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.
Effective July 1, 2016, the application fee for filing the Form 1023EZ has been lowered to $275. The old fee was $400. That’s a savings of $125, and is a welcome relief to small nonprofits applying for tax exempt status.
The new streamlined Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, was introduced by the IRS in 2014 to provide relief for small nonprofits applying for tax exempt status from having to complete the full Form 1023, Application for Recognition of Exemption Under Section 501(c)(3). The full form is 26 pages long, and the IRS estimates it requires an average of 15 ½ hours to prepare, with 185 hours of other reading and record keeping; compared to 2 ½ pages and 5 ½ hours to prepare the EZ version, with an additional 12 ½ hours reading and record keeping. So the new 1023-EZ form is a winner when it comes to cutting down on paper work and time invested to comply with IRS requirements.
And customer satisfaction rates are way up for the IRS on the Streamlined EZ form compared to the regular long form.
Not every organization is eligible to complete the streamlined EZ form. Here is a summary of the not-so-short list of twenty-six points your organization needs to pass in order to qualify:
On January 12, the IRS issued Revenue Procedure 2015-9 (See http://www.irs.gov/irb/2015-2_IRB/ar10.html) establishing the procedures the IRS will follow in issuing, revoking, and modifying exempt status determination letters for 2015. It supersedes Revenue Procedure 2014-9.
Pursuant to Revenue Procedure 2015-5, the IRS has also created a Form 1023-EZ “Streamlined Application for Recognition of Exemption under Section 501(c)(3)” (See http://www.irs.gov/uac/About-Form-1023EZ). To be eligible to complete this streamlined form you must have had annual gross receipts below $50,000 in any of the past three years and project that your annual gross receipts will not exceed $50,000 in any of the next three years. In addition, you must have total assets not in excess of $250,000 and not be formed in a foreign country and meet several other criteria.