It's not just California. Massachusetts and Rhode Island have similar sales tax laws. It basically comes down to this: someone has got to pay taxes on that phone -- since AT&T and Apple are not going to, it's your responsibility. The California State Board of Equalization FAQ lays out some of these rules, which are explained in more consumer-friendly terms by Dennis Rockstroh at the San Jose Mercury News.
When you purchase a subsidized iPhone, the retailer becomes responsible for taxes on the entire retail purchase price, despite any customer "discount" created in exchange for contract terms. In CA, MA, and RI (and possibly some other states) those taxes are passed on directly to the customer at the time of purchase.
Despite the advertising, the true price of the Apple iPhone 4 is $599 or $699, depending on the configuration. That's the price you'd theoretically pay to walk up and purchase units without making a contract commitment. Whether AT&T and Apple allow you to just "buy a box" without AT&T service or not is another story -- although if you live in Canada, you definitely will have the option of buying an unlocked and contract-free iPhone, which isn't possible now in the US.
Given the 'undiscounted' retail price, that's the price that sales taxes are calculated at. There is no discount because AT&T isn't having a sale on that item; it's simply kicking in a portion of the purchase price as an incentive for you to sign a two-year contract.
You're not really paying 20% in taxes, you're paying the normal sales tax rate -- it's just that you're buying into more than you think you are. The subsidy and contract hides some of your cost from the initial retail experience.
Sorry I don't have better news to share. It's not clear if you could avoid the sales tax slam by buying out-of-state, or if that would be legal -- best to consult your tax advisor, which would likely eat up any potential savings in a few minutes.
Love & hugs,
Thanks to reader Mark B. for pointing out the sales tax situation.
P.S. Reader Kevin emailed in to point out something that Auntie didn't consider: the sales tax charges over the course of the contract... which, in the case of CA, are nonexistent. Here's the relevant PDF (see the bottom). Kevin's comment:
The thing about California's sales tax law is that it's a tax on products only, not services as in many other states. That's the justification for not lowering the sales tax on the discount; since you're getting the discount by signing up for something you won't be taxed on, you don't get a tax break for it.
It's actually a better deal for consumers. In California, you pay $64.65 in tax on a 32 GB iPhone thanks to a 9.25% sales tax. Now, let's say you live in a place with a much lower tax rate for sales and use...5%. And let's give the person in that place a smaller 16 GB iPhone. They'd pay $9.95 in tax on the phone. But then, with a base $64.99 phone plan, they'd be paying $3.25 a month in tax. Over the life of the contract, that adds up to $87.95, much higher than the tax in California!
People always calculate the cost of an iPhone over the life of a contract, but never do it with tax. With this in mind, things in California don't look so bad, do they?
I don't know if this is the case in MA or RI.p.p.s. Reader Adam points out that Massachusetts has a flat rate "safe harbor" program, "where you can pay a flat rate amount of use tax along with your income tax that completely covers your obligation on out-of-state purchases for the year." We googled this up and discovered that "[t]he taxpayer may pay a combined use tax on purchases using the Safe Harbor method below, based on AGI, for all items purchased that cost under $1000." In other words, you can pay a few dollars ($35/year for Adam, but possibly less for many of our readers and slightly more for a few of you) and safely bring in tax-free iPhones purchased in New Hampshire.