Ah, exemption from sales tax! Topic of the century! It’s something that a lot of business owners like yourself are interested in and often confused by. Because nobody really likes taxes, right? Where do we start? Let’s talk about what it actually is. To understand that, we first need to take a step back and briefly talk about sales tax. Sales tax is basically a tax for consumption, and by consumption, we mean that sales tax is charged by the government whenever any goods or services are sold. Usually, the person to whom sales tax is charged is the end consumer.
You also must have heard the term “Sales and Use tax” thrown around, at least a couple of times. In case you’re wondering what that second is, use tax is basically a complementary tax you pay for the storing, using, and consuming a product or services for which you did not pay sales tax. If sales tax was charged, however, use tax would come back into the picture.
Another term that goes hand in hand with this topic, is nexus. Nexus basically refers to the connection between an authority which imposes taxes and a business. This connect triggers an obligation for collecting sales and use tax by that business. Many business are not aware of this, and end up damaging themselves in the long run. Here’s an example for the sake of clarity: someone has a big land full of apple trees. They harvest the apples every year, and sell it to a company which makes apple sauce.
The company will not be charged with sales tax because that’s not the last place where the apples are going. After the apple sauce is made, it’s sent out to stores, who are still not the end consumers and are not charged. Then the stores sell the apple sauce to you, the end consumer, and you get charged with sales tax. The amount of sales tax differs from state to state. Keep in mind that this a very simplified explanation!
Now, you’re probably thinking:
They do this by becoming exempt from paying sales tax. And this is where the fun begins! Buckle up, cause we’re heading into the rabbit hole of sales taxes and exemption certificates!
If you’re wondering how exemption from tax works, and how businesses circumvent sales tax, the answer is pretty simple: they acquire sales tax exemption certificates. And guess what? If you’re a business owner, you can also get a sales tax exemption certificate and purchase items without having to pay sales tax. This can be particularly beneficial if you are a small business, because you can generate more income if you are tax exempt and hold a sales tax certificate of exemption. We’ll explain why in a moment.
Let’s imagine that you are a small business that plans to purchase items for reselling them to end consumers. Naturally, because the supplier you are purchasing from considers you the end consumer, they must charge sales tax to you. Why? Because they are required by law to do so. You must pay sales tax unless you present your supplier with an exemption certificate which proves that you are not required to pay sales tax and will instead collect that sales tax from the end consumer that you are reselling the product to. If you present an exemption certificate to a supplier, they must not charge you sales taxes. Instead of being double-taxed, you’ll just end up charging sales taxes to your end consumer. As you can see, this can be very beneficial, especially if you’re a small business.
The answer is yes. There are organizations that are tax exempt by law and do not need to obtain tax exempt forms in order to avoid paying sales tax. The number of these exempt organizations is quite high. For example:
- Charitable organizations are exempt from sales tax.
- Same goes for religious, educational, scientific, literary organizations.
- Cemetery organizations are also not required to pay sales tax.
- If you are a nonprofit organization which does not distribute profit, and you’ve formed your organization for a public purpose, you will not get hit with federal income tax and you do not need to get tax exempt.
The requirements for exemption for organizations, businesses, and service can be found in detail on the IRS website. If your business, services or organizations meet that criteria, you can become tax exempt by law. It’s a given that all business are not naturally exempt organizations and many have to obtain documentation in order to circumvent taxes.
If you are not part of any exempt organizations and need an exemption certificate, you probably have a similar question in mind: