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Why California's sales-tax loophole should be closed

by Michelle Lanz | Take Two®

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A view of the California State Capitol in Sacramento. The state legislature has announced it will suspend provisions of the Brown Act public meeting law in an effort to shave 96-million in spending over the next three years. Justin Sullivan/Getty Images

Under current California sales tax rules, your local sandwich shop can charge sales tax for your meatball sub, but not for your cold cut trio. Does that make sense?

No, says Sacramento Bee columnist Dan Walters in a recent column calling for California to revamp its outdated sales tax system. In particular, Walters focuses on a provision that exempted software purveyors who develop custom software for other companies from paying sales tax on that software. 

For example, if Company A developed payroll software for Company B and charged them $5 million, they would not have to pay state and local sales tax on that sale because the product isn't considered "tangible personal property." However, software the average consumer buys off the shelf, being literally tangible, is subject to sales tax. 

"It turns out that there are a couple of court decisions that indicate that maybe the off the shelf software may not be taxable after all because the thing called the "transfer of technology" is not taxable," said Walters. "The governor wants the legislature to pass a bill saying 'yes indeed we can continue to tax off the shelf software,' but he doesn't want to do anything about the tax emption for custom software. I think that's unfair and it's illogical and if that's a loophole it should be closed."

Walters says that only taxing tangible items is outdated. In particular how cold food is not taxable, groceries are not taxable, but hot food is. Also, if you buy cold and hot food together, your whole purchase is taxable. 

"The craziest thing happened a few years ago when the movie industry went to the board of equalization and said they shouldn't have to collect tax on popcorn because popcorn may ave been hot when the customer bought it at the counter, but by the time the customer got back into the theatre and sat down, the popcorn was cold and therefore should not be taxed," said Walters.

Walters says the nature of the economy may change over time, but tax laws rarely change. 

"What we deeply need in California is tax reform. We need to rationalize the tax system, and not just the sales tax system but the income tax system as well," said Walters. "We have the worst possible taxation system: we have narrow bases of taxation both income and sales tax and very high rates, we should have broader bases and lower rates but no we go with this crazy system and it gets crazier every year. There's always a new exemption built in so they just build up over time until you have this crazy quilt of tax laws that make absolutely no sense."

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