Sales Tax 301

In Sales Tax 101, we covered the what, why and how of sales tax. In 201, we covered the steps companies take to collect and pay sales tax. Here we discuss exemptions.

There are two types of organizations who can generally claim tax exempt status:

  1. Governments

  2. Nonprofits & Charities

Federal Government

Under the U.S. Constitution, states are prohibited from directly taxing the federal government. Of course, in true sales tax fashion, there are nuances that add complexity to this rule.

  • Some states exempt all sales to the federal government. Others exempt the specific sales prohibited under the Constitution.

  • Government contractors may not be exempt from sales tax. This treatment varies by state based on what is being sold and who ultimately takes possession of the items. For instance, if the purchased items are going to be resold and end up as property of the federal government, they will likely be exempt from sales tax. However, if the products or services being sold are used by the contractor without resale, they are likely not exempt from sales tax. Ultimately, who the end user of the product is matters most.

  • How a company provides evidence of the federal exempt sale also varies by state. In some cases, a federal government purchase order is required. In others, a purchase made using federal government credit card is enough.

State & Local Governments

The state and local government exemptions have added complexity, as states are able to make their own rules about what is taxable.

  • Some states will provide tax exempt status to themselves and other state governments. Other states have no state government exemptions, not even for themselves.

  • In some states, individual branches of government may be treated differently. For instance, educational institutions (like public schools) may be exempt from sales tax, but other government agencies may not.

Nonprofit & Charitable Organizations

Another decision made at the state level is what nonprofit and charitable organizations can be taxed. Many states provide exemptions to these entities when specific requirements are met:

  • In many states, sales tax exemptions are granted to organizations that are registered as 501(c) nonprofits for federal tax purposes. Others use the specific purpose of the organization as the guide to sales tax exemption status.

  • Most states require the organization to submit an application directly to the state to approve the organization’s exempt status. States will often issue a separate exemption rather than relying on any pre-existing federal exemption.

  • The sales tax exemption likely only extends to purchases directly used in conducting exempt activities. If the organization is purchasing items to sell or is selling items they have produced, these transactions will likely be taxable.

Some individual transactions can also be sales tax exempt. The most common is when the purchaser intends on reselling the items to another consumer. In these cases, resale certificates are required to show the purchaser’s intent. Other cases vary widely by state based on the location’s strategy for the types of businesses they want to attract or support. For instance, some states will have exemptions for manufacturing equipment, high tech, agriculture, film production…and the list goes on.

Adding one more layer to the complexity is sales tax holidays. Some states participate in various sales tax holidays throughout the year to benefit consumers making qualified purchases. Holidays can include big ticket items like appliances, but the most popular exemption is for back to school purchases. Qualifications vary by state and are often regulated by the total purchase amount or the prices of items being sold. Typically, no documentation is needed for these holidays other than noting when the transaction occurred.

Sales tax exemptions help your customers save money, so it’s important to know which exemptions are available and make sure you’re treating each transaction correctly. To protect yourself, it’s critical to track each exemption, making note of where exempt sales are made and filing the correct documentation of each exemption.

Up Next: Sales Tax 401