The Complex Nature of Use Tax for Manufacturers

Use Tax for Manufacturers is More Complex Than You Think

You know that you must pay use tax on some business operations. You also realize that not properly managing use tax is complex and has the potential to cost your company large amounts of money in penalties and fees.

What often goes underappreciated are the true complexities of calculating use tax, and the somewhat unexpected additional costs of poorly managing the sales and use process.

For manufacturers, use tax comes into play in:

  • Machinery and equipment
  • R&D
  • Inter-plant transfers
  • Inventory withdrawals

The white paper for Use Tax for Manufacturers and Distributors covers all the complexities, but for most it starts with machinery and equipment.

Machinery and Equipment

Thirty-five states offer a use-based exemption from tax for machinery and equipment, and three more offer a reduced rate, according to research from CCH® IntelliConnect®.

These exemptions often require certain “tests” to qualify:

  1. Percentage of Usage — qualifying items must be used in manufacturing for “a preponderance of the time,” usually 51 percent to 100 percent usage, but it varies by state.
  2. New and Expanding Operations — use-based exemptions limited to items part of a “new manufacturing operation” or that “expand the existing manufacturing process.” Under this requirement, machinery/equipment for repairs would not qualify under some states’ provisions. Conversely, many states, such as California, Iowa and New York do not impose this qualification, and some states, like Arkansas, provide partial exemptions.
  3. Minimum Dollar Amount/Minimum Useful Life — the establishment of minimum dollar amount, such as $100-$500, and/or useful economic lifespan, such as 1-3 years.

Here’s an example applying the “New and Expanding Operations” limitation. Under some states’ use-based exemptions, a bolt is only sometimes exempt. For instance, if a company takes bolts and uses them in a manufacturing operation, many states will say that’s tax exempt. But if the same company uses bolts to replace the original bolts, those fall under repair, and in some states, the repair bolts would not qualify for the use-based exemption. In this case, the manufacturer, which bought the bolts with its use-based certification, would need to remit use tax.

Each of these qualifying tests involve complexity, and the regulations vary across states. Because of this, a manufacturer must understand:

  • What is tax exempt in all relevant taxing jurisdictions.
  • How the equipment/machinery must be used to make it tax exempt.

Getting Use Tax Wrong

The costs of mishandling use tax will quickly add up in terms of:

  • Penalties and fees
  • Overpaying of taxes
  • Tying up valuable IT and Tax resources supporting an inefficient process

Penalties, fees and interest charged on unremitted tax add up exponentially. Many states add on a 5–25 percent penalty for failure to file, 1–5 percent in interest per month, plus perhaps 3–25 percent for failure to pay — for total penalties of up to 55 percent.

Some manufacturers, wishing to avoid these penalties, may overpay rather than get caught in a negative audit situation. Overpayment is not only money lost — with no return — but also it comes with opportunity costs. These dollars could be better spent on investment, expansion, upgrades or improving the bottom line.

Additionally, not properly managing use tax will quickly drain the Tax and IT Teams’ resources instead of allowing them to use their expertise and knowledge to help your company achieve its goals.

For these reasons — the complexity of use tax and the costs of a poorly managed process — many savvy manufacturers are evaluating whether it’s time to invest in automated sales and use tax software.

Learn more about this important topic in the Use Tax for Manufacturers and Distributors.

AUTHOR

Sales & Use Tax Experts

All stories by: Sales & Use Tax Experts

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