What should companies know in order to sell tax-free to state and local governments and non-profit educational organizations?
Greg Althardt, managing partner of the Truck & Trailer Dealership Group for CliftonLarsonAllen LLP, had the answers in a webinar held by the National Trailer Dealers Association (NTDA).
Sales to state and local governments and non-profit educational organizations qualify as tax-free sales under code section 4221.
For state and local governments, the sale must be for the exclusive use of the state or local government. And the company must sell directly to the state or local government.
“You cannot sell to a retailer, who then sells to the state and local government under 4221,” Althardt said.
A state or local government includes a US state or the District of Columbia, or a political subdivision of either.
“It is quite interesting,” he said. “You could have many different subsets within a state or local government. The local government could obviously be the city that resides in that state or an organization within the city. State-run community colleges are considered a state or local government, not necessarily a non-profit educational group, and that will change the kind of certification that we will have to have, and also change the 637 registration requirements.
“Sales to the US government are not explicitly exempt from FET. As silly as it might sound, the government is basically assessing itself tax. They put it from one pocket to another pocket. If you’re selling to the US government, military department of defense, or the Secretary of State, specific sales to the US government are not explicitly exempt. You could run into other situations where you have off-highway-use exemptions to the military.”
He said it is necessary to register with the IRS using form 637 to obtain a number to complete certain tax-free sales. The purchaser must register with the IRS by filing Form 637, unless the purchaser is a state of local government or the sale is for export.
“The non-profit educational organization will be required to register with the government in order for you to sell in a tax-free manner,” he said.
“Where the purchaser is required to be registered, the purchaser must provide the seller, in writing, the purchaser’s registration number and the tax-free purpose for which the purchaser is buying the item. It can be written on the purchase order or on other documentation that is provided to the taxpayer. The tax-free use of the item must be first use of the item. Let’s say you have an item you have been demo-ing that you have had on lease, and is now off lease. That subsequent sale will obviously not be for the first use of that end user.”
He said the seller must advise the buyer of the following information: the items are normally taxable; the items are being furnished tax-free based on an exemption certificate or equivalent. They must also include enough information so the purchaser can tabulate tax if it’s then used for taxable purposes.
The seller cannot have any reason to believe that either the purchaser’s intent is to use the item other than for the specified tax-free purpose, or the purchaser is not registered (if required). The seller should keep all documentation relating to the tax-free sales under Internal Revenue Code 4221 for at least three years.
Exempt from federal taxes
He said state and local governments cannot register with the IRS, so the seller must collect either an exemption certificate signed by an authorized officer or employee of the government entity, or a purchase order that contains all of the necessary information contained in an exemption certificate.
A sale may be made tax-free only if the organization is exempt from federal income taxes under Internal Revenue Code 501(a) and normally maintains a regular facility and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on (or operates a school that meets these requirements, provided that the entity is a 501c(3) organization and the primary function is the presentation of formal instruction).
“Selling to Big Brothers or Big Sisters or any other non-explicitly exempted organizations, just based on the fact that they are non-profit organizations, does not exempt them from FET,” he said. “It will exempt them from federal income tax, but not Federal Excise Tax, at least explicitly as a tax-free sale. You could possibly be selling under one of the other exemptions of the code.”
It must be for the exclusive use, even if you are selling to a college not run by a state or a drivers’ training facility not run by a state. It also must be sold directly to the organization.
“This is where we see individuals get tripped up,” he said. “We’ll have a non-profit organization that comes to a dealer and says, ‘Hey, here’s our sales tax exemption, here’s our exemption certificate, we do not file federal income taxes.’ That is not good enough. If we don’t dot our I’s and cross T’s, an agent can ultimately unroll that, and if you did not conduct that sale in the proper manner, you—not the end user—are stuck holding the bag and paying the government.
“The organization is required to be registered with the IRS and give you their 637 registration number.”
Sales to the Red Cross and United Nations are considered
tax-free sales, but not under code section 4221 and instead under ruling 90-83 and code section 4293.
Exclusivity requirements:
• Cannot have prior knowledge it will be used for any other reason.
• Cannot enter into the agreement tax-free if the organization plans to resell the unit.
• If the organization sells to an employee to carry on the organization’s intended function, the exclusive use of the organization would be breeched and the sale would then become taxable.
“You cannot sell knowing that the non-profit organization plans to use the item for a year and then resell the item,” he said. “If it’s the Department of Transportation and they’re buying a specialty unit, and if in any part of the conversation they say, ‘We’re going to purchase this for a two-year and then sell it off,’ technically under law you cannot sell to them tax-free. Let’s say you sell it to them and you have no recollection or plan, I’d go as far as for you to have them sign a statement that specifies this purchase is for their exclusive use and their exclusive use only. That will absolve any questions after the fact.”
He said the specific private letter ruling number is 9416007 in that instance.
“Basically, the summary of this letter ruling is the dealer sold units to a truck-driving training facility that qualifies as a 501(a) organization, a non-profit educational organization,” he said. “The truck training facility would bring in drivers and train for a year-long period. At the end of their training, the drivers could purchase these units from non-profit educational organizations at a discounted value. Based on that fact that there was a stipulation of ownership at the time, this educational organization purchased from a reseller, but they had only intended to use this for one year and resell the items. Even if they didn’t resell the items to that truck driver and training, the IRS came and said this was not for the exclusive use of this organization and rolled up all of the sales and assessed an end-user tax on all of those sales.
“So it is very important you have no knowledge whatsoever or are even thinking of selling to this organization for a three-year period and having a buy-back provision written into a buyers order. Do not—even if it’s a wink, wink, nudge, nudge—indicate that anywhere that there will be specific residual value that you will purchase these back for. The IRS will view this as you having knowledge at the time and can come back and assess that tax against you.”