When a business buys custom software along with taxable hardware, is the software taxable — and what happens if the vendor doesn't separate the software price from the hardware price?

Plain-English summary

Rock's Tire and Battery, Inc. bought a computer system after months of detailed analysis by a vendor. On the initial purchase, most of the hardware and about half the software were bought, and the bill did not separate the software price from the hardware price. Since then, Rock's has bought software updates (to keep the system current with tax-law changes) and plans to buy the rest of its accounting programs one at a time, each preceded by a brief vendor analysis and installation.

The Department held: the custom software is exempt, but a bundle with no separated software price is taxed in full.

• The software qualifies as exempt. Per Technical Services Bureau Bulletin 1978-1, software is exempt intangible property when the vendor must analyze the customer's requirements or adapt the program to the customer's environment. Rock's software required analysis of its equipment and modifications to be compatible, so the software is an exempt intangible.
• Hardware is taxable, and mixing prices taxes everything. Computer hardware is taxable tangible personal property. If a vendor doesn't segregate the taxable-hardware charge from the exempt-software charge, the vendor must collect sales tax on the ENTIRE charge.
• The initial unit purchase is fully taxable. Because Rock's initial hardware-plus-software purchase was billed as one unit without separate prices, it's taxable in its entirety.
• Later software and updates can be exempt — if billed right. Subsequent purchases of software and software updates are exempt, but only if a separate charge is made for them and the vendor must perform analysis or modification before installing them.

What this means for you

Custom software can be exempt, but a sloppy invoice can tax the whole deal. In 1988, New York treated software the vendor had to analyze or adapt as an exempt intangible. But that exemption only helps if the software is separately priced. Lump exempt software together with taxable hardware on one undifferentiated charge, and the vendor has to charge tax on everything.

Separately state the software. For the exemption to reach the software (including updates), the invoice must break out a separate charge for it — and the vendor still has to be doing the qualifying analysis or adaptation before installing it.

The rules have changed. This reflects New York's 1988 treatment of software. New York's software-taxation rules have changed since, so confirm the current law before relying on this for a present-day purchase.

Common questions

Q: I bought a computer system where hardware and software were billed together. Is the software still tax-free?
A: No. If the vendor didn't separate the software charge from the taxable hardware charge, tax applies to the entire bundled amount — even though the software would qualify as exempt on its own.

Q: How do I keep my custom software exempt?
A: Make sure the vendor states a separate charge for the software (and updates), and that the vendor actually analyzes your requirements or adapts the program before installing it.

Q: Are the ongoing tax-law software updates taxable?
A: Not if they're separately charged and the vendor performs analysis or modification before installing them.

Q: Can I rely on this today?
A: Be careful — New York's rules for taxing computer software have changed since 1988. Verify the current rule for any present-day purchase.

Citations and references

Statute and authority:

• Tax Law Articles 28 and 29 — impose New York State and local sales and use tax; hardware is taxable tangible personal property, and a vendor who fails to segregate a taxable charge from an exempt one must collect tax on the entire charge
• Technical Services Bureau Bulletin 1978-1 (Computers) — treats software as exempt intangible property when the vendor must analyze the customer's requirements or adapt the program to a specific environment

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1988.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a88_28s.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-A-88(28)S
Sales Tax
May 26, 1988

Taxpayer Services Division
Technical Services Bureau

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. S880128B

On January 28, 1988, a Petition for Advisory Opinion was received from Rock's Tire and
Battery, Inc., 417 Oriskany Street West, Utica, New York 13502.
The issue raised is whether the purchases of software under the following conditions are
subject to sales tax under Articles 28 and 29 of the Tax Law.
Petitioner, after months of detailed analysis by a vendor, purchased a computer system.
Initially, most of the hardware and about half of the software were purchased. The initial billing did
not segregate the price of software from the price of hardware.
Since the initial purchase, Petitioner has purchased program updates. The software updates
are produced by a software company and sold through a local vendor and installed by such vendor.
This particular software is used to keep Petitioner's computer system current with changes in the tax
laws.
Petitioner is also planning to purchase the remainder of its accounting programs through the
initial vendor. These programs are pieces of the whole system which was analyzed previously and
which Petitioner is purchasing on a planned one-program-at-a-time basis. When Petitioner is ready
for each succeeding piece of the system to be installed, he contacts the software supplier. The
supplier makes a brief analysis of Petitioner's needs, sizes Petitioner's files and completes the
installation process.
Technical Services Bureau Bulletin 1978-1 defines software as:
"Instructions and routines (programs) which, after an analysis of the customers specific data
processing requirements, are determined necessary to program the customer's electronic data
processing equipment to enable the customer to accomplish specific functions with his EDP system."
To be considered exempt "software" for purposes of this bulletin, one of the following elements must
be present:
A.

Preparation or selection of the program for the customer's use requires an analysis of the
customer's requirements by the vendor.
or

B.

The program requires adaptation, by the vendor, to be used in a specific environment, i.e.,
a particular make and model of computer utilizing a specified output device. For example,
a software vendor offers for sale a pre-written sort program which can be used in several
computer models. Prior to operation, instructions must be added by the vendor which specify
the particular computer model in which the program will be utilized.

RODERICK G. W. CHU, COMMISSIONER
TP-8 (3/83)

GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR

-2­
TSB-A-88(28)S
Sales Tax
May 26, 1988
Since Petitioner's software requires analysis of its computer equipment and certain
modifications are necessary to make the software compatible to such equipment, the sale of such
software is considered the sale of an intangible and thus not subject to sales tax.
However, the sale of computer hardware is the sale of tangible personal property and is
subject to tax. If a vendor fails to segregate the charges for taxable hardware from exempt software,
the vendor is required to collect sales tax on the entire charge.
Accordingly, Petitioner's initial purchase of hardware and software as a unit without
segregation of the prices of each is subject to tax in its entirety. Subsequent purchases of software
and software updates are exempt from sales tax if a separate charge is made for such software or
software updates and if the vendor must perform analysis or modification before installation of the
software or software updates.

DATED: May 26, 1988

s/FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.