Does a county owe sales tax on debt-collection legal services performed by a law firm, and is the law firm's reimbursed expenses treated as taxable debt collection or sales tax?

Subject

Attorney Fees — Nontaxable Legal Services

Plain-English summary

This letter responds to concerns about a contract between a county (referred to as "COUNTY A") and a law firm for the collection of delinquent taxes. The Comptroller confirmed that the county does not owe sales tax on the law firm's services, for two independent reasons.

First, COUNTY A is an exempt governmental entity, so it doesn't owe sales tax on its purchase of debt collection services in the first place. Second, and more broadly, the letter states that legal services performed by an attorney to recover debts for a client are not taxable as debt collection services at all — that holding would apply even to a non-exempt client.

The letter also addresses reimbursed expenses. If the contract requires the county to reimburse the law firm for expenses, some of those expenses may include sales tax the law firm itself already paid when it purchased taxable items (like copies, faxes, or information services) used to perform the contract. Passing that cost through as a reimbursement is not treated as collecting sales tax from the county, as long as the law firm's records clearly show it's a reimbursement rather than a tax charge.

Finally, the letter notes that an attorney generally pays sales tax on taxable items (copies, faxes, information services, etc.) used to provide legal services, and that stating those items separately on the bill doesn't change the fact that the attorney is fundamentally providing nontaxable legal services. The letter suggests that the county could reduce reimbursed costs by having the attorney act as its purchasing agent — using an exemption certificate showing the county is the real purchaser — for taxable items bought in performing the contract.

What this means for you

Government entities hiring attorneys for debt collection

If your governmental entity is exempt from sales tax and you hire a law firm to collect delinquent debts (such as delinquent taxes), you don't owe sales tax on those legal services. This is true both because of your exempt status and because attorney debt-collection services are not treated as taxable "debt collection services" to begin with.

Law firms billing for debt-collection or other legal work

If you pass through reimbursed expenses to a client that include sales tax you paid on your own purchases (copies, faxes, information services, etc.), that pass-through is not the same as charging the client sales tax — but your records need to clearly show it's a reimbursement of your own cost, not a tax collected from the client. You can also consider acting as your client's purchasing agent, using an exemption certificate, when the client is tax-exempt and you're buying taxable items to use on their behalf.

Accountants and tax professionals

Note the letter's two-track reasoning: the exemption for COUNTY A rests on its governmental status, while the "legal services aren't taxable debt collection services" holding is described in general terms and isn't limited to exempt clients. Also flag the agency/exemption-certificate mechanism described here as a way exempt clients can reduce reimbursed costs on taxable items purchased in connection with legal services.

Common questions

Q: Does a governmental entity owe sales tax when it hires a law firm to collect delinquent taxes?
A: No. As an exempt governmental entity, the county does not owe sales tax on the purchase of debt collection services, and in any case, legal services by an attorney to recover debts are not taxable as debt collection services.

Q: If the law firm bills the county for reimbursed expenses that include sales tax the firm paid, does that create a sales tax charge to the county?
A: No, as long as the law firm's records clearly show the amount is a reimbursement of the firm's own expense, not a collection of sales tax from the county.

Q: Do attorneys pay sales tax on things like copies, faxes, and information services used to do legal work?
A: Generally yes — an attorney pays sales tax on taxable items purchased to provide legal services, even if those items are separately stated as expenses on the client's bill, because the underlying service being provided is nontaxable legal services.

Q: How could the county reduce the reimbursed cost of taxable items purchased for the contract?
A: The letter suggests the attorney could act as the county's agent when purchasing taxable items, using an exemption certificate showing the county is the actual (exempt) purchaser and the attorney is simply its authorized purchasing agent.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9607L1423G12

Original ruling text

July 22, 1996

Dear **:

Thank you for your letter expressing your concerns about the contract for the
collection of delinquent taxes between COUNTY A and the law firm of LAW FIRM.

COUNTY A, as an exempt governmental entity, does not owe sales tax on the
purchase of debt collection services. In any case, legal services by an
attorney to recover debts for a client are not taxable as debt collection
services. Therefore, COUNTY A is exempt from paying sales tax on the services
provided by the law firm. If the contract calls for the reimbursement of
expenses incurred by the law firm, some of these expenses may include sales
tax paid by the law firm when purchasing taxable items used in performance
of the contract. The reimbursement of the expense of sales tax is not
regarded as the collection of sales tax from COUNTY A provided the law firms'
records clearly shows this to be a reimbursement.

Generally, an attorney pays sales tax on purchases of copies, faxes,
information services, and other taxable items used in providing nontaxable
legal services. Even if these items are separately stated as expenses on the
attorney's bill, the essence of what the attorney is providing the client is
nontaxable legal services. In some instances, an attorney will act as agent
of a client when purchasing taxable items and give an exemption certificate
that shows the exempt entity is actually making the purchase and that the
attorney is simply the authorized agent to make that purchase for the exempt
entity. COUNTY A may wish to make purchases of taxable items used in
performance of the contract in this manner to reduce the cost that has to be
reimbursed.

I hope this information is helpful. Should you have any further questions,
please feel free to call David Somerville in my Tax Policy Division at
1-800-531-5441, extension 5-0030.

If I can be of any further assistance, please let me know.

Sincerely,

JOHN SHARP
Comptroller of Public Accounts