If you're a manufacturer trying to understand sales tax compliance, most guides you'll read treat you primarily as a buyer. This is a problem because if your company also sells goods to businesses, as many manufacturers do, you have additional compliance obligations.
Your dual role as both buyer and seller is just one of many reasons that sales tax compliance is challenging. You also need to understand manufacturing sales tax exemptions that allow you to buy inputs without paying sales tax, since those inputs become part of products that are taxed later.
Unfortunately, failure to follow the rules—including by making mistakes like claiming exemptions you don't qualify for as a buyer or accepting an improper exemption certificate as a seller—can put you at risk of owing sales or use tax during an audit.
This guide explains the rules for manufacturing sales tax exemptions and exemption certificate management, including a state-by-state breakdown.
What the manufacturing sales tax exemption actually covers
Buyers pay sales tax on most goods. However, states have rules in place to prevent tax pyramiding, which occurs when the same good or service is taxed multiple times along the supply chain.
Exempting manufacturing inputs is one of the most common rules to prevent tax pyramiding. However, states have different definitions of a qualifying input, and it's up to manufacturers to understand the definition and know when an item they're buying is exempt.
The "direct use" test
In many states, items used in manufacturing are tax-exempt only if the item is directly used in the manufacturing process. If the purchased item is adjacent to the process or serves in a support function, it will not qualify.
While this rule seems straightforward, there is no universal definition of "direct use." For example:
- Some states require a "direct contact" standard: This means an item is exempt only if it physically or directly acts upon the product being manufactured.
- Some states use an "integrated plant" doctrine: This means that items can qualify for an exemption if they are part of the manufacturing process, even if the items do not directly touch or transform the product.
Texas is a clear example of the "direct contact" standard. The state exempts tangible personal property used in manufacturing if it "is necessary or essential to the manufacturing, processing, or fabrication operation and directly makes or causes a chemical or physical change."
Pennsylvania, on the other hand, recognizes that manufacturing encompasses an "integrated series of operations," and allows for exemptions for less direct items, including property used in research aimed at producing a new and improved product or production method.
In any state that applies the direct use test, items adjacent to the manufacturing process, such as office furniture, aren't exempt.
The table below shows examples of items that are typically exempt and those that are typically not. However, you must remember that rules vary by state, which we go over later in the article.
Common categories of exempt purchases
Although the specifics vary, it's helpful to look at some common categories of items that many states classify as exempt manufacturing inputs:
- Raw materials: Raw materials are tangible items that become part of, or a physical component of, the finished product, or, in some states (like Georgia), that are impregnated into the product at any stage, even if they don't remain a component in the finished item.
- Machinery and equipment: This typically includes machines and equipment used directly on the production line. Some states have guidelines for the useful life of the machine, or the percentage of time it is used in the qualifying manufacturing activity.
- Repair and replacement parts: These are often exempt if they're necessary and integral to the manufacturing process. However, the parts typically must be used to maintain exempt machinery to qualify.
- Energy and utilities: Energy inputs may be exempt if the energy is used directly to power production. In Georgia, for example, energy includes "natural or artificial gas, oil, gasoline, electricity, solid fuel, wood, waste, ice, steam, water, and other materials necessary and integral for heat, light, power, refrigeration, climate control, processing, or any other use in any phase of the manufacture of tangible personal property."
Many manufacturers overlook the energy and utilities exemption, which is a high-value exemption that could result in substantial tax savings.
Predominant use requirement
A number of states have predominant-use requirements or primary-purpose tests to ensure that exemptions are available only for goods or services used primarily in the manufacturing process.
For example, in Florida and Kansas, machinery and equipment qualify for an exemption only if it is used more than 50% of the time in manufacturing.
Most states with a predominant use rule set the threshold above 50%, so an item must be used more than half the time for manufacturing activities. Many also apply an all-or-nothing rule. If the machinery is 51% used for exempt manufacturing, then it's exempt, but if it's 49%, it's not.
A limited number of states, including Texas, allow for apportionment, with the item partially exempt from sales tax. In these cases, you will usually determine the amount that is exempt based on hours of use or the item's total output.
