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Who Is Eligible For Sales Tax Exemption?

Being eligible for sales tax exemption as a seller depends on multiple factors. For instance, the products you are selling, the customers you are selling to, and the purpose for which the products sold are being used decide your eligibility for sales tax exemption.

Each state has its own rules for sales tax exemption, making it challenging for sellers like you to keep track of the complex tax exemption rules for multiple states. While some products may be exempt in certain jurisdictions, they may be taxable in others.

Likewise, each state has its own sales tax exemption certificates that customers must avail of and which the sellers must require their customers to submit at the time of sale for such sales to be tax-exempt. Not availing exemption certificates from tax-exempt customers at the time of sale may require sellers to pay sales tax at the time of audit.

Additionally, the ever-changing sales tax regulations add to the complexity. This may lead to failure on your part to comply with the sales tax laws in various jurisdictions, attracting fines and penalties.

In this article, we will let you know what is US sales tax exemption, who is eligible for sales tax exemption, and why is it important to obtain and manage sales tax certificates from tax-exempt customers.

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What is US Sales Tax Exemption?

Typically, sellers are required to collect sales tax on tangible personal property sold to customers in the state they are located in and out-of-state customers in states where sellers have a sales tax nexus. Sales tax exemption is an exception to this rule. It relieves the sellers from the obligation of collecting sales tax from customers and remitting the same to the appropriate states or jurisdictions.

The most common type of exempt sales is when goods sold are purchased for resale by the customer. In such a case, sales are not taxable at the time of purchase of goods for resale by the customer because the customer will charge sales tax on reselling the goods further.

However, goods sold for resale by the customer are tax-exempt only when the customer has an active resale number and a resale certificate from the appropriate sales tax authority. The seller is required to obtain the resale certificate from the customer at the time goods are sold for resale by the seller.

Not obtaining the resale certificate will make such a sale taxable and the seller would be required to pay the sales tax at the time of audit.

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Who Is Eligible For Sales Tax Exemption?

A host of factors decide who is eligible for sales tax exemption.

1. Type Of Product

If you are selling tangible personal property to customers in your state or to out-of-state customers where you have nexus with such states, you are liable to collect and remit sales tax to the appropriate tax authorities. However, each state has its list of products that are exempted from sales tax. This means that if you sell exempted products to customers, you have no obligation as a seller to collect sales tax from customers to whom such products are sold and remit the same to the appropriate tax agency.

Let’s take an example here to understand taxable vs tax-exempt products in Colorado.

Example – Colorado Taxable Vs Exempted Sales

a. When Is Sales Tax Applicable In Colorado?
i. In-State Businesses Doing Business In Colorado

A retail merchant is doing business in Colorado if he is selling, leasing, or delivering tangible personal property or services in Colorado. Further, he is also doing business in Colorado if he is involved in any activity that is connected with selling, leasing, or delivering tangible personal property or services in Colorado.

Accordingly, such retail sellers must register with the Colorado Department of Revenue, obtain a sales tax ID, collect sales tax on such sales, file sales tax returns, and remit the tax to the Colorado Department of Revenue (DOR). Remember, retail sales of tangible personal property are taxable in Colorado.

Read: How To File Sales Tax Return In US For Your Online Store?

ii. Out-of-State Businesses Doing Business In Colorado

You as a retail seller may not have a physical presence in Colorado but still be obligated to collect and remit sales tax to the Colorado DOR. This is when you are soliciting business from Colorado via a representative, advertisement, distribution of catalogs, or newspaper.

Also, you are liable to collect and remit sales tax on the retail sales of tangible goods or services as a remote seller if you meet the nexus criteria set by Colorado.

iii. Factor Nexus

If you are an out-of-state retail seller and have sold tangible personal property of less than $100,000 both in the current and the previous year, you are discharged from sales tax registration and collection requirements.

However, if your retail sales of tangible personal property to customers in Colorado are more than $100,000 in the current calendar year, you are liable to register with the Colorado Department of Revenue and collect sales tax on such sales.

b. What Items Are Not Taxed In Colorado?

The following are a few of the tax-exempt items in Colorado. Accordingly, if you are selling any of these items as a retail seller, you are exempt from sales tax registration and collection requirements. For a complete list and detailed rules for exempt items, visit Colorado sales tax exemptions and deductions.

  • Food, including the food sold via vending machines
  • Farm Equipment
  • Pesticides
  • Seeds, plants, and trains
  • Medical Equipment and Medicine

Want to know how sales tax works in Colorado?

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2. Buyer To Whom Goods Are Sold

The type of customer you are selling to also decides whether you as a retail seller are exempt from sales tax collection requirements.

For instance, if you are selling to business entities or organizations that are tax-exempt under section 501(c)(3) of the Internal Revenue Code, you are exempt from collecting sales tax from merchandise sold to such customers.

What Is Section 501(c)(3) Of The Internal Revenue Code?

Section 501(c)(3) of the Internal Revenue Code lays down the criteria for an organization to be tax-exempt. As per this section, any organization or entity that is organized or operated solely for tax-exempt purposes, as defined under this section, is eligible for sales tax exemption. That is, such entities are not required to pay sales tax on purchases made by such entities.

