This article first appeared in the April 2022 edition of The Tax Adviser magazine.
Exempt organizations often dedicate resources to complying with federal tax laws but may not recognize the complexity of state and local sales and use taxes. Unfortunately, the states have not uniformly adopted any blanket sales tax exemptions for exempt organizations, regardless of whether an entity's purpose is charitable, educational, religious, or even state-related. That said, favorable sales and use tax treatment often does exist for exempt organizations.
But a number of factors influence whether and how sales and use tax exemptions may apply, including:
- What type of exempt organization is the entity and what is its purpose? For example, many states provide exemptions for governmental entities but may not provide an exemption for every business activity of a typical Sec. 501(c)(3) organization. Additionally, whether the entity is an association, a foundation, a charitable organization, or a private or public college or university may matter.
- What types of sales does the organization make? Common sales may include membership dues, printed or e-delivered publications, in-person or virtual hosted conferences, tickets to events, or prepared food and meals, among many others.
- What types of purchases does the organization make, and are they intended for its own use? Common purchases include promotional items to be distributed as "free swag," office equipment, literature, and written promotional materials.
Every exempt organization needs to be familiar with the laws of the specific state or locality where the organization operates. The following discussion highlights some of the basic state sales tax considerations for any business or organization, with a focus on exempt organizations. Understanding nexus, taxability/exemptions, and compliance is necessary to successfully navigate a complex and nonuniform state sales and use tax landscape.
Nexus for sales and use tax purposes almost always is created if a business has a physical presence in a state, whether by having inventory, offices, or employees in the state. With the recent popularity of remote work, employees performing duties in home offices in different jurisdictions from their normal business location may be establishing sales and use tax nexus for the exempt organization, as well as establishing nexus for other tax types.
Additionally, sales tax nexus can be created through economic activity, such as exceeding a certain threshold of sales revenue or number of transactions in a state, even if the business has no physical presence. For example, the District of Columbia requires a taxpayer that has either gross receipts from all retail sales delivered in the District exceeding $100,000 or 200 or more separate retail sales to register for sales and use tax purposes. Maryland and Virginia have adopted similar economic sales tax nexus provisions. Nexus under an economic-activity standard is generally established in every state when a business has as little as $100,000 in sales to the state during the year, sometimes without regard to the taxability of those sales.
Considering whether nexus exists is the first step in determining state or local sales tax exposure. It is important to understand that nexus is not abrogated simply because an entity may be exempt. In addition, even if an exempt organization's sales qualify for an exemption, nexus may still exist and could expose the entity to other compliance or state tax obligations.
Taxability and exemptions
Once nexus is established, exempt organizations must determine whether there is a sales tax collection and remittance obligation on their sales or whether a use tax is due on their purchases. States generally assess sales and use tax on the sale or purchase of tangible personal property and certain enumerated services. For exempt organizations, this means determining whether sales such as memberships, printed or electronically delivered publications, and event space rentals, or purchases such as office supplies, giveaway items, consulting fees, lodging fees, and other items are subject to tax.
Understanding how a state treats a transaction will help identify whether there are applicable exemptions. Many states employ their own nuanced approach to categories of transactions commonly engaged in by exempt organizations. Certain transactions may be exempt by their nature while others may be exempted because the item is purchased or sold by an exempt organization.
The majority of states provide generous exemptions for sales made by, or to, an exempt organization in the performance of its exempt purpose. However, exempt organizations should not assume every purchase or sale is exempt from sales or use tax. For example, in California, exempt organizations are generally treated like for-profit businesses for sales and use tax purposes; i.e., sales and use tax applies to the sale and purchase of tangible personal property. Although there are no broad exemptions, California does provide narrow special exemptions for certain types of organizations engaged in the relief of poverty and distress (see Cal. Code Regs. tit. 18, §1570).
Ultimately, the states greatly differ in (1) how they treat the taxability of various items purchased or sold by an exempt organization and, more importantly, (2) the type of exempt organization that may qualify for exemption, e.g., a Sec. 501(c)(3) organization (e.g., religious, education, or charitable entities) versus a Sec. 501(c)(7) organization (e.g., a social club). In addition, not all organizations exempt under the same Code section are necessarily treated the same (e.g., relieving the poor and distressed versus performing scientific research).
To claim an exemption, an exempt organization needs to take certain steps. Generally, states take the position that every sale, admission, use, storage, consumption, or rental is taxable unless eligible for an exemption. To qualify for any eligible exemptions, exempt organizations may need to provide an exemption certificate to a vendor to indicate that sales tax should not be charged on the transaction. A state may require the organization to apply for a specific state exemption in order to claim an exempt organization exemption. Most states have registration processes or requirements in place to qualify specifically for a sales tax exemption, and some jurisdictions require periodic renewal of an exempt status.
For example, to qualify for a sales and use tax exemption in Virginia, a nonprofit organization must apply to the Virginia Department of Taxation and meet all of the exemption criteria, including but not limited to (1) being exempt from federal income taxation under Sec. 501(c)(3), 501(c)(4), or 501(c)(19); (2) providing proof the organization is in compliance with Virginia's law related to contribution solicitation; and (3) having annual administrative costs not exceeding 40% of the organization's annual gross revenue (see Va. Code §58.1-609.11).
Other states, such as Michigan, allow an alternative to completing a certificate. In lieu of a certificate of exemption, the qualified nonprofit entity may provide information to the seller, in paper or electronic format, identifying both the reason for claiming the exemption (including its sales tax license number if the exemption claim is for resale and the purchaser has a sales tax license) and the purchaser (see Mich. Comp. Laws §205.62(9) and Michigan Dep't of Treasury, Notice to Taxpayers With Direct Pay Authorization and Nonprofit Entities Claiming Exemption From Sales or Use Tax (Feb. 8, 2018)). In North Carolina, a Sec. 501(c)(3) organization is required to pay sales tax on purchases of goods and services and then, if eligible, apply to the North Carolina Department of Revenue for a semiannual refund of the sales and use tax paid (see N.C. Gen. Stat. §105-164.14(b)(2)).
Exempt organizations will need to review the exemption documentation requirements for the states where business is transacted. Additionally, adherence to all administrative requirements, such as periodic renewals of state exemptions and proper completion of exemption certificates, is key to maintain and preserve eligible exemptions.
Exempt organizations must consider the state and local sales and use tax implications of each state in which they are conducting business. Rarely will similar exemption rules or compliance requirements apply across all states. Proactively addressing proper sales and use tax compliance is paramount, especially considering that an "everything's exempt as a nonprofit" policy is hardly ever the case. Exempt organizations must be diligent in considering how existing state and local sales tax obligations can impact their organization.