If you are audited, state departments of revenue often closely scrutinize items with divergent uses to make sure you did not claim an exemption you weren't entitled to, or claim a larger exemption than you should have received.
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Issuing exemption certificates as a manufacturer (the buyer side)
When manufacturers purchase inputs from suppliers that qualify as exempt, it is up to the manufacturer to document the exemption by issuing an exemption certificate to the seller. There are state-specific requirements for fulfilling this requirement that manufacturers must know.
When and how to issue a certificate
Manufacturers purchasing exempt items should issue the exemption certificate to the seller before or at the time of sale, when possible. While some states offer an extended deadline —sometimes as long as 90 days—issuing the certificate at the time of purchase is simpler.
The Multistate Tax Commission (MTC) has a Uniform Sales & Use Tax Resale Certificate that buyers can provide to sellers to indicate that the items being sold are exempt from sales tax.
However, some states require their own state-specific form, and some states will accept the MTC's uniform form only for resale exemptions—not for manufacturing exemptions.
For example, in Georgia, you'd need Form ST-5M to certify that manufacturing items are exempt.
When you make recurring purchases of the same type from the same vendor, you aren't always required to issue a new exemption certificate each time. You can use a blanket exemption form that remains in effect until revoked or until it expires under the state's rules.
What happens if you claim an exemption you don't qualify for
If you claim an exemption you don't qualify for as a buyer and the seller accepts it, the seller will not collect sales tax at the time of the purchase/sale. However, your compliance obligations do not disappear.
Instead, you have shifted the burden of reporting and remitting the required tax payment to yourself. Now, instead of owing sales tax, you will owe use tax. This is a tax on the storage, use, or consumption of taxable goods and services when sales tax wasn't collected.
States frequently discover exemptions that were claimed but shouldn't have been. This issue can be found during an audit and can result in you owing back taxes, interest, and penalties.
If you purchase from sellers in multiple states and claim exemptions in all of them, you face a significant risk of audits and being found noncompliant. The rules for exempt manufacturing inputs vary by jurisdiction, and it's your responsibility to know whether your purchase is exempt.
Since items that are exempt in one state, like Colorado, may be taxable in another, it is difficult to track all of the different requirements. Without compliance help, you could accidentally violate the rules and be left with a large tax bill.
Multi-state certificate management
Multi-state certificate management is complicated because each state has its own forms, rules, and certificate expiration dates. If your manufacturing business is a multi-state operation, you must understand the rules in all the states where you're a purchaser.
Best practices for compliance include:
- Track issued certificates in a central system so they are accessible if you need them
- Take note of whether each certificate you are submitting is a per-transaction exemption or a blanket authorization
- Track which certificates expire or need renewal at periodic intervals
As a buyer, keeping copies of the exemption certificates you find can protect you if you must prove the exemption you claimed was legitimate. If your supplier is audited, they may also need to produce the certificate to justify not taxing you.
Accepting exemption certificates as a manufacturer (the seller side)
Manufacturers are not just buyers. Many are sellers as well. If your company sells to others, you must understand your seller-side sales tax obligations. These obligations are distinct from your buyer-side obligations.
Your responsibility as the seller
As a seller, you must know when you're required to charge sales tax and collect the correct amount. In any state where you have nexus (sufficient physical or economic connections), you're also required to register for sales tax and file and remit payment.
If you sell an item to an exempt buyer, however, you will not collect sales tax on that transaction. You must have your buyer's exemption certificate on file, though, and take reasonable steps to ensure it is legitimate.
Reasonable steps do not mean confirming, beyond a reasonable doubt, that the certificate the buyer has provided is legitimate and valid. The standard is good faith, so if you accept a certificate that's complete and plausible, you should be protected if it turns out it wasn't.
If you accept a certificate that is obviously incomplete or that has an exemption reason that is clearly not a match for the transaction, this can result in you being held responsible for the uncollected sales tax.
The risk of being found liable for uncollected sales tax is why validating each certificate is important. The validation process includes confirming:
- The name and address of the buyer
- The buyer's tax ID
- A description of the item
- The buyer's signature and date
You can verify the exemption using your state's tools, and you should confirm the plausibility of the exemption based on the nature of the purchase.
What you're on the hook for if a certificate is invalid
If you are missing an exemption certificate, or you accept an invalid certificate as a seller, including one that is expired or incomplete, your company is responsible for uncollected sales tax.
Unfortunately, manufacturers have the highest audit rate of any industry, with around 18% subject to audits, compared with 10% of retailers and 4% of software companies.
Each exempt transaction is reviewed during an audit, and a single missing certificate on a high-volume line could result in a six-figure adjustment.
Exemption certificate management is a direct audit defense, but you must ensure you're validating and storing the required certificates to raise it.
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Blanket certificates from your customers
When you have repeat customers who are exempt, those customers can issue a blanket certificate covering all recurring purchases of the same type. The certificates may be valid until revoked, or until the state's expiration date, but periodic review is essential in case of changes.
If a customer's business or use changes, the blanket certificates may no longer apply—and if you don't remove invalid exemptions and begin charging sales tax, this creates tax liability for your business.
Establishing a scheduled review cadence can help you minimize risk.
Exemption certificates must also be stored and accessible in case of audits. Most states require sellers to keep the certificates for around three to seven years, depending on the state's statute of limitations.
Manufacturing sales tax exemptions by state
Because sales tax rules are state-specific, you must understand manufacturing sales tax exemptions in every state where you're a buyer or seller, so you can comply with sales and use tax rules. There are substantial variations across jurisdictions regarding issues like:
- How broadly manufacturing is defined
- The definition of an exempt manufacturing input
- Which forms you must issue to sellers (or collect from buyers) when claiming exemptions
- Whether energy costs are exempt
The table below shows the state-specific exemption rules so you can better understand what's required.
Note that it is for guidance only: rules change over time, and while we try to keep it up to date, it is important to verify the state's current rules.
Also, as discussed, machinery exemptions often require predominant use. These are marked with a checkmark below, even if this requirement exists.
As you can see, the majority of states do have at least some type of exemption. And many states, including Texas, Georgia, and North Carolina, are very manufacturer-friendly, allowing exemptions for machinery, raw materials, and often energy.
However, a significant number of states offer only limited or no sales tax relief for manufacturing equipment, for various reasons.
States with no sales tax
In five states, no sales tax is charged, so there's no need for an exemption. These five states include:
- Alaska
- Delaware
- Montana
- New Hampshire
- Oregon
States that don't have a traditional sales tax model
New Mexico and Hawaii do not operate under a traditional sales tax model and generally do not offer broad manufacturing exemptions comparable to those offered by states that charge sales tax.
Hawaii charges a general excise tax (GET) and New Mexico a gross receipts tax (GRT). Both are charged on nearly all goods and services for the privilege of doing business in the state.
States with limited or no manufacturing exemptions
Finally, a number of states provide only limited relief from sales tax for manufacturers, including:
- Nevada, South Dakota, and Washington D.C., which have very limited or no exemptions for manufacturing equipment
- States that don't exempt machinery but charge a reduced rate, including Mississippi and California.
- States with a narrow exemption, like North Dakota, which exempts machinery or equipment used primarily for manufacturing for a new or expanding plant only
Because the stakes are high and the rules evolve, manufacturers should check updated state rules in any jurisdiction when purchasing or selling to ensure full compliance with the most current regulations.
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Managing exemption certificates across multiple states
Multi-state manufacturers face significant challenges with sales tax compliance, including managing exemption certificates.
Manufacturers must follow different rules regarding what qualifies as exempt. They also must use each state's unique certificate form and understand different retention requirements.
To maximize the chances of remaining in compliance, this means developing systems to:
- Standardize the certificate intake process. Your company needs a state-by-state checklist so accounts payable and accounts receivable teams can prepare acceptable certificates if you're a buyer and identify valid certificates when you're a seller.
- Track issued certificates in a central database. You'll need systems in place to track certificates by vendor, coverage type, and expiration or renewal status, as well as whether the certificate is blanket or per-transaction.
Manufacturers should also watch out for common pitfalls, including:
- States with short expiration dates for exemption certificates. In some states, certificates expire after one to two years, while in other jurisdictions, certificates are valid until revoked.
