The Sales Tax Guy: Manufacturing

Showing posts with label Manufacturing. Show all posts

Wednesday, June 18, 2014

FAQ - Keeping the Lights On in the Manufacturing Plant

This issue comes up a lot in seminars...

Usually, environmental equipment (keeping the lights on, maintaining a comfortable temperature in the plant, etc.) is taxable, even in states that grant exemptions for manufacturing equipment and materials. The problem is that, while necessary, the lights and temperature in the plant don't have a direct impact on the product being processed. If you want to make the argument that you need the lights on to operate the equipment, I'd agree with you. But you also need the sales and marketing department to keep the plant operating. That doesn't make them exempt. The rules are generally that the item must be directly used in the manufacturing process.

What does directly mean? This is not the rule in the majority of states, but it's my rule of thumb.

In order for an item to be exempt under manufacturing rules, the item must touch the product.

I admit that's strict and most states aren't quite that nuts. But if you're going to argue for an item to be exempt before the Sales Tax Guy Tribunal, you'll need to rationalize from that statement. Good luck.

The Sales Tax Guy http://salestaxguy.blogspot.com

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Tuesday, March 20, 2012

Great Article: States to manufacturers: We want you ASAP!

Lines Angles Pipes Braces Girders Tracks Concrete

from CNN Money

While light on the sales tax component, this article illustrates how hungry states are for manufacturing jobs. And why they give incentives, like manufacturing exemptions. Enjoy the article.

This link is part of a series called "Excellent articles that I wish I had written." The short name is "Great Articles."

The Sales Tax Guy
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Tuesday, May 31, 2011

Detailed Manufacturing Rules

Every state has different rules for manufacturing. And I covered the major rules here. Today, I thought I'd review some of the more detailed taxing policies that you may deal with.

Where does the manufacturing process begin and where does it end? The first requirement to worry about, for most manufacturing exemptions, is that the item must be used in the manufacturing process. Usually, it starts at the first machine and ends at the last machine. The last machine is often packaging the product for the final consumer - putting beer in the can, for example. Sometimes the manufacturing process includes the transportation of raw materials to the first machine and transportation of the finished goods to the warehouse. And in a few situations, the process even includes the raw material and finished goods inventory as well as the shipping department. Not often, though.

Materials handling equipment, like lift trucks, pipes and conveyor systems, if used directly within the manufacturing process, will usually be exempt. But beware. There are a couple of states that specifically exclude this type of equipment from the manufacturing exemption. Also, some states require that the equipment be used exclusively in the process. The rest usually require that the equipment be used predominantly in the process. This is a challenge when you're running lift trucks all over the plant.

Concrete mixers are, in many states, considered manufacturing equipment. This is because, after the materials are loaded into the truck, there is still some processing being done in the drum as it's heading to the job site. Hence, it could be considered manufacturing equipment. But note that, in states where this exemption exists, it doesn't extend to the truck itself. The exemption only applies to the mixer.

Cleaning of manufacturing equipment is usually not considered directly used in manufacturing. However, if the cleaning is necessary for a food processor, then it's sometimes exempt.

Speaking of clean, clean rooms are sometimes exempt as well.

Sometimes, big manufacturing machines will require specialized concrete foundations. These may be exempt in some states, even though they are permanent (and really heavy) additions to real property.

Power generation equipment is frequently exempt if the power is being used by manufacturing equipment. Less often, transformers for electricity coming from mains is exempt.

Employee safety items, such as gloves, goggles, helmets, aprons, etc. are surprisingly not generally exempt, even if they are required by OSHA. One problem is that they are rarely directly used in the manufacturing process.

There are even more detailed manufacturing rules, but this should do for now. And I just realized that there were no jokes in this article. Sorry. Maybe next time.

The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only. Research these issues thoroughly before making decisions. Remember: there are details we haven't discussed, and every state is different. Here's more information

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Tuesday, December 14, 2010

Gotta watch those widget sales

I had a question from a class participant a few days ago, and it was such a good question, I thought I'd use it here. But I promised her I'd sanitize the heck out of it. So think of this as a question "inspired" by the real question.

