Why businesses can have sales tax obligations with tax exempt sales

If your business sells products and services that aren’t subject to sales tax in the states where you have customers, you may think sales tax isn’t something you need to worry about. It is. Although you may not need to collect and remit sales tax if you don’t make any taxable sales in a state, you can still develop an obligation to register and file returns. 

Transactions can be exempt for several reasons, so your sales tax obligations will depend on what you sell, who buys it, why they’re buying it, and where the sale occurs. 

For example, most states provide an exemption for certain goods and services, such as food for home consumption (groceries), prescription drugs, or professional services. Such exemptions are provided by statute and apply no matter who makes the sale or purchase. 

Alternatively, specific customers can qualify to purchase normally taxable goods or services tax free. Tax-exempt entities include government agencies, certain nonprofit organizations, manufacturers, and resellers. In this case, the exemption must be validated: The customer must provide the seller with a properly completed exemption certificate or resale certificate.

Keep in mind that there can be exceptions to any rule. When in doubt, check with your tax advisor or the relevant state’s department of revenue.

Whether a business needs to register for sales tax depends on sales tax nexus. Nexus is a connection to a taxing jurisdiction.

You likely need to register for sales tax in states where you have a physical presence, even if your business exclusively makes exempt sales. A physical presence generally includes an office or other brick-and-mortar facility, employees, or inventory, but laws vary from state to state. For example, the presence of inventory in a third-party warehouse doesn’t give you physical presence nexus in some states; in other states, it does.

It’s also possible to develop a sales tax obligation in states where you have no physical presence. This is relatively new. In June 2018, the Supreme Court of the United States ruled that physical presence in a state is not requisite for sales tax (South Dakota v. Wayfair, Inc.). As a result, states can now base a sales tax obligation on economic activity alone. This is known as economic nexus.

All states with sales tax now have an economic nexus law, but no two economic nexus laws are alike. Each state provides a unique exception for remote businesses whose sales into the state fall beneath a certain threshold. 

Economic nexus thresholds range from $100,000 in gross sales in the state in the current or previous calendar year (South Carolina), to $500,000 in cumulative gross receipts from tangible personal property and 100 transactions in the state in the previous four sales tax quarters (New York). State-specific details can be found in our state-by-state guide to economic nexus laws.

Here’s the catch: Many states include exempt sales of products or services in their economic nexus thresholds. Some state tax departments spell this out clearly in their guidance. Others assume businesses understand the difference between “gross sales,” “retail sales,” and “taxable sales.” 

Here’s a primer, in case your Econ 101 class is a distant memory:

• Gross sales generally include all sales, including exempt sales and sales for resale 
• Retail sales exclude sales for resale
• Taxable sales exclude all nontaxable sales, including sales for resale

The following table will help you quickly determine whether your exempt sales of tangible personal property (TPP) or services count toward a state’s economic nexus threshold. Include the exempt transaction when calculating the state’s economic nexus threshold if there’s a check mark in the box. If there’s no check mark, don’t. Where applicable, see the notes for additional details.

The information in this chart is subject to change and offered for informational purposes only. It should not be used as tax advice.

In most states, you’re required to register for sales tax and comply with all applicable sales and use tax laws once economic nexus is established. However, as noted above, Vermont and Wisconsin do not require a remote business to register if its only sales into the state are nontaxable.

Once registered, businesses must file timely sales and use tax returns. Depending on your volume of sales in the state, returns are usually due on a monthly, quarterly, or annual basis. 

Registered businesses must also collect an exemption certificate or resale certificate from customers to validate exempt sales of normally taxable goods or services. Certificates must be kept as required by law, and state tax departments may ask to see them. One of the biggest challenges for businesses that make a lot of exempt sales is managing exemption certificates and ensuring they’re valid (i.e., accurate and not expired).

If you make exempt or taxable sales in any state where you’re not currently registered for sales tax, the first thing you need to do is determine whether you have nexus. Our free sales tax nexus risk assessment is a good place to start. 

This post refreshes an earlier article, Do exempt sales count toward state economic nexus thresholds.