- Improper use of the MTC Uniform Resale Certificate, which is acceptable for resale purchases in most states, but is not always acceptable to document manufacturing exemptions
Exemption certificate management software can help multi-state manufacturers comply with requirements by automating tasks such as certificate validation and renewals, as well as by providing a centralized database to store exemption certificates.
Regardless of whether manufacturing companies turn to software solutions, developing effective protocols to comply with exemption certificate requirements is critical to being audit-ready.
How Numeral helps manufacturers manage sales tax compliance
Manufacturers face unique sales tax compliance challenges, especially when operating across multiple states and when acting as both buyer and seller, which requires them to both issue exemption certificates and validate certificates provided to them.
These dual roles, combined with multi-state compliance obligations once nexus has been established in different states, create layered compliance obligations that introduce significant risk and require time-intensive policies and procedures.
Getting help with these obligations is often the best approach, and Numeral is here to offer it. Numeral can take sales tax compliance off your plate, handling all the tasks your company needs to be fully compliant with the rules across the United States.
Numeral can help you spend less than five minutes per month on sales tax by:
- Automating nexus monitoring so you'll understand when you must collect sales tax
- Registering for sales tax when required after you establish physical or economic nexus
- Calculating the correct amount of sales tax due for each transaction, including applying exemptions when appropriate
- Managing exemption certificates, including collecting and validating certificates, ensuring tax isn't collected from exempt buyers, and storing certificates so you're audit-ready.
- Filing and remiting sales tax for your company, including expert review before every filing
- Operating a virtual mailbox to manage and respond to correspondence from state departments of revenue
Numeral backs all our services with the Numeral Guarantee, so if our error leads to an audit, we'll cover any penalties and fees.
Book a demo with us to learn more about how we can help.
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Manufacturing sales tax exemption FAQs
Do all states offer a manufacturing sales tax exemption?
Most, but not all, states offer a manufacturing sales tax exemption.
- Five states don't offer an exemption because they don't charge sales tax (Alaska, Delaware, Montana, New Hampshire, and Oregon).
- Two states (New Mexico and Hawaii) don't operate under the traditional sales tax structure and tax virtually all goods and services with no manufacturing exemption.
- Several states, including Nevada, South Dakota, and Washington, D.C., don't exempt manufacturing machinery.
- Some states, including Mississippi and California, offer reduced rates instead of exemptions.
- Some states, like North Dakota, have very limited exemptions.
The rules can change, so you should always verify the updated regulations for your state.
What's the difference between a resale certificate and a manufacturing exemption certificate?
A resale certificate allows a reseller to buy goods to resell without paying sales tax on the purchase. A manufacturing exemption certificate allows manufacturers to buy manufacturing inputs without paying sales tax.
Both are used to avoid tax pyramiding, or prevent items from being taxed multiple times along the supply chain. The reseller will charge tax when the items are sold to the final buyer, while the manufactured products will be taxed when sold in their finished form.
Some states require separate forms for the resale and manufacturing exemptions, while others use a single generic form for both.
If I accept a bad exemption certificate, am I liable for the uncollected tax?
In general, if you accept a bad exemption certificate, you are liable for the uncollected tax. However, you can raise a good-faith defense if the certificate is complete and plausible. If the certificate is obviously inapplicable or incomplete, the defense doesn't protect you from liability.
Can I use one exemption certificate to cover all purchases from the same vendor?
In most states, it's permissible to use a blanket exemption certificate to cover all recurring purchases of the same type until the certificate is revoked or expires under state law. The certificate must still match the type of purchase being made.
What happens if I'm audited and can't produce my exemption certificates?
If you are audited, you're required to produce an exemption certificate for exempt transactions. Most states require you to retain exemption certificates for between three and seven years, depending on the statute of limitations for sales tax audits.
If you do not have the required certificate, the transaction will be treated as taxable. As a seller, you will owe uncollected tax, interest, and potential penalties.
Does packaging qualify for the manufacturing sales tax exemption?
Packaging may qualify for the manufacturing sales tax exemption depending on the state's rules and how it is incorporated into the product. For example, a bottle is often exempt, but external shipping material like boxes, pallets, or wraps likely wouldn't be.
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