects in Oklahoma

Taxation of Architectural Services

April 2002

ISSUE

AIA Oklahoma, a component of the American Institute of Architects, believes tax reform is necessary to grow Oklahoma's economy. However, AIA Oklahoma is very concerned that a sales tax on architectural services would be detrimental to architectural businesses.

STATEMENT OF CONCERNS

Competitive Disadvantage: A sales tax on services will place Oklahoma architectural firms at a competitive disadvantage with out-of-state firms. The tax will favor out-of-state firms that may or may not be subject to the tax. Architecture is already a highly competitive business. The additional cost of sales tax on architectural services will cause many Oklahoma clients to seek services from outside our state to avoid paying this added cost. Even if the tax is applicable to out-of-state firms, the state would find it difficult to collect.

Small Business Disadvantage: Small, rural, single discipline firms will suffer most. Small architectural design firms contract-out for many legal and accounting services that large firms provide internally. Because the smaller firms will not be able to bring these services in-house, they will have to pay sales tax on their consultants' fees, in effect "pyramiding" the impact of the tax which must eventually be reflected in a further increase in their own fees.This will be particularly detrimental to small firms, which tend to rely primarily on in-state business and must already compete for in-state projects with larger out-of-state firms.

One More Reason Not To Do Business in Oklahoma: It also will not make economic sense for clients outside Oklahoma to hire Oklahoma firms which must charge sales tax on their services. A number of architectural and engineering design firms presently export their services outside the state. This exporting of services creates Oklahoma jobs and generates Oklahoma tax revenues. When a purchaser of architectural design services can obtain those services from a non-Oklahoma firm and avoid a tax on services, he or she will do so. The net result will be less design services provided by Oklahoma firms, less income and profit for Oklahoma firms, and one more reason not to do business in Oklahoma. The tax will cause larger architectural and engineering design firms and other frequent users of design services to relocate outside the state, significantly reducing jobs and tax revenue.

Pyramiding Will Occur: This same "pyramiding" will occur when small, single-discipline firms subcontract for engineering design services. Typically, engineering design fees make up in excess of 50% of a project's total fee structure. This will result in tax "pyramiding" on more than 50% of the total design fee.

An Administrative Nightmare and Bureaucracy Grows: A sales tax on services will be an administrative nightmare for both design firms and government. Architectural design firms, as the collectors of the sales tax, will be responsible for keeping records of the tax collected and remitting that tax to the state. Collection and remission of the tax will require more administrative staff or contracting for this service to be performed by others. Similarly, large increases in state tax bureaucracies and administrative budgets will be necessary to cope with the large number of new businesses subject to a sales tax on services. This tax is much more costly to administer than taxes on existing goods and limited services.

AIA Oklahoma, Post Office Box 18714, Oklahoma City, OK 73154

Phone 405.810.8809 FAX 405.840.5730 aiaok@worldnet.att.net

BACKGROUND

Like all professionals, architects seek to make a profit on the services they provide to the public. As a business, architects pay licensure and other costs related to registering as a business. Although relatively few, some states have an additional tax on architectural services. Almost every state component has defended the profession against such a tax in recent years – and the pace of the proposals has increased this session as legislators struggle to generate revenue for spending priorities. The taxation of architectural services comes in various forms – most often as a sales tax, an excise tax or a gross receipts tax.

HOW THIS AFFECTS THE DESIGN INDUSTRY

Many services–haircuts, lawn care services, and auto repair services, for example--are already taxed in many jurisdictions. On the surface, ‘broadening’ the tax base to include professional services seems a simple option for states. But substantive reasons exist that prove taxing professional services – especially architectural services – makes poor economic sense. In states and localities where the tax is assessed, several realities have emerged. Some clients will seek non-professionals to perform work in order to avoid the extra costs associated with the tax. This conflicts with the goal of state laws that require licensing of design professionals to protect the health, welfare, & safety of the public. The tax may further adversely affect the quality of the built environment by encouraging re-use of old plans to cut costs, thereby reducing new and innovative building design. Small in-state firms confined by the tax loose a competitive advantage to multi-state firms who can farm the projects out to an out-of-state office, thus avoiding the tax. Over 50 percent of AIA member firms have fewer than four employees. Overall, the taxation of architectural services favors out-of-state firms that are not subject to the tax. Since architectural services are high-cost items involving long-term capital expenditures, more clients could turn to out-of-state firms in order to avoid paying the tax. An estimated 30 percent of all 2001 billings from AIA member firms came from federal, state, and local governments, who often exempt their billings from the tax. In the end, many states have found revenues from a tax on architectural services are offset by the cost of additional administration, enforcement and litigation.