Making assumptions when it comes to sales and use tax is ill-advised for any entity’s approach to compliance. This is especially the case for not-for-profits. Exemption from federal income tax can count for nothing in the sales and use tax world, and states are anything but uniform when it comes to exemptions available for not-for-profits. Even when there are sales and use tax exemptions available for not-for-profits, it’s essential to ensure that all administrative requirements are followed in order to properly claim the exemption.
At the very least, all not-for-profits need to ask themselves three questions when it comes to sales and use tax: What states? What purchases? What sales?
No entity, not-for-profit or otherwise, will have a sales and use tax payment or collection obligation unless a state has jurisdiction over the entity. In the state tax world, this concept is known as “nexus.” For sales and use tax, an entity needs to have a physical presence in the state before a state can have jurisdiction to tax it. Many taxpayers mistakenly interpret the “physical presence” test to mean a substantial permanent presence – for example, having an office in a state. Clearly, an office location in a state would be considered a physical presence by all states, but many other in-state activities can constitute nexus. For example, a physical presence can be established by having a telecommuter in a state, having employees temporarily in a state, or having independent contractors in a state performing services for the not-for-profit.
Once a not-for-profit determines that it has nexus with a state, it must determine if any of its purchases being made in the state are subject to sales tax. Many states have sales and use tax exemptions for purchases made by not-for-profits, but these exemptions vary significantly in terms of which not-for-profits are exempt and the scope of the purchases that are exempt. For example, California only provides sales and use tax exemptions for purchases made by entities meeting its rather narrow definition of a “charitable organization.” Further, if an entity meets that definition, the only purchases that are exempt from sales and use tax are those that are made for the purpose of donation by the organization. All purchases of supplies (such as tools and office supplies) are not exempt. Under these rules, most associations and membership organizations (i.e., non-IRC 501(c)(3) entities) would be taxable on all of its purchases.
Other states, such as Maryland and Ohio, have broader exemptions on purchases made by not-for-profits, but even in these states the exemption does not apply to all entities that may be exempt from federal income tax. Further, most states require not-for-profits qualifying for a sales tax exemption to obtain an exemption certificate from the applicable taxing authority, which must be provided to vendors at the time of purchase.
Not-for-profits also need to be aware if its sales of products or services are subject to a state’s sales and use tax. If a not-for-profit’s sales are subject to sales tax, then it must register to collect and remit sales tax to the state. Merchandise sold, training materials (i.e. tangible or digital), software applications, access to a database, and subscriptions to publications are items to which not-for-profits need to pay particular attention. States often have exemptions for certain sales of admissions to events hosted by not-for-profits and sales of food and beverages items. Sales of merchandise are typically subject to sales and use tax. This is especially the case when a not-for-profit has a permanent retail store, as opposed to sales that are isolated in nature. For example, Colorado, Georgia, Illinois, and Pennsylvania generally impose their sales tax on sales made by not-for-profits unless the sales meet the applicable rule pertaining to isolated/occasional sales.
It’s important for not-for-profits to be proactive in the area of sales and use tax. When activities are expanded to new states, whether from hiring an in-state employee or frequently hosting conferences or seminars in a state, not-for-profits should immediately look into whether it will be making any purchases or sales that may result in a sales tax compliance obligation. Being reactive can result in penalties, interest, and the practical in-ability to recoup uncollected taxes.
If you have any questions about sales and use tax, please contact your Aronson tax advisor or Michael L. Colavito, Jr. at 301-231-6200.
Virginia Changes Sales Tax Policy on Meals Purchased by Tax Exempt Entities – Effective as of April 22, 2016, a change in policy by the Virginia Department of Taxation allows state and local governmental entities, nonprofit organizations, and nonprofit churches in Virginia to purchase prepared foods, catering, and related services without paying Virginia sales tax. Caterers and restaurants in the Commonwealth should take note of this development; as such entities will now present exemption certificates to make tax-free purchases.
Prior to the change in policy, the majority of catering and prepared food purchases made by such exempt entities were subject to Virginia sales tax. The taxability of such purchases was based on the Department’s position that the purchases were for “taxable services,” which is generally outside the scope of the sales tax exemption for the tax exempt entities addressed in the ruling. Further, the Department will no longer take the position that food purchased by the exempt entities is being consumed by individuals, and not the exempt organization. The policy change does not impact food purchases made by the federal government, which are generally exempt from sales tax and will remain exempt.
The Tax Bulletin (16-3) that was issued on May 2, 2016, indicates the exemption from sales tax for nonprofit entities and state and local governments purchasing prepared food and catering services only applies if the Department’s new use and consumption test is met. Although the Bulletin describes this test as a “bright-line test,” the first and third elements of the test are somewhat subjective in nature. The “use and consumption” test is satisfied if the following requirements are met:
The Bulletin does provide some useful examples on the application of the test, but the examples also leave some questions unanswered. For example, will the purchase of a meal by a state/local government employee while traveling ever meet the test? One of the examples suggests that it will not because the governmental entity does not determine to whom, when and how the meal will be consumed. This is in contrast to an annual banquet honoring employees, which seemingly would meet this element of the test. The example addressing the annual banquet scenario, which concludes that the catering services purchased are not subject to sales tax, suggests the element of the test requiring that the purchase further the organization’s function or purpose will be interpreted somewhat broadly. One could certainly make a reasonable argument that the function of a government agency is not furthered by the honoring of its employees.
Churches and federal government entities are not required to satisfy the use and consumption test in order to purchase meals, catering, and related services for the exemption to apply. So long as the church or federal government entity issues the applicable exemption certificate to the seller, the purchase is exempt from Virginia sales tax.
Restaurateurs and Caters need to ensure that they receive the sales and use tax exemption certificate from an exempt entity attempting to make a purchase tax free, and that the payment for the meals and catering services are being paid for directly by the entity claiming the exemption. If payment is made in cash, sales tax will generally apply even if an exemption certificate is provided. The exemption certificates and the records pertaining to payment should be retained for a minimum of three years in case a sales tax audit is conducted on your business.
If you have any questions about sales and use tax compliance, please call your Aronson tax advisor or Michael L. Colavito, Jr. at 301-231-6200.