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Finding Your Direction for Sales and Use Tax

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Sales tax exemptions  for manufacturers are available in most states. The challenge is finding the time to dissect the regulations and understand how to maximize your sales tax savings.

What’s the fastest way to take advantage of sales tax exemptions without making costly mistakes?

Begin by having a clear understanding of how your manufacturing process fits into the state’s regulations for sales tax breaks. Most of your tax savings will fall into one of four buckets:

1.  Machinery and equipment
2.  Production supplies
3.  Packaging supplies
4.  Utilities

Let’s begin by looking at the area where the most complicated sales tax exemptions exist…machinery and equipment.

Where does production begin and end?
If you have been dealing with sales tax in a manufacturing environment for any length of time, you know that just because a state provides a manufacturing exemption doesn’t mean that machinery or equipment is exempt all the time. You need to understand the state’s interpretation of where production starts and stops.

Answering these questions will help determine taxability:
• How does your state identify the beginning of the production process, as well as the end?
• Does the material handling equipment bringing raw materials into the plant qualify for a manufacturing tax break?
• Does testing equipment qualify for exemption?
• Is packaging equipment included in the exemption and does it have to be part of the continuous manufacturing line?
• What about material handling equipment that takes your finished product from the end of the line into the warehouse?
Knowing what your state considers to be “production” is the first step in ensuring correct taxable decisions.

Equipment used inside and outside of production
Each state has its own set of guidelines to determine if dual-use equipment (used in both a taxable and exempt manner) qualifies for a sales tax exemption. It’s imperative to understand your state’s benchmark.

Most states follow one of three standards:
Substantial Use: equipment is used 33% or more of the time inside the production process
Predominant Use: equipment is used 50% or more of the time during production
Exclusive Use: equipment operates 100% of the time inside of production


Additional Exemption Standards
Here are other factors to consider when determining the taxability of manufacturing equipment:

1. Directly Used or Necessary and Essential: Does your state have a requirement that the equipment make a physical change to the product or does it have to simply be necessary and essential to the manufacturing process? The “direct use” standard sets the bar significantly higher than the “necessary and essential” standard, so take time to know the difference.
2. New and Expanding Business Exemption: Is your state one of many that only provides an exemption for machinery purchased for new or expanding business? Are you aware of the benchmarks that need to be met? What’s the impact for replacement machinery?
3. Repair & Replacement Parts: Does the manufacturing exemption apply to repair parts and component parts of such machinery? Do “rapidly consumed parts” qualify?
4. Useful Life Criteria: Some states provide exemptions if a part has a useful life of 3 years, one year, or less than one year. Understand your state’s criteria, then set up guidelines to track the life span of your equipment.
5. Ancillary Equipment: A lot of other states also provide exemptions for ancillary equipment, such as pollution control or R&D equipment.

The people at your company making sales and use tax decisions should be familiar with the state guidelines and how they apply to your operations.

To get more advice about taking advantage of sales tax exemptions, subscribe to the Cherry Bekeart Sales and Use Tax newsletter. 

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Lauren Stinson, CMI
Written by Lauren Stinson, CMI

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