"My company is an HVAC contractor [in most states, contractor sales aren't taxable - they pay tax on the building materials they use]. We prepare widgets in our shop that will be attached to the HVAC equipment. Since it's part of the construction job, we just cost the materials used for the widgets to the job and pay sales tax on the few hunks of steel that we use.

However, we have a lot of customers who buy the widgets without our doing any actual HVAC work (our widgets are very popular and user installable). When this happens, we just send the widget to the customer, and bill them. We don't charge sales tax. Should we?"

You should be charging tax on the widgets that you sell at retail to your customers. If the widgets become part of the building where you're doing the HVAC work, then you would pay tax on the widget components when purchased.

But when you sell the widgets outside of a construction contract, you are making retail sales of tangible personal property, and those are taxable sales. You should be charging tax.

The problem is that, if you've already paid tax on the components of the widget when you bought them, and then you collect tax on your retail sales of them, then the state is getting too much money. In most states, there are two solutions (and you need to check your state rules to make sure of your options):

Purchases resold - Many states make provision for purchases you make that were taxed, and are subsequently sold at retail where tax is collected. The states usually let you deduct your "purchases resold" from your use tax liability.

Buy for resale - If your retail sales of widgets are substantial, consider giving your vendor a resale certificate for all of the widget components and pay no tax on any of those purchases. Then collect tax on your retail sales and accrue use tax on the materials that become part of your construction contracts.

Either way, there is extra bookkeeping involved. But if the retail sales of the widgets are substantial, you should come up with a solution before the next auditor finds it.

This is another example of a situation where a business was making taxable retail sales without even realizing it. Does anyone else have this problem? You betcha!

And finally, if you are actually manufacturing the widget, you should look into whether or not there are any manufacturing exemptions available to you.

Friday, October 08, 2010

Manufacturing Exemption: The "Use It Here" Rule

Here’s a sneaky situation involving the manufacturing exemption.

There are quite a few states who require that, in order for the exemption to work, the use of the exempt items must be within the state. This makes logical sense, given the purpose for the exemption. But there are a couple of situations (that I can think of) where a problem would occur:

Situation 1

The reason I even thought about this rule was because of a guy in the class who ran a truck routinely from his plant in state B to pick up manufacturing equipment at a dealer in state A. He had asked an unrelated question, and I started thinking about it and realized that there was a problem.

Let’s say you’re the seller in state A. Your customer, from state B, comes in and picks up manufacturing equipment. You try to charge him state A’s sales tax, but he waves around his exemption certificate from state B, maintaining that he’s going to be using this equipment in manufacturing. But in YOUR state, the manufacturing exemption only applies to manufacturing equipment that will be used in state A. The "use-it-here" rule. Since the purchase will not be used in state A, the customer’s state B manufacturing exemption is worthless.

Even if the buyer fills out state A's manufacturing exemption form instead, it won't be valid because he's not "using it here." And you will owe state A the sales tax you should have charged your customer.

The solution is easy - simply ship the equipment to the customer in state B. Then, since it’s a shipment out of the state, state A has no jurisdiction, and the delivery is in state B. Everybody happy.

A similar problem exists if state A didn’t have any manufacturing exemption at all. In that case as well, the buyer’s state B certificate is irrelevant. Same solution.

Situation 2

You purchase equipment and have it shipped to your location in state B. There’s a manufacturing exemption in state B, so no sales or use tax. But you then reship the machine to state C. Since you never used, or intended to use, the purchase in your plant in state B, and state B has a “use it here” restriction, you will owe use tax on that machine to state B.

Note that state C has a manufacturing exemption, but state B doesn’t care. And since you stored (used) the equipment in state B, they get to nick you for the use tax.

Remember, not every state has this "use it here" rule, so check it out first.

And if you can think of any more situations where this "use it here" rule would be a problem, please let me know.

Thursday, September 23, 2010

Whenever the conversation goes this way, I cringe

Frequently, someone will say to me, either in a seminar or in a comment or email “we’re a manufacturer so we’re exempt from sales and use taxes".

If I’m feeling frisky, I’ll usually interrupt them and say, "No you’re not."

