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How to Handle State Tax Exemption Requirements IMR, March 26, 1996 Distributors and manufacturers should be aware of the questions about state tax exemptions that may arise in the course of doing business. When manufacturers ship products ordered by distributors in one state to customers in other states, the tax situation can become complicated. This report is intended to help explain various legal requirements. Be sure you consult with your tax expert for advice about handling taxes for business conducted outside your home state. Tax Exemption Basics Manufacturers sell products to distributors. Sometimes the manufacturer ships the product to the distributor's office in the distributor's home state. Sometimes the manufacturer drop ships the product to the end user on behalf of the distributor, and the end user is in the distributor's home state. In these two situations, the distributor should provide the manufacturer with a copy of the Tax Exemption Certificate for the distributor's home state. This provides the manufacturer with evidence that the distributor has registered with his home state as a business that distributes product for resale. This allows the manufacturer to waive charging tax on product shipped to that distributor or drop shipped to an end user within that distributor's home state. If your distributorship does not have physical presence such as a sales office, distribution center or manufacturing facility in a state, you are not required to collect sales tax from your end user customers. The legal precedent under which states must operate stems from a 1992 U.S. Supreme Court decision, Quill vs. North Dakota. Quill, the office supply catalog sales company, had been charged with sales tax violations by the state of North Dakota. Quill drop shipped orders into that state, but had no physical presence there. The court ruled that Quill was not required to collect sales tax because it did not have physical presence in North Dakota. Distributors with multiple locations in different states must have tax exemption certificates for each state in which they have physical presence. For example, your branch sales office in a neighboring state is, in the eyes of the law, no different than your "home office" in your home state. Complications When a manufacturer drop ships a product to an end user on behalf of the distributor and the end user is in a state other than the distributor's home state, the tax situation can be confusing. That's because although the distributor may not have physical presence (called "nexus" in state tax language) in those states, some manufacturers do because they have multiple plants, warehouses or sales offices. Thus, manufacturers with nexus in multiple states are required by law to collect sales taxes on products drop shipped to those states unless the distributor can produce a tax exemption certificate. To further complicate matters, certain states will not accept the distributor's home state tax exemption certificate for products a manufacturer drop ships there. In these cases, distributors should secure a tax exemption certificate directly from those states and file a copy with their manufacturer. Manufacturers that have physical presence in multiple states have little maneuvering room. Lacking the distributor's tax exemption certificate, the manufacturer is liable for the state tax. If the manufacturer has a copy of the distributor's tax exemption certificate for those states outside the distributor's home state, the manufacturer will not be required to charge state sales tax. Questions Do all manufacturers require all distributors to provide tax exemption certificates for all states in which the distributor has clients? No. Local or regional manufacturers are less likely to have physical presence in multiple states. Their physical presence is probably limited to a handful of states, at most. The larger the manufacturer, the more likely that manufacturer would have some physical presence in many or all 50 states. Also, the larger the manufacturer, the more likely it will become a target of state tax auditors. States concentrate their resources on businesses with the greatest "potential" for tax exposure. Of course, as states become more sophisticated in collecting and interpreting tax data, it will be easier for them to move down the chain and audit smaller manufacturing companies. How do I contact states that do not accept my home state exemption certificate? See the list included with this article. Call and explain your situation. They will send you a form commonly called an application to obtain Sales Tax Vendor Identification Number. Fill out the form and send it back to the state. Within a couple of weeks, the state will issue you a tax vendor identification number. Once you have this number, fill out a tax exempt certificate (resale certificate) and forward copies of the certificate to your manufacturers. The key to this process is securing the tax vendor identification number for the states where you do business. Why is this an issue now? Some states have adopted aggressive postures lately. As the federal government relinquishes more authority to individual states, more states are enforcing their "drop ship" laws. After all, it is a revenue producer for those states if they can prove businesses are not following specific tax laws established by their state. Recently, the state of New York audited one DMIA manufacturer member and found the taxes due to be more than $100,000 plus interest and penalties if the manufacturer could not secure valid tax exemption certificates from its distributor customers. By registering with various states, won't that put a distributor's business on their "radar screen?" Yes, but that's OK. The registration process simply explains to the state that your distributorship is tax exempt for resale only. And as long as your distributorship does not have physical presence in that state, you are not required to collect sales tax from your end user customers. State Positions on Exemption Certificates States that will accept the out-of-state purchaser's home state exemption certificate: Alabama Arkansas Colorado Minnesota New Jersey North Dakota Ohio Oklahoma South Carolina Texas Utah Vermont Virginia Washington West Virginia Wyoming States that require distributors to provide a valid state exemption certificate: Arizona* California Connecticut District of Columbia Florida Georgia Hawaii Illinois Indiana* Iowa* Kansas Kentucky* Maryland Michigan* Mississippi Missouri* Nebraska Nevada New Mexico New York Pennsylvania* Rhode Island South Dakota Tennessee Wisconsin * These states have various exemptions. It's best to contact the respective state authorities on specific requirements. States that will accept a statement from out-of-state purchasers that sales are for resale: Idaho Louisiana Maine Massachusetts North Carolina States with no requirements: Alaska Delaware Montana New Hampshire Oregon Back to Taxes