While most manufacturers are only located in one or two states, there may be the assumption that their risk is lower when it comes to product taxability. This might be true if you are talking about sales tax obligations, but this does not necessarily apply to your use tax obligations. So how can a manufacturer insure that they are meeting all of their tax obligations with accuracy. Product taxability affects items you purchase to use in your manufacturing process, items related to shipping or even the ones that become part of a final product.
Based on the state, you may also find that some products are not taxable if used to build manufacturing equipment but the same product might be taxable when used to repair the manufacturing equipment. As a result, it can be a complicated process to determine what you owe sales tax on and then tracking and calculating how much you owe. The accurate and early identification of use tax liability, properly exempted items and properly taxed items is a special challenge for a vast majority of manufacturers.
Direct Pay Permit
To avoid trying to determine if a bolt or other item is taxable or not, some manufacturers choose to get a Direct Pay Permit. This allows for parts to be purchased with no sales tax paid at the time of purchase. Then when the part is pulled, the manufacturer must then track how the part is used and any tax that should be accrued based on its use. Bulk purchases are another struggle, because these purchases are typically then shared out to several plants or other facilities.
Therefore, central inventory tracking is key, as it helps you to determine what ends up where and how it is used. The central inventory will also track how each item is used and that can then assist in determining the taxability of that item in terms of use tax.
At the point, it must be pointed out that each state has a variety of exemptions and exceptions to their use tax laws and some may not have these laws at all. Therefore, you will need to work with your accountant or bookkeeper to be sure that you set up your central inventory tracking appropriately to capture all the information that you need to comply with the use tax.
Once you have identified the use and taxability, then you must ensure that the correct amount of use tax is accrued for each item and file a use tax return based on your state’s filing regulations. The tax rates may vary, not only from state to state, but also based on your locality. Then, each state will have their own specific qualifications to meet in order to be eligible for a Direct Pay Permit. One of the common requirements, however, is that you can demonstrate that you have a system in place to track sales and show the use tax that is owed.
Drop Shipping for Your Distributors
As a manufacturer, there are often multiple requests to drop ship their products to a specific location or even directly to their consumer. If you are shipping directly to the distributor, the product will be considered tax-exempt for resale. As a result, this means no tax is required, but you will need copies of resale documentation.
This gets much more complicated when you ship directly to the end customer. As we have seen, each state has their own sales tax and use tax laws. This means that even the freight costs could be considered taxable. So you need to have a system in place that will constantly keep this information researched and current. This will help your business to stay up to date in all the states where you may be sending product for your distributors and wholesalers. Your distribution system also needs to be able to grow to incorporate more information as you add shipping locations to your system.
As you can see, manufacturing brings its own unique challenges to the tracking of use tax, plus it adds the potential of having to compute, collect and then pay the state sales tax, based on the types of transactions. Therefore, you need to be sure that your accounting department has an individual or team who tracks the necessary tax information and keeps your system up to date. By doing this research, you avoid having to pay any tax penalties due to missing a filing date or not making a payment in a timely fashion.
ERNIE BUSTAMANTE