They’ll be nonplussed and say, "Oh yes, we’re a manufacturer. We make doo dads."

"No, you’re not exempt because you’re a manufacturer. You’re exempt on some of your purchases because you use them in manufacturing. All of your purchases aren't exempt. And your sales aren’t exempt."

"Well, yeah, OK. If we buy a copier for the office, it's taxable. But everything in the plant is exempt. And we don't have to charge tax on what we sell."

"I'm guessing you're not charging tax on what you sell because you're selling it to others who are buying it for resale. It's got nothing to do with the fact that you're a manufacturer. Hopefully your'e getting resale certificates. And that bit about 'everything in the plant is exempt' is wrong."

Arrrrgggghhhhh! And then I cringe.

Not understanding these exemptions is a dangerous trap to fall into. Manufacturers, in many states, can buy materials and equipment tax free if the purchase will be directly used in the manufacturing process. The rules vary enormously by state, from California who gives virtually no exemptions, to Pennsylvania who is pretty generous. But there aren't any states that just say, "You're a manufacturer so you're exempt."

The only types of organizations that can even begin to make a claim that they're "exempt" are non-profits and government agencies. But even in those situations, the exemption is not total. There are usually restrictions on how they use their purchases and what they can sell tax free. And some states don't even have the exemptions.

Frankly, the only organization that can truly make the claim that they're exempt is the federal government.

So please remember that it's your specific types of sales, purchases, and use that are exempt. The rules are restrictive and they vary from state to state. So don't go around saying you're exempt. You're not.

Tuesday, August 24, 2010

Mistaken Manufacturer

I exchanged a couple of emails with a past participant yesterday. She'd been stung during a sales tax audit because one of her vendors hadn't charged her sales tax. So she wound up having to pay the use tax, plus interest and penalties. Standard stuff, of course.

What was interesting is that, after the audit, she called the vendor and asked why they didn't charge her tax. Their response was that they didn't have to, they were a manufacturer and therefore exempt.

What?

Now, to be fair, the product was odd enough that I can see there being some really arcane exemption lurking in the statutes. So I suggested she check on that. But it amazed me (I should learn to never be amazed) that a company would think that the manufacturing exemption would apply to what they sell.

Just to make sure, for some of you who may be reading this, when we're talking about the manufacturing exemption, it's for the purchases of the manufacturer who uses them in manufacturing. Every state has different rules of course, but that's the big concept. It doesn't grant an exemption to what the company sells! Sheesh.

Now, I'm sending a link to this article to (we'll call her "Jane") who gave me the idea for this article (thanks and a gold star to you!). But I'm going to have to chide her a little. I talk about the fact that, when an in-state vendor fails to charge you tax on something you think is taxable, you should call them and find out why. If she had made that phone call back when these purchases were made, she might not have convinced the vendor. But she would have known to accrue the tax, and thereby avoid the interest and penalties that she paid as a result of the audit.

And, as a consolation prize, I did tell her that the vendor was probably going to get audited. Let's face it. When an auditor comes across a few invoices from an in-state vendor where they didn't charge sales tax for any apparent reason, they're audit-bait.

The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only. Research these issues thoroughly before making decisions. Remember: there are details we haven't discussed, and every state is different. Here's more information

Get these articles in your inbox - subscribe at http://salestaxguy.blogspot.com

Don't forget our upcoming seminars and webinars.
http://www.salestax-usetax.com/

Picture note: the image above is hosted on Flickr. If you'd like to see more, click on the photo. And the subject of the picture has nothing to do with this story!

Tuesday, November 03, 2009

Illustrations and Parables - The Story of the Fizzy Turkey

A guy in the class worked for a poultry processor. The auditor busted them on the carbon dioxide gas that they injected into the meat. The company had always assumed that this gas was exempt from sales tax because it was an ingredient. Ingredients are almost always exempt.

"Sounds good to me," I said. "But why do you inject carbon dioxide into the meat?" All I could think of was fizzy turkey.

The guy said, "I don't know, I work in accounts payable." I kid you not. Absolutely true.

