Controlling costs is always at the forefront of manufacturers’ minds and avoiding overpaying state sales taxes is a good place to start. This is an especially ripe time for manufacturers to reconsider their sales tax practices. Ongoing supply chain disruptions have already prompted some manufacturers to shift to new domestic suppliers that can expose them to additional sales tax regimes. Here are steps you can take to minimize overpaying state sales taxes.
Understand All the Relevant Exemptions
Manufacturers often can benefit from state sales tax exemptions. It’s important to realize, though, that the available exemptions vary — sometimes significantly — by state. You need to stay on top of the exemptions available to you in every state where you and your suppliers operate or you could end up overpaying state sales taxes which sometimes can be hard to recover.
It isn’t enough to know that a jurisdiction offers a manufacturing exemption — you also need to know the specifics. For example, Illinois and Texas both exclude hand tools from the exemption. But Illinois explicitly includes graphic arts machinery and equipment within its exemption, and Texas includes safety apparel and work clothing purchased for employees. Louisiana allows a phased-in exemption on the “cost price” of tangible property consumed in the manufacturing process, specifically citing fuses, belts, felts, wires, conveyor belts, lubricants, motor oils, and repairs and maintenance of qualifying manufacturing machinery and equipment.
States also can vary on the definitions of similar statutory phrases, as well as activities that fall within the exemption. For example, Illinois extends its exemption to “production-related tangible personal property” used or consumed for research and development. Texas, however, excludes items used in the research and development of new products.
States may differ on when the manufacturing process begins and ends, too. In Illinois, the process begins with “the first operation or stage of production in the series.” Louisiana law states that manufacturing “begins at the point at which raw materials reach the first machine or piece of equipment involved in changing the form of the material.” These types of variances might make you eligible for larger exemptions in some states than others.
Don’t Rely on Your Vendors
You shouldn’t assume your vendors are charging you the proper amount of sales tax. Often, vendors don’t have the time or resources to stay up to date on legislative developments that change the taxability of the items they sell.
You might not learn of discrepancies until you go through a reverse audit that reveals one or more vendors have been overcharging. In the meantime, you may have accrued a substantial amount of overpayments — money you could have invested elsewhere.
It’s worth noting, too, that vendors’ failure to keep up on sales tax developments also could mean you’re underpaying your sales tax. Ultimately, you’re responsible for paying the correct amounts, and underpayment can lead to hefty penalties.
Take a Proactive Stance on Refunds
If you find that you’ve made overpayments, you must affirmatively request a refund. No state department of revenue will reach out to you on the matter.
The proper way to handle a refund request is yet another area that varies by state. Some states require the vendor to request the refund, while others allow vendors to assign their refund rights so the customer can apply for the refund. Texas requires purchasers without a sales and use tax permit to first ask the seller for a refund.
Don’t drag your feet on seeking refunds or wait until your overpayment is more significant. Refunds generally are subject to statutes of limitations. Moreover, a request for a large refund could end up triggering a state audit of your business.
Stay on Top of Things
As outlined above, minimizing your sales tax liability can be complex and time-consuming and the best thing to do is to strive to avoid overpaying state sales taxes in the first place. We can help you get started with a reverse audit that uncovers past and ongoing overpayments, as well as explore options to automate the process and mitigate the risk of costly human error. Contact a member of our Manufacturing and Distribution Team to discuss best practices to avoid overpaying state sales taxes.