Historically, manufacturers have been concerned primarily with the sales and use tax rules in their home states and how the rules impacted their purchases, and to a lesser extent, their sales. That all changed on June 21, 2018, when the U.S. Supreme Court rendered its decision in Wayfair v. South Dakota. The ruling allowed states to impose sales tax collection requirements based on a seller’s economic activity in their states, and what has followed is legislation in every state that imposes a sales tax to capture that additional revenue via economic nexus thresholds. The impact on manufacturers’ income can be substantial and the new laws make it imperative for manufacturers to understand key aspects of contemporary sales and use taxes, including economic nexus, manufacturing exemptions, exemption certificates, and sales tax compliance.
Before the emergence of economic nexus in 2018, the sales tax nexus standard was physical presence. A taxpayer was not required to collect or remit a state’s sales tax unless it had a physical presence (office, employees, property, etc.) in that state. Prior to Wayfair, it was common for a manufacturer to be registered and filing sales/use tax returns only in its home state. Now, any manufacturer with substantial sales outside its home state likely has economic nexus in one or more states. Economic nexus laws, along with their sales and transaction count thresholds, vary by state. The sales or receipts threshold is never less than $100,000 and a few states are as high as $500,000 (California, New York, and Texas). The transaction count threshold is typically either 100 or 200, although many states have chosen to forgo a transaction count when determining whether activity is sufficient to create economic nexus. Another consideration for manufacturers when assessing economic nexus is whether they are selling at retail or wholesale; several states do not count wholesales or nontaxable sales against the receipts threshold. Manufacturers with multi-state sales should evaluate their activity in each state to determine if economic nexus exists.
When an entity creates sales tax nexus it needs to take additional actions to achieve compliance. To file the required sales tax return, a business must register with the state and create an online tax account. Then the business needs to consider how it will determine the taxability of its sales and manage customer exemptions and the related exemption certificates. In most cases, sales of tangible personal property are taxable, but there are many potential exemptions that vary by state, including resale, use in manufacturing, and product specific exemptions, such as clothing or medical devices.
If your business has a robust ERP or sales system, taxability by state may be easily configurable. But for manufacturers lacking tax software or advanced systems, the process is manual, time-consuming, and prone to error. An efficient implementation is possible if you understand all the considerations associated with creating economic nexus for sales tax.
Sales tax exemptions for manufacturing are nuanced and subject to interpretation. The exemption language in most states includes phrases such as “directly used” or “directly and primarily” used in production. These phrases can be interpreted in different ways. Operations personnel often argue that manufacturing cannot occur without a specific piece of equipment, but that does not necessarily mean the equipment is directly used in production. Conversely, auditors will often attempt to narrow the scope of the manufacturing exemption based on when the production process begins and ends.
To further complicate matters, every state’s manufacturing exemption is different. For example, New Jersey, Ohio, and Pennsylvania all have manufacturing exemptions, but New Jersey’s does not apply to parts with a useful life of less than a year. Ohio and Pennsylvania exempt parts on equipment or machinery directly used in manufacturing.
Pennsylvania’s exemption includes purchases of “tangible personal property and otherwise taxable services to be used directly in research operations …” while other states such as Ohio largely limit the research and development portion of the exemption to “… capitalized tangible personal property, and leased personal property that would be capitalized if purchased ….” The contrast illustrates the disparate approaches states take with their manufacturing exemptions.
Utilities used in production are commonly included in a manufacturing exemption, though not by all states. Here again there is a lack of consistency: New Jersey provides no exemption from tax for electricity used in manufacturing; Florida, Ohio, and Pennsylvania offer exemptions on utilities used in production in most cases. Utility exemptions are frequently based on utility studies that quantify production use versus general use. But utility studies are rarely updated on a regulation basis and can be out of date or inaccurate resulting in either exposure or opportunity if the manufacturer’s operation has changed since the previous study.
The use of a forklift is another issue that can result in exposure or opportunity. Forklifts may be used to unload raw materials (typically considered pre-production) or move finished goods (usually considered post-production). In most cases, these uses of a forklift are taxable, but what happens when that same forklift moves in-process goods or materials? The answer depends on the state’s statutes and regulations, but in many cases, that forklift—or at least its percentage of use in the exempt activity—will be eligible for exemption.
Sales Tax Compliance
Filing requirements due to economic nexus can overwhelm a tax department or the individuals responsible for filing the manufacturer’s sales tax returns. Many businesses have gone from filing in one state to filing in 40-plus states since Wayfair was decided in 2018. Filing multiple sales tax returns is a major adjustment that requires investment in technology and people. There are over 10,000 discrete state and local sales tax rates in the United States. Accurately charging and reporting sales tax is a monumental task without advanced software. Is your business prepared to handle sales tax and filing returns in all states where you have sales if required? Based on increased sales and use tax filing obligations, you may need to consider compliance options, including outsourcing or software solutions.
With more sales tax obligations in more states, the complexity around compliance increases. Are you obtaining exemption certificates from customers that purchase goods tax-free? If yes, is the certificate valid as completed by those customers? Florida, for example, requires a new certificate every year to qualify for its resale exemption. Other states require the seller to verify the purchaser’s tax ID on the state website. In addition, the “good faith” rules imposed by states vary dramatically, and incomplete or invalid exemption certificates prove an unwelcome surprise during a sales tax audit. As anyone who has been through an audit knows, tracking down exemption certificates three or four years after a sale is like playing craps, you roll for a while with some success, but eventually you crap out and lose to the house, or in this case, the state. Being prepared means knowing each state’s requirements and reviewing certificates as they are received.
The HBK SALT Advisory Group is here to provide solutions based on your unique set of circumstances. Whether you require consulting, compliance, or audit defense services, we are your SALT partner and resource. Collectively, our team has more than 50 years of experience with indirect taxes and has been advising our manufacturing clients since before the turn of the century. We can help you address economic nexus, apply manufacturing exemptions, and explore outsourcing your sales tax compliance.