This is one of my favorite stories, frankly because the AP piece is the funny part. When I told it in a different seminar, another poultry processor told me that the CO2 is a preservative. And, since it's the stuff that gives your Coke the bubbles, it's gotta be safe.

Anyway, the auditor said it didn't qualify for the exemption, and they were nicked for the sales tax. The amount was BIG - the assessment hurt. Now, the carbon dioxide IS an ingredient in the meat. They inject it into the chicken. So why was it taxable?

The auditor said that, in order for the CO2 to be considered an ingredient, it must be present in the final product when opened by the final consumer. And by the time you take your chicken home from the store, and open up the package, the carbon dioxide is gone. So, according to the auditor, it's not an ingredient - it's taxable.

But is the auditor right? I looked at the statute and the regulations after the seminar. There is no restriction, in that particular state's laws, saying the the ingredient must be present in the final product when opened by the consumer.

Some states do require that the ingredient be in the product sold at retail. To me, this means the CO2 must be there when the customer picks up the package from the cooler. And other states merely say that the ingredient must be in the final product, not specifying the point in time. Which could mean when the product is packaged and moved to the shipping department. But I've seen no state that specifies that the ingredient must be there when the customer opens the package.

Since the law, in this state, didn't even specify that the ingredient must be present when sold at retail, the taxpayer could have fought it. The assessment was big enough to make it worthwhile to hire some expensive professionals to appeal. But the taxpayer made the big mistake: he assumed the auditor was correct. He didn't even ask to see the law. He just wrote the check to the state.

So the morals of this particular parable are:

1. Know the rules for what qualifies as an ingredient in your state and adjust your procedures accordingly,
2. Have a better understanding of your processes, even if you work in accounts payable,
and most importantly,
3. Never assume that the auditor is right. Make them prove it!

Sales Tax Guy

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Wednesday, October 28, 2009

Are You a Manufacturer?

In most states, if you take something that has one form and name, and turn it into something with another form and name, you're a manufacturer. For example, there was a court case where a quarry was able to qualify as a manufacturer, at least as far as their rock crusher was concerned. That machine took boulders and turned them into gravel. Different forms and different names. Viola! They're a manufacturer. Which is a good thing.

If you qualify as a manufacturer, then congratulations! There are all kinds of wonderful and delightful exemptions that you can enjoy.

But if you're not...well, sorry. If you read the rest of this article, don't blame me if you get ticked off. Because you're not a manufacturer.

What I want to cover for you are the laws that make life grand for manufacturers, at least as far as sales and use taxes are concerned. You need to check these opportunities for your state, and see which ones apply. Because there's a chance you're giving the state money they don't deserve.

1. Machinery. In most states, manufacturing machinery is either exempt from tax or taxed at a lower rate. There are restrictions, but this is a pretty common and money-saving exemption. Common restrictions (which vary enormously) include:

The machine must be used to directly change the product from one form to the other
The machine must be used predominantly in the manufacturing process
The manufacturing process usually doesn't include the finished goods or raw materials inventory. It typically begins at the first machine and ends at the last machine on the line.
The machine often must be depreciable or have a minimum purchase price.
A few states require that the machinery expand production

For example, lift trucks are usually exempt if they are used in the manufacturing process to move WIP (work in process) from one machine to another. But if that truck is usually found in the warehouse moving raw materials, then it wouldn't be predominantly used in the manufacturing process. And therefore the lift truck would be taxable.

2. Repairs. In most states, repair labor and parts for exempt machinery aren't taxable.

3. Tools. In some states, smaller equipment, like hand tools, safety equipment, etc. are exempt.

4. Consumables. Generally, the ingredients that become part of the product are exempt. This really is just the resale exemption. But some states also grant an exemption for consumables (eg. like lubricants, drill bits, sand paper, catalysts, etc.) that are used during the process, but don't become an ingredient of the product.

5. Utilities. In some states, electricity, natural gas, propane, and other energy sources are exempt or taxed at a lower rate.

These are the big categories. And there are lots of complications and exceptions with each state being completely different. And these exemptions only apply to manufacturers. But if you are one, you owe it to yourself to get very familiar with the exemptions in your state so that you save every last dollar.

