Sales tax is a simple yet complicated thing when you are a business owner. Am I required to charge it or not? Can I be exempt from paying it or not?
The basic rule is this: sales tax should be charged to the end-user of the item purchased. In most states, most items are assessed sales tax. When you go to the store to buy clothes you pay sales tax because you are the person who will wear the clothes, unless they are a gift. When you go to a restaurant you pay sales tax because you are the person receiving the meals. When you buy a sofa you pay sales tax because you are the person who will benefit from the comfort of laying or sitting on it.
Sounds simple right? So why do people get confused?
Well I find that the businesses who typically face confusion in this area are contractors. They buy materials for construction use and then charge a customer for a renovation. So who pays the tax? Unless you are a manufacturer, you as the contractor pay the tax. You are simply providing a service.
Typically the items that are exempt from being assessed sales tax are:
- Prescriptions drugs
- non prepared food
- agricultural products and animal feed
- items purchased for resale such as raw materials or inventory
The last item is where the misunderstanding about sales tax occurs. So let me clear things up.
A distribution company purchases items in bulk for re-sale. This would be your clothing store or furniture store in my above examples. Therefore they do not pay sales tax when they buy the items; they charge the purchaser sales tax when they come in to purchase the item. They are buying products in large quantities and then re-selling them to the end-user.
A company who purchases raw materials would be any company who engages in production activities such as manufacturing plants and concrete yards. These companies provide production activities such as “assembling, manufacturing, processing, or refining tangible personal property for resale; generating electricity for sale; preparing textiles such as uniforms and linens for rental; establishing or maintaining clean rooms or clean zones required by federal laws pertaining to manufacturing drugs, medical devices, or biologics; and producing, repairing and maintaining machinery or equipment used in a production activity. Servicing, maintaining, or repairing tangible personal property other than production machinery or equipment , or providing for the health and comfort of employees are not production activities.” 1
What does all that mean in simple terms? That you can only be exempt from paying sales tax if you purchase the materials or equipment to make something from scratch. Otherwise you must pay sales tax on the materials you purchase.
What does that mean for a construction company who does not manufacture its own products? It means you as the purchaser of the materials are the end-user of the products. The fact that you provide a service for your clients by building or renovating personal property does not make you exempt from paying sales tax and does not authorize you to charge sales tax. If you want to re-coup the sales tax for the materials you purchase, you will simply have to raise your rates.
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1-Per the Comptroller of Maryland. Law may vary depending on your state.