Nonprofit Sales Tax Exemption – Simple or Complex?
“Can we get sales tax exemption?” Wagenmaker & Oberly, LLC law firm’s State Compliance and Tax Practice Group handles this question on a regular basis, usually for a specific state and increasingly with an eye toward online activity and multi-state legal compliance. Additional questions arise depending on whether the anticipated activities will involve purchases, sales, tangible goods, and intangible goods, as well as how and when such activities will be carried out. While this short question seemingly could be answered by a quick “yes” or “no” response, the answer usually warrants a more extensive and fact-specific legal evaluation. This article addresses key points of such evaluation for nonprofits, including purchases, sales, online activity, and guidance about state-specific dimensions.
A STARTING POINT
Nonprofit organizations are generally subject to state sales tax on retail goods for both purchases and sales, just like any other purchaser or seller. Certain exemptions may apply, however, depending on specific laws in the state where such retail goods are bought or sold. To fully address availability of sales tax exemption, several important questions warrant evaluating under the specific state’s law under which the nonprofit is operating in the seller or purchaser capacity. Each question helps determine what the nonprofit needs to do for optimal compliance with state sales tax requirements, as follows.
WHICH STATE(S) ARE INVOLVED?
State sales tax requirements vary broadly regarding what is taxed, any exemptions available, necessary registration and reporting, and how often any tax must be remitted to the state taxing agency. The first sales tax question is thus which states’ laws should be reviewed. The answer may include the state where the nonprofit has its headquarters, the state where it has a warehouse or fulfillment center, the state where it is conducting a particular program, or the state where a program participant lives or is receiving delivery of a product.
Once the nonprofit has narrowed down the states for review, the next question is whether its activity is limited to states that do not have a generally applicable state-wide sales tax, which leads to a fairly simple answer. Five states fall in this category: Alaska, Delaware, Montana, New Hampshire, and Oregon. Note, however, that Alaska allows local sales taxes, Montana has a sales tax in certain tourist locations, and each of these five states may have other specific taxes such as lodging/hotel taxes (as addressed further below). If a nonprofit leader asks about sales tax exemption in these five states, the response should be mercifully brief: no exemption request is necessary because there is no state sales tax!
SELLER OR PURCHASER?
Some states broadly exempt nonprofit organizations from requirements related to collection and remission of sales tax when they sell retail goods, based solely on their federal Section 501(c)(3) status. These states include Arizona, Iowa, Missouri, Nevada, New Mexico, South Carolina, and Utah. But some states are more restrictive than simply providing sales tax exemption based on Section 501(c)(3) status. For example, Arkansas uses a narrower definition to determine whether an organization is “charitable” for purposes of its seller exemption. Note too that organizations may be required to apply for the exemption, depending on the particular state.
On the purchasing side, many states specifically exempt nonprofits organizations from paying sales tax on items they purchase for use. Or again, states may provide limited exemptions to a narrower range of nonprofits. Where exemptions are available, some states likewise require the organization to submit applications, while other states automatically allow exemption for any organization with a Section 501(c)(3) determination letter.
DISTINGUISHING RESALE/WHOLESALE TRANSACTIONS
Note too that almost every state provides exemptions to organizations making purchases of items intended for resale to an ultimate consumer, under wholesale rules applicable to all sellers (not just nonprofits). Some states require the organization to obtain a seller’s account number. If so, this number must be included on any resale certificate provided to vendors. Organizations should consider whether they need such an account for the ultimate sale before claiming exemption based on resale.
Note that it is sometimes harder than it seems at first glance to determine whether the organization is purchasing an item for resale vs. for its own use. Some state definitions consider the organization itself the consumer even if it subsequently “sells” the items to members, students, or others.
Consider the following example. A California school purchases yearbooks and then subsequently “sells” the books to students. California considers the school as the ultimate “purchaser,” so any sales tax exemption available would relate to purchases made for the school’s own use, not purchases made for resale. The “distribution” to the student is then excluded from the definition of a “sale” to which the tax applies, so the school would not collect sales tax from the student (even if the school charges the student the purchase price for the yearbook).
IN-PERSON OR ONLINE?
