Nonprofits and sales tax questions answered
Common nonprofit sales tax questions answered
There are roughly 2 million registered tax-exempt nonprofit 501 (c) organizations in the U.S., including churches, schools, civic groups, arts, clubs, labor relations groups, agricultural organizations, political campaigns, ad infinitum. Nonprofits provide a significant boost to many local economies and are an increasingly important driver of national GDP. Despite the prevalence of nonprofits and the common assumption that they’re all tax exempt organizations, misinformation persists. Nowhere is this more evident than in sales tax compliance.
There are many circumstances in which a nonprofit is required to pay or collect sales tax on a particular transaction or in general. In both cases, sales tax requirements might exist despite a general IRS exemption. By any measure, the sales tax puzzle faced by nonprofits both on the selling and purchasing side is far more complex than first appears.
This Q&A addresses typical areas of confusion regarding nonprofits and sales tax.
QUESTION: Which nonprofit organizations are exempt from paying sales tax?
ANSWER: Any 501 (c) organization can potentially be required to pay sales tax.
Tax-exemption applied to nonprofits means that in most cases the sales tax for certain sales is waived for transactions relating to the charity’s “charitable mission.” In some states, exemption from paying sales tax depends on the nature and volume of the sales activities by the non-profit.
In many states, if a non-profit vendor is engaged in business and making sales of taxable items or services, the non-profit is obligated to collect just like any other vendor. In some cases in states that might excuse collection under other circumstances.
There are many types of tax-exempt organizations as defined by the IRS, including:
- 501(c)(2) — Title Holding Corporation for Exempt Organization
- 501(c)(3) — Religious, Educational, Charitable, Scientific, Literary, or Prevention of Cruelty to Children or Animals Organizations
- 501(c)(4) — Civic Leagues, Social Welfare Organizations, and Local Associations of Employees
- 501(c)(5) — Labor, Agricultural and Horticultural Organizations
- 501(c)(6) — Business Leagues, Chambers of Commerce, Real Estate Boards, etc.
- 501(c)(7) — Social and Recreational Clubs
- 501(c)(8) — Fraternal Beneficiary Societies and Associations
- 501(c)(9) — Voluntary Employee Beneficiary Associations
- 501(c)(10) — Domestic Fraternal Societies and Association
States define rules regarding these tax exempt organizations differently. It is incumbent on nonprofits to understand state-specific rules and their implications for transactions within a specific jurisdiction or industry. At a minimum, nonprofits typically need to:
- Submit an application for recognition with the IRS.
- File the appropriate paperwork to maintain exemption status.
QUESTION: How do nonprofits prove they’re tax-exempt?
ANSWER: By providing exemption certificates and other documentation.
To substantiate tax-exempt status, a nonprofit must present a business with a valid, timely, and accurate certificate of sales tax exemption for each applicable jurisdiction. The burden of keeping records of exemption certificates also lies with the seller. Common exemption certificate activities include certificate verification, storage, associating transaction with certificate, and managing expiration and renewal notifications.
Whether or not nonprofits have to pay sales tax on taxable purchases depends on the state and local tax rules that apply to that transaction. The research to determine whether or not sales tax is due lies with the nonprofit. Even though the federal government awards federal tax-exempt status, a state can require additional documentation to honor it. For example, in Illinois companies who qualify as exempt according to the IRS cannot assume that their exemption qualifies them for exemption from sales tax at the state level. In the state of Illinois, “…organizations must obtain an exemption identification number (an “E” number) to qualify” for a state sales tax exemption.”
When completing a sales tax exemption certificate, a nonprofit should be certain to complete the form in full and avoid an simple mistakes that may delay processing.
Sales Tax Exemption Certificate Validity Checklist
- Each item needs to be filled in and not left blank
- Seller name / address (make sure the name listed on the certificate matches the name on the customer account)
- Buyer name/address
- Current date
- State of exemption
- Sales tax registration number
- Type of sales tax exemption claimed
- Type of property purchased
- Type of nonprofit
- Customer signature (some states require an “authorized” signature, either a board member or executive director)
- Only state-approved exemption certificate forms are permitted
- Nonprofits must pay for purchases using only organization or government funds
EXAMPLE: Consider Florida where all entities, except federal agencies, wishing to qualify for sales tax exemptions to complete an Application for Consumer’s Certificate of Exemption (Form DR-5). In many cases, exemption certificates expire 5 years after the date of issuance and are subject to review and re-issuance procedures.
QUESTION: Do nonprofits that sell goods or services to consumers need to pay sales tax?
ANSWER: In some cases, yes.
It is crucial for nonprofits to understand the significant difference between paying sales tax and the obligation to collect sales tax on goods and services they sell to consumers. It’s important to recognize the ‘excuse from collection’ allowed to some non-profit vendors in some cases does not apply to items they sell. The underlying items are taxable or not based on existing state law whether the non-profit vendor is obligated to collect or not. For merchandise, Tangible Personal Property (TPP) rules apply. For memberships or events, there are special rules applicable for memberships and admissions, we have pro rules for these type activities too.
EXAMPLE: In states such as Washington State, nonprofits are required to collect and remit retail sales tax on their sales of goods and services. In others, like Michigan, exemptions offered to nonprofits for purchases of tangible personal property were expanded in 2013. This is great news for nonprofits, but it creates another layer of exemption certificate management complexity.
QUESTION: Can nonprofits be audited?
As a matter of fact, nonprofits are more likely to be audited than their for-profit counterparts, but businesses selling to them are equally at risk. Failure to properly substantiate tax-exempt and erroneous or missing sales tax exemption certificates are among the top audit triggers.
A number of states, notably Texas and California, publish common sales tax related errors that increase the chances of triggering an audit. In both states, erroneous or incomplete exemption certificates are among the top three audit triggers.
Common mistakes in sales tax exemption certificate management include:
- Nonprofits charging consumers sales tax when the transaction should have been tax-exempt.
- Nonprofits using expired or erroneous exemption certificate to prove tax-exempt status.
- Given the rate of change to sales tax rules and the variability between jurisdictions, a company would be hard-pressed to manage the process accurately.
EXAMPLE: The Cascade Christian Center of Skagit Valley, a nonprofit church that runs programs to support the community, also operates a fun center for kids. After Washington State enacted a new law regarding nonprofits, the fun center was no longer tax exempt. It took a sales tax audit to bring this to the attention of the Center. The resulting penalties fines and fees nearly bankrupted the organization.
To learn more about your state’s specific nonprofit sales tax requirements, you can research their codes on nontaxable transactions, sales to nonprofits and other related codes.
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