In every state, certain types of items, most commonly food and medicine, are exempt from sales tax or are taxed at lower rates. Certain types of sales transactions are exempt from sales tax, not because the item itself is nontaxable but because of some characteristic of either the buyer or the seller.
In every state that imposes a sales tax, the general rule is that each retail sale of tangible personal property is presumed to be taxable. In other words, if you make retail sales, you generally must collect or pay sales tax with respect to each sale unless you can show that the sale was somehow exempt from tax.
What are the major exemptions from sales tax?
Each state offers its own unique set of exemptions from its sales tax. In general, exemptions are provided on the based upon:
- the type of property being sold,
- the identity of the purchaser, or
- the use to which the property will be put.
Exemptions based on type of property sold. Every state recognizes that there are certain commodities that individuals must purchase to survive. Accordingly, most states offer product-specific exemptions for items such as food, clothing, prescription medicines, and medical (prosthetic) devices. Those states that don't provide a complete exemption for these items often impose a lower tax rate on them.
Exemptions based on type of purchaser. Under federal law, states can not tax sales that are made to the federal government or its various agencies. Similar exemptions exist in most states for sales to the state and its agencies and to cities, counties, and other local jurisdictions in the state. Also common are exemptions for sales to nonprofit charitable, religious, and educational organizations.
Exemptions based on type of use. The exemptions that fall into this category are those that are provided to support certain industries (such as agriculture, manufacturing, or industrial processing) or to encourage certain activities for the public good (such as industrial development or expansion or pollution control). For example, many farming states offer exemptions for sales of products or equipment that are used to produce food for human or animal consumption. Similarly, most states offer exemptions for sales of machinery and equipment used in manufacturing a product for sale.
Proving entitlement to exemption. For both purchaser-based and use-based exemptions, the purchaser bears the responsibility for affirmatively showing that a particular purchase is exempt from tax. Or, looking at the transaction from the other side of the counter, a seller cannot refrain from collecting or paying tax on a sale unless the seller believes in good faith that the sale is exempt. Meeting the requisite level of proof is generally a matter of the purchaser providing the seller with one of the following:
- an exemption certificate that documents the exemption the purchaser is claiming
- a direct payment certificate that shows the purchaser is permitted to pay taxes directly to the state
Products bought for resale may be tax exempt
Perhaps the most common sales tax exemption flows from the fact that sales taxes are assessed on retail sales, which are sales to the ultimate user or consumer of the item being sold. In other words, sales tax is due only on the final sale of the property. Accordingly, if you purchase items that you intend to resell prior to making any significant use of it, there is no tax due on your purchase.
In general, the exemption continues as long as you don't make any use of an item being held for resale other than for display or demonstration purposes. If you do use the item for other business or personal purposes, you become liable for use tax on the item.
Liz operates a small art shop. Among the items she sells are lithographic prints that she purchase from a commercial printer. The printer's sales of the prints to Liz are exempt from sales tax because she intends to sell them to her customers. However, she took a two of the prints to hang in your home office. Liz is liable for use tax for those prints.
As is the case with most other exemptions, purchasers claiming the resale exemption must furnish their sellers with written proof that they are entitled to the exemption. This proof is usually provided in the form of a resale certificate.
State law governs exemption certificate requirements
In most cases, for a sales tax exemption to apply, the purchaser must present the seller with a written certificate that documents the exemption the purchaser is claiming. The seller will then be relieved from paying or collecting tax on the sale, provided the seller accepts the certificate in good faith and with a reasonable belief that the purchaser is entitled to the claimed exemption.
Some states provide specific exemption certificate forms that purchasers should use in claiming different exemptions. Other states, while not issuing specific forms, specify what information must be included in an exemption certificate. At a minimum, the certificate should include the following information:
- the date, which should predate or be the date of the sale
- the signature of the purchaser or the purchaser's agent or employee
- both the purchaser's and the seller's names and addresses
- the purchaser's business license or tax registration number
- a description of the property being purchased
- the basis of the claimed exemption
Most states permit blanket certificates. Most states recognize that it would be burdensome for purchasers to supply sellers with whom they frequently deal separate exemption certificates for each separate purchase. Accordingly, these states generally allow sellers and vendors to agree to use a "blanket certificate" that will continue in force for a period specified on the certificate. However, some states put a limit on how long blanket certificates may remain valid without being renewed or updated. Regardless of any such state limitation, as a practical matter it's probably a good idea to request that a purchaser annually provide you with an updated certificate to ensure that your records are current.
Exemptions must be claimed in good faith. States impose this requirement on sellers to ensure that proffered exemption certificates have some minimum degree of accuracy and reliability. Obviously, "good faith" is an extremely subjective standard, and it doesn't require that sellers delve into every detail of their purchasers' business operations. What the requirement generally obligates sellers to do is to verify that basic information on the certificate is accurate, that the certificate fits the business for which it is given, and that the claimed exemption could reasonably apply to the transaction at hand.
Tom owns a tire shop. The owner of a restaurant across the street provides him with a resale certificate for the purchase of some tires. Tom should ask the customer to explain how the resale of tires applies to his restaurant business. That is, Tom should require some further evidence that the restaurant owner is engaged in the retail tire business.
While taking these additional precautions may seem intrusive to the purchaser, you need to protect yourself from any claim that you improperly accepted the exemption certificate.
Occasional sales are often exempt from sales tax
Most states offer an exemption from sales tax for occasional, casual, or isolated sales. This avoids requiring every person who happened to sell an item of tangible personal property during the year to collect or pay sales tax. This is the reason you may be have a garage sale every spring and not collect sales tax. In most cases, eligibility for the exemption is based on the seller not having more than a specified number or dollar amount of sales during the year.
Among the states having a sales tax, Alaska, Colorado, Delaware, Oklahoma and Wyoming are the only states that do not provide specific exemptions for occasional sales (with the exception of occasional sales by charitable organizations.) However, a number of states deny the exemption to any person who is normally engaged in the business of making taxable retail sales. In contrast, other states allow the exemption to retailers with respect to sales that are not made in the regular course of their business.
Direct payment permits shift liability for tax from seller to purchaser
Many states authorize purchasers to apply for a direct payment permit. Purchasers holding such permits do not pay any sales tax to their sellers. Rather, the permit holders assume the full responsibility for determining which of their purchases are taxable and which are exempt, and remit any tax that may be due directly to the state. Upon receiving a valid direct payment certificate, a seller is relieved of all responsibility for collecting tax from the permit holder.