When a nonprofit organization sells items, whether it is subject to sales tax may depend on how the item is being sold. In-person sales generally will be taxed, barring a specific exemption or minimum sales threshold applied by a state. Sales over the internet, on the other hand, are more complex. Many states have now adopted specific laws or administrative rules regarding when they will consider an organization to have sufficient physical “nexus” with the state, such that sales over the internet to consumers in that state will be subject to taxes. Thankfully, many online sales platforms have developed to monitor whether the organization may be nearing certain thresholds.
GOODS OR SERVICES?
In addition to how something is sold, what is being sold also matters. While state laws generally require payment of tax for sales of goods, required payment of tax for sales of services is less common. States further vary on the types of goods subject to tax. For example, in some states, food is not subject to sales tax. Illinois and many other states apply their tax only to tangible goods, so intangible products such as e-books are not subject to the tax. State statutes must be reviewed for these definitional considerations when evaluating the types of transactions for which organizations should be collecting and remitting sales tax.
IS A STATE-ISSUED EXEMPTION CERTIFICATE NECESSARY?
In conjunction with each state’s purchase exemptions, a nonprofit organization typically will need to provide a form or certificate to its vendors evidencing its exemption from the tax. Misuse of exemption certificates could result in loss of the exemption and civil and criminal penalties. Information about proper use may be found in the state’s exemption statute or on instructions provided with the form or certificate.
A common requirement is that the exemption certificate may only be used for purchases made using an organizational bank account, not using an individual’s personal account for reimbursement by the organization. Organization leaders should be aware of these limitations when taking on the administrative time and expense of obtaining exemption, as this will affect the actual usefulness of the exemption certificate. Leaders should be prepared to monitor use of exemption certificates by employees and to provide training as needed.
WHAT ABOUT OTHER RELATED TAXES?
Many states allow municipalities, counties, etc., to impose an additional local sales tax up to a certain amount. Commercial sales platform vendors and sales tax software may be very helpful for maintaining compliance with the myriad of requirements, including automated calculations based on the purchaser’s shipping address or notifications when the nonprofit has met certain thresholds. As noted above, organizations should also be sure to consider local requirements for its headquarters or other locations where it has some form of physical presence.
Lodging or Hotel Taxes
Additionally, many states impose a separate “lodging tax” or “hotel tax” either on top of or instead of sales tax on temporary overnight accommodations. Exemptions from such taxes are typically much more limited than exemptions from sales tax on purchases of goods and should be reviewed on a case-by-case basis. Nonprofits should be aware that their sales tax exemptions may not apply to hotel taxes, such as in Illinois.
State Income or Franchise Tax
Finally, remember that sales could also result in income taxes, both at the state and federal level. Such income tax liability is known in some states as “franchise” taxes, but not necessarily so. Potential federal income tax liability raises a host of tax issues within the “unrelated business income tax” realm, primarily if the sales activity is (1) unrelated to the organization’s tax-exempt mission, (2) is carried on regularly, and (3) is a trade or business.
A FINAL NOTE
Sales tax considerations quickly can become very complicated for nonprofits depending on the breadth of their selling and purchasing activities. Key points: (1) determine state-specific exemption requirements in mind; (2) identify whether the activity involved is selling or purchasing; and (3) remember wholesale exemptions, at least for purchases. More broadly, plan ahead for tax-exempt purchases, such as to identify steps needed in advance to obtain a particular state’s sales tax exemption for anticipated purchases. Likewise, organizations that plan to sell goods within a particular state should register in advance with the applicable state’s Department of Revenue, once a determination is made that sales tax liability will result from anticipated organizational sales.
 For more examples, see Wagenmaker & Oberly, LLC law firm’s blog article: How Much Do We Collect? Sales Tax Liability for Nonprofit Sales.
 For examples of available state sales tax exemptions for purchases and guidance on obtaining them, see How Much Do We Owe? Multi-State Nonprofit Sales Tax Exemptions for Retail Purchases.
 For more information, see Wagenmaker & Oberly, LLC law firm’s recent blog article: What – Another Tax? Nonprofits’ State “Franchise” Taxes and Related State Tax Compliance.