If I offer customers a discount for paying early (or charge a fee for paying late or not ordering electronically), how does that affect the sales tax I have to collect?

Subject

Cash Discount — Computation Of Sales Tax

Plain-English summary

A seller asked the Comptroller how sales tax applies to four different billing arrangements it uses with customers, each involving a separately stated line-item fee or discount tied to payment timing or ordering method:

1. "A/R" late fee -- if a customer doesn't pay within the agreed time, they're charged a percentage-based fee on future purchases, shown as a separate line item. Response: not taxable, because a separately stated charge for late payment is not part of the sales price.
2. "EOE" (Electronic Order Entry) fee -- if a customer doesn't place at least an agreed percentage of orders electronically, they're charged a percentage-based fee on all orders (a separate line item) until they meet the threshold again. Response: taxable, because the Comptroller treated it like a price increase for orders that don't qualify for a volume/method-based reduction -- it's part of the selling price.
3. "A/R" fee used as an early-payment discount -- if the customer pays within the set number of days, they get a percentage discount, listed as a line item that reduces the invoice total. Response: not taxable on the discounted portion -- a true cash discount for early payment is not subject to tax; tax applies to the reduced amount actually billed.
4. "EOE" fee used as a discount for exceeding the electronic-order percentage -- similar to #3, but tied to exceeding (rather than missing) the ordering threshold. Response: treated like a cash discount -- tax applies to the actual selling price net of the discount.

The letter also draws a related distinction found in the "A/R" late-fee discussion: a genuine late-payment charge is not taxable, but if a customer forfeits an early-payment discount by paying late, that forfeited discount is not treated as a nontaxable late charge -- it's added back into the taxable sales price.

What this means for you

Sellers who offer early-payment or volume/method discounts

If you give customers a true cash discount (e.g., a percentage off for paying within a set number of days, or for meeting an electronic-ordering threshold), sales tax is computed on the discounted price actually charged, not the original list price -- as long as the discount is genuinely for early payment or meeting the agreed condition.

Sellers who charge late fees or non-compliance surcharges

A separately stated fee charged purely for late payment is not taxable. But be careful: if that same fee structure is actually a forfeited early-payment discount (i.e., the customer loses a discount they would have gotten for paying on time), the Comptroller treats the forfeited amount as taxable sales price, not as an exempt late charge. Similarly, a surcharge for falling short of an ordering-method target (like the "EOE" fee) is treated as part of the taxable selling price, comparable to a price increase for smaller or less-efficient orders.

Accountants and bookkeepers

Watch the labeling on invoices -- whether a line item is called a "fee" or a "discount" doesn't control the tax result; what controls is the underlying economics: true late-payment charges are exempt, true early-payment/cash discounts reduce the taxable base, and forfeited discounts or non-compliance surcharges are added to (or excluded from reducing) the taxable base.

Common questions

Q: If I give a customer a discount for paying their invoice early, do I still collect sales tax on the full pre-discount amount?
A: No. Per this letter, a cash discount for early payment is not taxable, and tax applies to the reduced (discounted) selling price actually billed.

Q: I charge a separate late fee if a customer misses the payment deadline. Is that fee taxable?
A: No, a separately stated charge for late payment is not taxable, according to this ruling.

Q: What if the "late fee" is really just the customer losing an early-payment discount they would have otherwise gotten?
A: Per this letter, a forfeited early-payment discount is not treated as a nontaxable late charge -- it is taxable, because it's effectively part of the sales price.

Q: I charge customers extra if they don't place enough of their orders electronically. Is that surcharge taxable?
A: Yes. This letter treats that type of fee as comparable to a price increase for orders that don't qualify for a reduction, so the full charge is taxable. Conversely, a discount for exceeding the electronic-ordering target is treated like a cash discount and reduces the taxable price.

Citations and references

No specific statutes or administrative rules are cited in the body of this letter.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9603L1404G04

Original ruling text

March 25, 1996

Dear **:

Thank you for your letter dated March 12, 1996,
concerning the taxability of late charges and discounts. The transactions you
asked about are restated below followed by our response.

1. Your customers are under agreement to pay their bill
   in a set number of days. If they fail to do so, you charge a fee. The fee is
   an agreed upon percentage of their future sales to you. For example, they may
   have agreed to a 1% fee. If they do not pay within 60 days for example, and
   they order $200 of merchandise from you, they are charged with an "A/R" fee of
   $2.00. This is a separate line item on the invoice. Once the account remits
   to us the over due amount plus any new amount which is now due within the
   agreed payment time frame, the "A/R" fee is no longer charged. As you may
   imagine, the "A/R" fee charge is therefore billed to the customer
   inconsistently. If the customer pays on time, they are never charged this fee.
   Would the "A/R" fee be subject to sales tax? Response: A separately stated
   charge for a late payment is not taxable. However, a forfeiture of an early
   payment discount is not considered a late charge and is taxable.

2. You have customers who have signed contracts to
   order from us electronically. Electronic Order Entry ("EOE") saves both us and
   the customer time and money. The contracts state that an agreed upon amount of
   orders must be "EOE", for example 90%. If for some reason, less than 90% of
   their orders are "EOE", the customer is charged an "EOE" fee. The "EOE" fee is
   an agreed upon percentage of their sales, for example 1%. It is similar to the
   "A/R" fee in its workings. If the customer orders less than 90% "EOE", they
   are charged a 1% "EOE" on all orders until they again meet the 90% agreement.
   This is a separate line item on the invoice. Would the "EOE" fee be subject to
   sales tax? Response: This is comparable to a price reduction for large orders
   or buy two and get the third one for 1/2 price, etc. The "charge" is part of
   the selling price and is taxable.

3. The "A/R" fee discussed in #1 can also work to the
   customers advantage. If the customer pays in a set number of days, for
   example, 15 days, they can receive a discount. For example, a customer pays in
   15 days and then places an order for $1,000. If the agreed rate is .5%, they
   will have listed on their invoice "A/R" fee ($5.00) and therefore sales billed
   would be $995. Would this "A/R" fee be subject to sales tax? In other words,
   would tax apply to $1,000 or $995? Response: A cash discount is not subject to
   tax (a selling price is discounted for early payment).

4. The "EOE" fee in #2 can also work to the customer's
   advantage. If the customer exceeds the required percentage, for example, 95%,
   they can receive a discount. This is a similar situation to #3 above. The
   customer would receive for example, a .5% discount, on future sales until they
   fail to meet the second 95% percentage. This is also a separate line item on
   the invoice. Would this "EOE" fee be subject to sales tax? Would tax apply to
   $1,000 or $995? Response: This is comparable to a cash discount. The actual
   selling price which is less the "discount" is the amount subject to sales tax.

This opinion is based on the facts presented.
Different facts though similar, may result in different answers. Call me if
you have any questions or need more information. The toll free number is
1-800-531-5441, and my extension is 50330. The direct line is 512/475-0330.
You may also write to Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Bettie Peterson
Tax Policy Division

NOTE: Previous Accession Number 9603123L