Sales tax exemptions are an important but often misunderstood part of US sales and use tax compliance. They allow businesses and certain buyers to avoid tax in specific circumstances, but the rules differ by state and require strict documentation. Exemptions generally fall into four categories. Resale exemptions apply when goods are purchased for resale, provided a valid resale certificate is maintained. Entity-based exemptions cover sales to government agencies, nonprofits, and qualifying institutions. Use-based exemptions depend on how the goods are used, such as in manufacturing, agriculture, R&D, or pollution control. Transaction-based exemptions apply to isolated or occasional sales and large business asset transfers. Correctly applying exemptions reduces tax liability but requires verifying eligibility, keeping current certificates, and aligning documentation with state rules. Mismanagement can lead to denied exemptions, audits, and unexpected liabilities.
Types of Sales Tax Exemptions
Sales tax exemptions are exceptions to the general rule that the sale of tangible personal property and certain services is taxable. However, exemptions vary from state to state — and are rarely automatic. Broadly, they fall into four categories:
- Resale Exemption
- Entity-Based Exemptions
- Use-Based Exemptions
- Transaction-Based Exemptions
Each category is governed by state-specific provisions and documentation requirements. Knowing which apply — and when — is key to maintaining compliance and avoiding penalties.
Resale Exemption
A resale exemption applies when a buyer purchases goods with the intent to resell them in the ordinary course of business. In such cases, the buyer must provide a valid resale certificate to the seller.
The resale certificate typically includes:
- Name and address of the buyer
- Buyer’s state registration or seller’s permit number
- Description of the property being purchased
- A declaration that the goods are intended for resale
The seller is required to retain a copy of the resale certificate for their records. This is essential for audit defense and proof that the transaction qualified as exempt.
Additionally, resale certificates often have a validity period, and businesses must ensure certificates on file are current and complete. Failing to maintain proper resale documentation can result in denied exemptions and unexpected tax liabilities during an audit.
Entity-Based Exemptions
Some sales are exempt because the buyer qualifies as an exempt entity under state law. These often include:
- Government agencies
- Non-profit organizations (e.g., schools, religious institutions, charitable entities)
- Federal or state institutions
Eligibility rules vary widely across states. Some states may require advance approval, while others accept standard exemption certificates. In all cases, sellers must verify the buyer’s exemption status and retain proof to support non-taxed sales.
Use-Based Exemptions
Use-based exemptions depend not on who buys the goods, but how the goods or services are used. Common examples include:
- Manufacturing & Processing Exemption
Many states exempt equipment, raw materials, and utilities used directly in the manufacturing or production process. - Agricultural Exemptions
Items used in farming or agricultural production — such as seeds, fertilizers, or qualifying machinery — may be exempt if used in producing food or other agricultural products. - Research and Development (R&D)
In some states, materials and equipment used in qualified R&D activities may be tax-exempt. - Pollution Control and Community Benefit
Certain states also offer exemptions for equipment used in pollution control or projects that benefit the community. These are often tied to environmental compliance programs or state-led incentives.
To qualify for use-based exemptions, intent and actual use must align, and businesses must often submit detailed documentation or apply for exemption certificates in advance.
Transaction-Based Exemptions
These exemptions apply to specific types of transactions, often those that fall outside regular business operations. Examples include:
- Casual, Isolated, or Occasional Sales
If a person or entity makes infrequent, non-recurring sales of tangible goods or services, they may not be required to collect sales tax — especially if they are not engaged in regular selling activity. - Bulk Sales or Business Asset Transfers
When a business sells all or a substantial portion of its assets — for example, during a liquidation, reorganization, or full business sale — the transaction may be exempt. These are typically outside the ordinary course of business, and certain states provide automatic or conditional exemptions for such sales.
For both types, documentation is essential. In some cases, businesses must notify the state, register the sale, or obtain approval in advance to ensure exemption eligibility.
Stay Tuned for More
Sales tax exemptions are a powerful tool for reducing tax liability — but they must be properly understood, applied, and documented. Each exemption type involves different rules, and businesses must actively manage their exemption processes to stay compliant.
The M2K US Sales Tax Series will continue to explore key topics like:
- Determining nexus
- Sales tax registration and compliance
- Voluntary disclosure agreements (VDAs)
- Tax rules for software and SaaS
- State-by-state overviews
We’ll help you navigate the complexities, avoid common pitfalls, and build confidence in your compliance strategy.
For more updates, visit www.m2kadvisors.com and subscribe to the full series.
