Understanding Exemptions in US Sales Tax

Navigating US sales tax laws and regulations can be a complex and challenging task for many businesses operating in the United States. This article explores sales tax exemptions, their scope and purpose, and the different criteria on which they are based.

What are exemptions in sales tax?

State sales tax laws often contain broad statements taxing large categories of transactions. However, within these broad categories of taxable transactions, states often carve out certain specific types of transactions and exempt these from sales tax.

Exemptions exist after the scope of the sales tax is determined. They relate to items or services that would normally be considered taxable, but they are specifically identified as "exempt" from the tax in statutes, and regulations.

For example, a taxing jurisdiction may often indicate that sales tax must be charged on all sales of tangible personal property. However, a separate section of the tax statute may specify that sales of a certain item may not be subject to the tax. This is how the exemption mechanism "carves out" this item from tax liability, even though it would normally fall under the definition of tangible personal property.

An exemption is usually seen as a privilege granted to the taxpayer by the government, rather than an inherent right. This means that if a taxpayer wants to claim an exemption, they need to be able to provide clear evidence that the exemption is provided for in the law.

There are various types of exemptions, and each state has its own rules and criteria for them. Here are some of the most common exemption types.

Resale exemption

Sales tax is normally charged only to the final customer. When a supplier makes a sale of a product to a reseller, sales tax normally doesn't apply since the reseller is not the final customer.

The resale exemption aims to ensure that businesses can make tax-exempt purchases of goods that they intend to resell to others, with the expectation that sales tax will only be collected during the final sale to the end consumer.

This mechanism greatly differs from value added tax, where the tax is charged on all steps of the transaction chain, even on resellers; however, they can claim back VAT paid on their purchases.

States require proper documentation to prove that a buyer is a reseller. In most instances, the purchaser must provide a written certificate proving that they can benefit from the reseller exemption.

Exemptions based on the nature of the property being sold

One of the most common types of exemptions is based on the nature of the property being sold. Many states offer exemptions or reduced sales tax rates for certain items, such as groceries, feed for commercial agriculture, and prescription drugs for human treatment.

A sales tax exemption or rate reduction can make essential items more affordable for consumers. This helps create a balance between raising taxes and ensuring that consumers can afford the most basic products.

Exemptions based on the purchaser

Some states exempt sales to government entities, including federal, state, and local governments.

In addition, sales to non-profit or charitable organizations, including religious institutions, are often exempt because they are deemed necessary for serving the greater good of the community. The purchase of the same items by a for-profit business would result in the application of the sales tax.

Exemptions based on use

The exemptions granted allow for relief from sales taxes on items used for specific economic reasons, such as in agriculture, manufacturing, industrial processing, and pollution control.

For example, to promote agriculture, many states offer preferred exemptions on the sales of products and equipment required for food production. Conversely, exemptions to encourage manufacturing can be given on sales of machinery and equipment used directly in the manufacturing process.

Exemption on occasional or isolated sales

Exemptions may apply to occasional or isolated sales of property not held or used in the ordinary course of the seller's business or activities for which the seller holds a seller’s permit from the state. For example, a butcher selling an old chair that he intends to replace could qualify for an occasional sale exemption, since the butcher is not in the business of selling chairs.

Typically, there are limits on the number of occasional sales that a business can make before they are considered regular taxable sales.

Sales tax holidays

There are limited-time periods where states allow certain purchases to be made without incurring sales tax. These exemptions are intended to encourage consumer spending in specific categories.

For instance, states can offer sales tax holidays during back-to-school shopping periods, where clothing and school supplies are exempted from sales tax. State legislatures define the items exempt from sales tax on specific holidays, including items like energy-efficient appliances during a hurricane preparedness sales tax holiday, for example.

By allowing consumers to make purchases without dealing with the added sales tax, sales tax holidays drive consumer spending and promote commerce in specific categories.

How can Fonoa help with sales and use tax?

With the complex and constantly changing sales tax landscape across jurisdictions, staying compliant with sales and use tax rates and laws can be daunting for many businesses. Fonoa offers a global tax engine that can be a valuable tool for companies operating in the US, providing a simple and efficient solution for managing sales and use tax obligations.

Get in touch to discover how we can help you meet the challenges and take the complexity out of tax.