Sales Tax Guy

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Tuesday, December 02, 2008

Shocking But True!

This may come as a surprise to some of you, but there are manufacturers out there who didn’t know that they have really cool exemptions.

In most (but definitely not all) states, if you’re a manufacturer, you can invest in machinery, get it repaired, and buy consumables tax free, or at a lower rate. And even in states that aren’t very generous to manufacturers, there still may be some exemptions available.

And it’s not just manufacturers. Here are some other industries where I’ve seen exemptions that other folks at the chamber of commerce mixer don’t get:

Manufacturers
Mining
Common carriers
Funeral directors
Utilities
Radio and TV stations
Movie producers
Photographers
Contractors

So check your state’s laws to see if there might not be some exemptions for your business.

Sales Tax Guy

Wednesday, December 28, 2005

Manufacturing Issues to Consider

One of the recommendations I make in my seminars is that sales tax folks need to subscribe to a newsletter. And the one that I recommend is Sales & Use Tax Alert from CCH. It is a very worthy publication. The 12/15 article contains a very useful article about the manufacturing exemption. To summarize it:

1. Many states offer manufacturing exemptions.
2. Are you a manufacturer? It's not necessarily a dusty, noisy shop that makes you one. If you change stuff from one form to another, you may qualify depending on the state.
3. What is the "scope" of manufacturing. Depending on the state, this can include areas that you have been treating, incorrectly, as taxable
4. Look at what's exempt including raw materials, consumables and equipment. State defer, but again, you may have been taxing stuff that was not taxable.
5. Look carefully at the actual words in the laws. Issues turn on very specific phrases.

Obviously there's more in the article. Subscriptions are expensive, but well worth to for an SUT professional, particularly with multi-state exposure.

Sales Tax Guy

Thursday, September 29, 2005

What constitutes "direct use?"

What constitutes "direct use?"

I get this question in EVERY seminar when we start talking about manufacturing. In most states, there are exemptions for manufacturing equipment directly used in production. The same idea, by the way, also applies to agriculture, mining, fishing, etc.

So what IS direct use?

Every state has a different definition, but here are my rules of thumb to help you, at least, understand the issues:

Space proximity: How close is the item to the actual process itself. If it is far removed from the production area, it probably isn't directly used.

Time proximity: How close, in time, is the use of the product to the actual production. If it's used at some point in time well before or after the production, then it probably isn't directly used in the process.

For example, a packaging machine used in the shipping department to wrap up a skid of product is used significantly AFTER production and away from the process. But a wrapping machine that packages the product while it's moving through the production equipment IS probably close enough in time and space to be considered to be directly used in the process.

Causal relationship: Does the item cause a change in the product. Or does it affect something else that causes a change. If it's not directly causing a change, it probably isn't directly used in production. For example, if a drill is used to drill a whole in the product, it's directly used. But if it's used to fix a piece of manufacturing equipment, it isn't used directly in the process.

Another example might be a step-down transformer. Does it act on the product? No. It acts on the electricity, which acts on the machinery, which acts on the product. So a step down transformer, under this logic, would be indirect. Note, however, that many states DO consider step-down transformers to be directly used.

Essential to the process: This ropes in a bunch of stuff that may not be previously covered, like foundations, step-down transformers, foundations, safety equipment, etc. The question may simply come down to this question: Would production SHUT DOWN immediately if this item was suddenly to disappear?

Remember, EVERY state has different rules for what they consider to be directly used in the process. So review their rules carefully. But hopefully, you'll now have a better perspective on what "direct use" means.

Sales Tax Guy

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If you're new here, you may wish to start your exploration with our article on Sales Tax in a Nutshell and our subject index.

We've also written master articles on sales and use taxes:

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Please keep in mind that our purpose is to provide general information to familiarize you with certain issues. The information we provide may not apply to your particular situation or to the applicable state, may oversimplify an issue, or may omit a point that is relevant to you. In addition, exceptions, unwritten rules, and different interpretations abound. And every state (and sometimes local jurisdictions) will do it differently. Therefore you should not rely on the information provided for your specific needs.

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