The Highlights
- Tax-exempt entities include religious organizations, educational institutions, and non-profit organizations, based on state and federal law
- When selling to these organizations, the buyer needs to provide their exemption certificate or other valid proof
- You generally do not need to collect the sales tax at the point of sale after verification
- Store the exemption documentation safely for audit purposes
Here’s the scenario: You’re a small business owner who just received your first big order from a nonprofit. You’re excited, but also confused. Are you supposed to charge sales tax? What taxes are tax-exempt organizations exempt from?
It’s simpler than you might think. Cut through the noise with this quick RJM Tax Exemption sales tax guide.
What are Tax-Exempt Organizations?
You’ll need to know exactly what these entities are if you’re going to sell to one. Tax-exempt organizations are typically:
- Charitable organizations
- Churches and religious organizations
- Private foundations (unless they meet an exception under Section 509(a))
- Political organizations (subject to Section 527)
- Other nonprofits, like welfare orgs, labor organizations, and social clubs
The basis for each exempt entity comes from federal and various state regulations. For example, religious organizations are exempt under IRS Section 501(c), and some states extend that exemption to sales tax as well.
Based on the organization and the state, an entity can be exempt from federal income and/or state income, sales, property, and use tax. We’ll be focusing on sales tax exemptions for this guide.
Are State Exemptions Uniform?
Unfortunately not. States have not adopted a blanket tax exemption regulation, which can make handling sales tax when selling to tax-exempt organizations a challenge.
For example, consider Virginia and Michigan. Virginia requires nonprofits to apply for a specific exemption from the Virginia Department of Taxation, subject to certain conditions, including that administrative costs not exceed 40% of annual revenue. If they meet the criteria, they can get a certificate from the department.
Michigan, on the other hand, allows charitable organizations and other similar entities to purchase items tax-free without a certificate. The catch? They need to provide the seller with information directly, stating the reason for claiming an exemption and including details such as their state tax license number.
What to Do When Selling To Tax-Exempt Organizations
Now that you know what tax-exempt organizations are, let’s look at the simple three-step process you should follow when dealing with sales tax.
Step 1: Verify The Customer’s Tax Exemption
The very first step is to be absolutely sure you’re selling to a tax-exempt entity. Depending on your state, this can be as simple as requesting a tax-exempt certificate or an IRS determination letter from the buyer. A state certificate would be something like an ST-12 form in Massachusetts.
Once they’ve provided the documentation, you’ll want to check key details like:
- The organization’s name
- Their tax-exempt number
- Issuing state and expiration date (if applicable)
If you’re unsure what taxes tax-exempt organizations are exempt from, we strongly recommend working with a sales tax specialist to understand your tax nexus and compliance obligations to avoid any penalties.
Step 2: Collect and Store Documentation
When handling sales tax and selling to sales tax-exempt organizations, be sure to retain and securely store the exemption proof for the record. You might need to display these documents come audit time.
Step 3: Apply Exemptions at the Point of Sale
Applying the exemption at the point of sale is easier than you might think. For ecommerce businesses using platforms like Shopify or BigCommerce, this is as easy as linking the buyer’s customer profile to their valid exemption certificate. If you’ve just learned what tax-exempt organizations are and how to move forward, you can also use add-ons like TaxWisp to do this.
You’ll want to double-check whether the items qualify for an exemption. Some states, like California, apply strict exemption laws based on the intended purpose of the purchase, while states like Texas can be more lenient. If you’re unsure, contact a sales tax registration expert like RJM for a tax strategy.
Are There Penalties for Non-Compliance?
Absolutely. Penalties can vary significantly by state and include:
- back taxes
- monetary fines
- audit costs
- Interest on unpaid taxes
Not complying with sales tax requirements when selling to tax-exempt organizations in California, for example, can lead to a $1,000 penalty per offense.
Simplify Sales Tax with the Pros
Navigating the twisting maze of exemptions is no easy task, especially if your business sells across multiple states. Work with a top-rated ecommerce sales tax expert to keep your business compliant and sell confidently. Contact RJM Tax Exemption for a consultation today.
Frequently Asked Questions
What are tax-exempt organizations?
These organizations are entities like:
- A 501(c)(3) nonprofit
- Educational institution, or
- Local associations of employees
These entities can be exempt from paying sales tax based on state or federal law. You’ll want to check their status by asking for a tax-exempt certificate. Some states may also have their own unique documentation as proof.
What happens if I don’t collect a tax-exempt certificate?
The liability for the uncollected tax may fall on you during an audit. The penalties and potential fines for non-compliance with sales tax exemptions when selling to tax-exempt organizations vary from state to state. If you’re not completely sure what taxes tax-exempt organizations are exempt from, contact a trusted expert like RJM right away.
How can I stay compliant if tax-exempt rules vary state by state?
Keeping track of what organizations qualify for exemptions based on your tax nexus is always going to be a challenge, especially if you’re also focusing on growing your ecommerce business. The best way to simplify sales tax is to work with an expert like RJM Tax Exemption.