What Are Tax-Exempt Purposes Defined In Section 501(c)(3) of the IRS?
The tax-exempt purposes defined in this section include the following:

  • Charitable
  • Religious
  • Scientific
  • Educational
  • Literary
  • Testing For Public Safety
  • Preventing cruelty to children and animals, etc

As per these tax-exempt purposes, the tax-exempt organizations include:

  • Nonprofit Organizations
  • Churches and Religious Entities
  • Charitable Organizations including educational institutions
  • Private Foundations
  • Political Organizations like federal government agencies

To take an example here, let’s see the organizations that are tax-exempt in New York.

Example Of Tax-Exempt Organizations – New York City

For an entity to apply for tax-exempt status in New York City, it must solely be operated and organized for one or more exempt purposes, as mentioned in section 501(c)(3).

Accordingly, the organizations that can apply for tax-exempt status in New York include:

1. 501(c)(3) entities such as charitable, nonprofit, religious, educational, etc.

2. United States Armed Forces posts and organizations

3. UN and other international organizations

Want to know how sales tax works in New York?

Read: New York Sales Tax 2023 For Businesses: A Complete Guide

3. Purpose For Which The Goods Sold Are Used

If the tangible personal property is sold by a retailer to a purchaser who is buying it for resale purposes, such a sale is tax-exempt for the retailer. This is typically called wholesale sales since the purchaser is buying items that are going to be resold by him to the end-user. In such a case, the tax-exempt purchaser will charge sales tax on the goods resold to the end-user.

Example – When a Sales tax Exemption Certificate Is Needed By the Purchaser

Let’s say a customer buys candies from a retailer that are taxable in New York. However, if the customer buys these candies to add to his inventory which he will resell later, he is not required to pay sales tax on candies while purchasing them from the retailer.

Since the candies are typically taxable, the retailer will need some evidence of why he did not collect sales tax on candies that are otherwise taxable items. This is where the purchaser is required to provide a completed exemption certificate to the retailer at the time of sale. If the purchaser buys candies and other such items on a routine basis from the retailer, the purchaser can give a Blanket Certificate.

What Is A Blanket Certificate?

If a buyer purchases items from a distributor/retailer for resale on a routine basis, he may preferably use a Blanket Certificate. This allows the buyer to use one certificate for all the similar purchases he makes from the retailer instead of providing a separate exemption certificate to the retailer for each purchase. The buyer can use a Blanket Certificate for different types of exemption certificates.

Obtain And Verify Exemption Certificates

One thing that retail sellers need to know is that it is their duty to verify the exemption certificates submitted by the customer buying goods for resale. Of course, buyers need to obtain the exemption certificates and submit the same to you at the time of sale. However, you as a seller too need to keep track of exemption certificates and maintain a record for audit purposes.

Till the time the buyer provides you with a completed exemption certificate at the time of sale, you as a retail seller are not liable to collect sales tax on goods sold for resale.

While obtaining the certificate from the buyer, you must verify the certificates so submitted. It is your responsibility as a retail seller to verify that the details provided on the resale certificate are valid.

For instance, you need to:

  • check if the resale number or the certificate provided by the buyer is valid or active. You can check if the buyer is registered for the resale exemption by visiting the website of the sales tax agency of the concerned state.
  • check that the purpose of the exemption certificate is valid

What Do Sellers Need To Validate?

You as a seller need to ensure the following:

  • The goods purchased are for resale purposes and the resale certificate is not being misused by the purchaser
  • You as a seller are aware of the exemption certificate laws of the states in which you are selling goods for resale
  • Be aware of the latest changes made to the exemption laws so that you do not default on obtaining and validating exemption certificates

Here’s an example of the Illinois Exemption Certificate CR-61 Resale Certificate for your reference as a retail seller. Again, not obtaining such a certificate at the time of sale or within the time stipulated by the state’s sales tax laws may require you to pay sales tax at the time of audit.

Want to know how sales tax works in Illinois?

Read: Illinois Sales Tax 2023 For Businesses: A Complete Guide

Who is Eligible for Sales Tax Exemption

Sales Tax Exemption Certificate Management

One of the most important parts of selling goods for resale by a retailer is maintaining and managing the exemption certificate submitted by the exempt buyers.

Maintaining paper records of such certificates is not a good way to maintain exemption certificates as there are chances of errors. Therefore, sellers must maintain digital files of exemption certificates submitted by the buyers at the time of sale.

It is the responsibility of the sellers to store and maintain exemption certificates submitted by the tax-exempt buyers. The state tax agencies can demand such certificates as evidence for tax-exempt sales from the seller at the time of audit.

To make sales tax exemption certificate management easy, sellers can even have sales tax exemption certificate management software to easily store and maintain exemption certificates.

Want to know which is the best sales tax software for your eCommerce Business?

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Additionally, the sellers can register with the Streamlined Sales Tax Program (SSTP) via Certified Service Providers (CSPs) and get rid of the burden of managing sales tax calculation, collection, and sales tax exemption.

What Is A Streamlined Sales Tax Program (SSTP)?

The local governments, states, and business community came together and rolled out the Streamlined Sales Tax Program. The result of this program was the Streamline Sales and Use Tax Agreement (SSUTA). This is a combined effort of 44 states, the District of Columbia, local governments, and the business community to simplify and bring uniformity in sales tax administration and collection for retailers.

For instance, the Streamlined Sales Tax Exemption Certificate is accepted by all 24 Streamlined member states.

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