Sales tax and nonprofits

Nonprofit organizations are often thought to be exempt from sales taxes, but is that correct?

According to Statista, there are almost 750,000 public charities in the U.S. (most devoted to religion, human services and education). Other stats say more than 2 million charities exist that are tax-exempt according to Internal Revenue Service rules.

And just like any other major sector of society, such entities consume large amounts of tangible personal property. They also frequently sell TPP such as merchandise, memberships, books and so forth that for-profit companies generally have to charge and collect sales tax on.

Are non-profits exempt from sales tax obligations? That depends on many factors.

Definitions

For Federal income tax purposes, according to the IRS, tax-exempt organizations include:

Charitable: Organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, educational or other specified purposes.

Religious: Among those that may qualify for exemption from federal income tax under Internal Revenue Code Section 501(c)(3).

Private Foundations: Typically have a single, major source of funding (usually gifts from one family or corporation) and primarily make grants rather than directly operate charitable programs.

Political: A party, committee, association, fund or other organization organized and operated primarily for directly or indirectly accepting contributions or making expenditures, or both, for an exempt function.

Other: Meeting specified requirements that qualify for exemption under subsections other than under IRC Section 501(c)(3). These include social welfare organizations, civic leagues, social clubs, labor organizations and business leagues.

These same organizations are not necessarily exempt from sales tax. The sales tax treatment usually depends on the type and purpose of the organization and the types of sales and purchases that it makes. Any sales tax exemption for a nonprofit depends on the transaction’s relation to the organization’s main mission.

Location, location, location

501(c)(3) organizations are exempt from sales tax on their purchases in Colorado and in Utah. Sometimes nonprofits and not-for-profits must pay sales tax when they buy items, at least initially, as in North Carolina. Most states, like Michigan, require special registration for exemption.

But as always with sales tax, rules vary state to state. In Arizona, for instance, sales to nonprofits are generally not exempt but retail sales  usually are. In Virginia, the annual administrative costs of the organization, including salaries and fundraising, must not exceed 40% of its annual gross revenue to qualify for an exemption.

Washington State gives no blanket exemption to nonprofits. Minnesota exempts non-profits from collecting sales tax when the sales are for fundraising. Exemption for a contractor providing services to a nonprofit requires specific circumstances in Tennessee.

Illinois greenlights exemptions for churches, licensed not-for-profit day care centers, arts and cultural not-for-profits, schools and seniors’ organizations, to name a few, but not for American Legions; chambers of commerce; Elks, Lions and Rotary clubs; VFWs; or unions/trade associations. Also in Illinois, not-for-profit hospitals and nursing homes that qualify as exclusively charitable institutions are not subject to sales tax when selling food or medicine to their patients; and hospital dining facilities not open to the general public are also exempt. But a hospital or hospital auxiliary incurs a sales tax liability when selling candy, chewing gum, tobacco products and razor blades, “since these items aren’t necessary for basic hospital service and place the hospital in competition with community businesses.”)

Exemption details

Generally, sales of TPP are subject to sales tax obligations whether a nonprofit is involved or not. However, in most situations, claiming an exemption requires a state-specific exemption certificate.

How important are these certificates? During a sales tax audit, one of the first requests from the auditor will be for copies of all exemption certificates for any exemptions claimed on sales tax returns. A few missing certificates can result in large assessments, including penalties and interest.

These forms should include a registration/account number (every state issues one to a tax-exempt entity), the customer’s and seller’s name, the nature of the exemption (resale, manufacturing and so on) and the customer signature and date. Some states’ exemption certificates do not expire; others do expire within a set time.

Contact us to find out if your business could be impacted by exemption certificates and to gain a better understanding of your burden of sales tax compliance.