If you are a seller, you’ve likely received a tax exempt form from a customer claiming an exemption on their purchase. From a seller’s perspective, it may not be clear who is entitled to a sales tax exemption on their purchases or much less why they’re exempt.
There are three basic types of organizations that are generally exempt from sales tax across the states. How are these organizations granted an exempt status? Let’s dive in.
States are prohibited from taxing direct sales to the Federal Government under the principal of federal sovereignty and the supremacy clause of the U.S. Constitution. Some states specifically include an exemption for sales to the Federal Government. Others simply exempt sales that they are prohibited from taxing under the U.S. Constitution.
However, sales to government contractors might not receive the same treatment. The tax treatment of purchases by government contractors remains a troublesome issue in many states. Several states have had court decisions ruling on the taxability of government contractors’ purchases. The key concept in the various cases is whether title passes to the Federal Government and/or the items are resold to the Federal government. The states’ court decisions vary on exempting Federal contractor purchases.
Contractors must pay sales/use tax on purchases of tangible personal property and taxable services pursuant to contracts with the Federal government in which the contractor is the consumer of the property or services. States like Arkansas, Kentucky, and Michigan, among others, do not exempt government contractors purchases in such cases.
For all sales to the Federal Government, evidence of the sale must be retained in order to claim the exemption. Some states will exempt sales only substantiated by a government purchase order. Others will permit an exemption for sales paid with a federal government credit card.
Unlike the exemption for the Federal Government, which applies to all states, the exemption for state and local governments is purely a product of the legislative process. States are free to provide exemptions without question of discrimination against other non-governmental agencies.
Some states provide exemptions to state governments of other states only if the other state provides a similar exemption. North Dakota requires reciprocal treatment of exempt sales to political subdivisions by other states.
Not all states provide an exemption for sales to themselves. For example, Florida, Illinois, Indiana, Maryland, and Texas do provide an exemption for the state government, but Arizona, California, Hawaii, South Carolina, and Washington do not.
Sales to certain branches of government may be provided an exemption under other provisions. For example, sales to government agencies may be taxable, but sales to educational institutions may be exempt. Therefore, public schools operated by a municipal or state government may be exempt. For example, in Minnesota, sales to state or local governmental units are generally subject to tax, but the state exempts sales to public schools.
State legislatures are free to choose whether to tax nonprofit organizations and charitable organizations. There is no constitutional prohibition to taxing these types of entities. Most states provide some sort of exemption.
Certain requirements must be met for an organization to qualify for a sales tax exemption. Many states tie their exemption to federal provisions under Section 501 of the Internal Revenue Code. Other states tie their exemption determination to the purpose of the organization, i.e., charitable, religious, or educational, or simply not-for-profit.
Most states require an application by the organization for the exemption to apply. Additionally, a separate exemption number or letter may be issued for the sales tax exemption. The federal exemption letter will generally not be considered substantiation for the state sales tax exemption. For example, Illinois issues a separate exemption number beginning with an “E” in a letter which is required to support all exempt sales to the exempt entity.
For most states that grant an exemption to nonprofit organizations, the exemption is for their purchases of items used in conducting their exempt activities. Examples of potentially exempt organizations are schools, churches, nonprofit hospitals, and charitable organizations. If they make sales, these may be taxable – particularly if the sale is to the general public or if the sales compete with for-profit sellers.
Connecticut provides a sales and use tax exemption for qualifying nonprofits. Sales made at a nonprofit’s retail establishment like a thrift store or gift shop do not qualify for the exemption. However, the state does provide a special exception for sales made at fundraising or social events like fairs and picnics. A nonprofit organization may make sales at up to 5 fundraising or social events per year without collecting sales tax.
Exemptions are an opportunity to save your company or organization money. For this reason, knowing which sales tax exemptions are available in the states where you do business is crucial.
If you sell to various levels of government, you need to make sure your sales are treated correctly for sales tax. Make note of whether sales to state and local governments are exempt in the states where you do business and collect the appropriate exemption documentation.
Sellers who engage in business with nonprofit and charitable organizations must dive even further into state by state rules as states may exempt nonprofits with certain purposes, but not others. Some states, like Georgia, don’t grant sales and use tax exemptions to religious, charitable, civic, and other nonprofit organizations in general but allow limited exemptions from tax for qualifying nonprofits with specific missions.
If you work for a governmental or nonprofit organization, make sure you understand which forms must be completed in your state to secure sales and use tax exemptions on your purchases. Cost saving exemptions mean more money for your mission! And don’t forget to renew the exemption as they often expire.
To dive deeper into all types of sales tax exemptions, check out our new on-demand training: The Great Exemption Adventure: Finding Them, Applying Them and Making Sure They Stick. You will get a greater understanding of the different types of exemptions that are available and maybe even discover a few exemptions that you didn’t know existed!