Understanding state sales tax exemptions for nonprofits
I often remind nonprofit leaders that the privilege of being exempt from federal and state income tax does not extend to other areas of taxation. IRS tax-exempt status does not apply to most payroll taxes, certain excise and business income taxes, and state sales tax, which is today’s topic. In fact, we are seeing heightened compliance efforts by state and local governments nationwide with respect to sales tax audits of nonprofits.
As you may be aware, many of our governmental units are a bit short of cash these days and are looking high and low for additional revenues. Nonprofits can be an easy target for additional revenue because many nonprofit leaders are not aware of the rules.
The first step in understanding the responsibilities of a nonprofit organization with respect to state sales tax is knowing that you have two sets of responsibilities: as a both buyer and seller. Also important to know is that, unless specifically exempted, your responsibilities are the same as a for-profit business. That means you are required to pay sales tax on purchases, and to collect and remit sales tax on sales. Many organizations get the purchasing side right, because retailers enforce those rules. However, there is often confusion regarding when to charge sales tax on sales, and remit that tax to the state via the filing state sales tax returns.
Today’s topic is the exemption allowed nonprofits for purchases. Please visit this column next month as I continue our sales tax discussion with collection and remittance. I will focus on the rules for Illinois, however; if you are conducting activities across state lines you may have multi-state considerations.
The Illinois Department of Revenue is our state reporting agency for sales tax and the authority that determines the applicable exemption. The IDOR exemption and associated “E-Number” allows you to make sales-tax-free purchases, and requires renewal once every five years. There are limits on the exemption. First, the exemption should only be used for purchases of merchandise used for your tax-exempt purpose. Secondly, the IDOR has become increasingly discerning when granting sales tax exemptions. Only “true” Illinois charitable organizations are “worthy” of the E-Number – just having an IRS exemption under section 501(c)(3) is not enough. An important point to remember is your IRS tax-exempt letter and your IDOR tax-exempt letter are not interchangeable!
The benefit of having the E-Number is purely economic: if an organization does not have to pay sales tax, there is more money to support programs. So how do you obtain the E-number? The IDOR provides an application process with specific criteria. You must provide them:
• Articles of incorporation, if incorporated, or constitution, if unincorporated.
• By-laws. IRS letter, respecting federal tax-exempt status, if your organization has one.
• Most recent financial statement (religious organizations do not need to submit a financial statement with the initial request).
• A brief narrative that explains purposes, functions, and activities of your organization. Brochures or other printed material explaining the purposes, functions, and activities of your organization. Any other information that describes the purposes, functions, and activities of your organization
Applications are reviewed and determinations made on a case-by-case basis. It has become increasingly important to take the time to prepare a thorough application, and don’t forget to make it easy to review. Remember: our state agencies are becoming less inclined to willingly forgo revenue. Consequently, IDOR representatives are scrutinizing applications, especially your purpose and functions (items 5 and 6, above). However, if you can demonstrate you are worthy, the state sales tax exemption will provide savings that will contribute to your bottom line.
• Nancy Gonsiorek is a Certified Public Accountant providing audit, tax and consulting services to nonprofit organizations. Her firm, Nancy L. Gonsiorek, CPA, LLC is based in Crystal Lake. She can be reached at 815-455-9462 or via email at NancyGonsiorek@comcast.net.