Despite complexities, state and local tax (SALT) compliance shouldn’t be hard medicine. Businesses should consider compliance a chance for new opportunity. There are at least ten.
Expense and complexity of SALT (state and local tax) compliance has increased dramatically –increased legislation and regulatory intricacy has coupled with additional scrutiny by state revenue departments.
Nowhere is this more evident than in manufacturing, where tax exemptions and exclusions are plentiful, yet encircled by traps for the unwary. As a result, many companies fail to claim all of the entitled incentives.
Here’s the Top Ten of most significant and money-saving opportunities for manufacturers:
1. Resale Exclusion – Everything that becomes part of the manufactured product is exempt from sales and use tax. This obviously includes the raw materials that make up the product but extends to packaging, cartons, labels, instruction and safely pamphlets, skids, bags, and pallets.
2. Manufacturing machinery – Many states provide a sales tax exemption for machinery, tools, and equipment used in manufacturing tangible personal property for sale or profit.
3. Testing, modification, inspection – Some states provide a sales tax exemption for purchases of tangible personal property for testing, modification, or inspection if the ultimate use of the product is outside the state and the testing period does not exceed 90 days.
4. Items used out of state in selling other products – Some states also provide an exemption for transfers of tangible personal property without consideration to out-of-state customers for use outside of your home state in selling products sold by the manufacturer.
5. Utilities – Sales of electricity, gas, and other fuels used in processing, manufacturing, mining, and construction can be exempt from sales tax. While this exemption has been suspended at the state level in some cases, it still exists for local cities and thus is often overlooked.
6. Computers – Software may be exempt as part of a machinery exemption, but computer software purchased and downloaded electronically may alternately be exempt from state sales tax whether it is used directly in manufacturing or not.
7. Renewable energy – Components used in the production of electricity from a renewable energy source and components used in solar thermal systems are exempt from some state sales and use tax.
8. Clean rooms – Machinery used in qualifying clean rooms used in producing computer components, software, biotechnological products, and pharmaceuticals can be exempt from state sales and use tax.
9. Research and Development – In addition to the national Research and Development Tax Credit, many states provide a refund of all state sales and use tax paid during a calendar year on tangible personal property used directly and predominantly in biotechnology, clean technology, and medical devices.
10. Enterprise Zone incentives and credits – If your business is in a state enterprise zone, it may qualify for a variety of tax credits for research and development, job training, hiring and job creation, and investing in new equipment. These credits can be statutory, which means that everyone who qualified for them gets them, or they can be discretionary, which means that they are negotiated separately with a local city, county, etc. The credits and incentives often cover both sales tax and income tax.
Establish a Plan
Qualifying for many of the previously described opportunities requires understanding the specifications, conditions, and risks associated with each SALT credit and exemption. However, many of these obstacles can be minimized, or even eliminated, with proper planning and preparation.
Questions to Address
Some of the most common criteria state and local auditors focused on include these questions:
- How does that state or local government identify a manufacturer? – Does your business meet these criteria? The term is often narrowly defined and can exclude activities such as assembly, fabrication, and processing.
- If you are a manufacturer, where does the manufacturing begin and end? – Qualifying activities may not be eligible for exclusion or exemption, if the activity occurs before or after the manufacturing process or is located in a facility in a different location.
- Is the credit being claimed for a “manufacturing aid”? – Items that do not become part of the product – but are used as a catalyst, lubricant, or cleaning process – might not qualify for exemptions.
- Is the machinery and equipment used in manufacturing used “directly and predominantly” in the process? – If not, it may be challenged by an auditor.
- Is scrap left over? – If so, try to sell it, even for a nominal sum. Increasingly, auditors have been assessing use tax on scrap materials.
- Is the credit being claimed on a floor sample or as “demo” equipment? – Auditors may impose use taxes on display merchandise and demos, arguing that display itself can be a taxable use.
Though qualifying for some of the above SALT credits and exemptions may seem challenging, the potential payoff is significant. Working with a knowledgeable and informed CPA, your organization can leverage the above while avoiding some of the criteria-based pitfalls.
About the Author
Bruce Nelson, CPA, is a director of tax service for EKS&H. He has more than 30 years of public accounting experience, and has written more than 50 articles and books on a wide variety of topics including state and local taxes. Bruce holds a BA from the University of Nebraska and an MA in History from Colorado State University.