It’s no surprise to pay sales tax when buying goods at stores. But what happens when a nonprofit organization sells goods, through a website, at periodic conferences, or as part of its program activities? Must the nonprofit collect sales tax too on its sales of T-shirts, books, or other items made available to others, just like a store? Aren’t nonprofits exempt from taxes? If a nonprofit’s sales are not exempt, under which state sales tax law will it owe sales tax?
A nonprofit indeed may owe sales tax to state taxing authorities arising from such sales, unless a specific exemption exists under applicable state law. Such liability may be owed to more than one state, depending on the nonprofit’s activities across state lines. If the sales revenue constitutes “unrelated business income,” additional tax liability may arise notwithstanding a nonprofit’s Section 501(c)(3) income tax-exempt status. Here’s a roadmap for legal compliance, starting in Illinois.
The Basics – Nonprofit Sales Tax for In-State Sales; Limited Exemptions
We’ll start with Illinois as a representative state. Illinois law requires retailers – i.e., sellers of goods at retail – to collect and remit sales tax when selling goods in Illinois. No categorical exemption exists for nonprofits based on their nonprofit status alone. The policy implication is clear: to level the playing field of commercial sales activity.
Very limited exemptions provide relief for nonprofits, however, if their sales activities are non-commercial in nature and the organizations are charitable, religious, or educational (i.e., a Section 501(c)(3) organization). First, sales exclusively to a nonprofit’s direct program participants qualify as exempt, such as non-public sales of uniforms or books to members, students, or patients. Second, occasional dinners, social events, or similar activities qualify as exempt, so long as they do not occur more than twice a year. Third, other non-competitive sales may qualify. In such cases, the dominant motive for the purchase should be to make a donation, not to acquire goods. Such exempt sales are typically characterized by a relatively high price paid for a small amount of good, thereby reflecting the purchaser’s main intent to support the nonprofit financially. Some sales may qualify under more than one exemption (e.g., a Christmas-time wrapping paper fundraiser offered only to a school’s students).
Two notable exemptions are additionally available, based on the sales’ non-commercial nature and not necessarily the seller’s nonprofit status. First, Illinois provides a wholesale tax exemption, if the seller is selling the goods to a buyer who will then resell the goods. Second, a buyer who presents an Illinois sales tax exemption certificate for its purchases, based on the buyer’s tax-exempt status, is exempt from paying sales tax. The seller is therefore not required to collect and remit sales tax from such buyer’s purchase.
Absent the above exemptions, a nonprofit seller of goods in Illinois must collect and remit sales tax to the state of Illinois. To do so, the selling organization must first register with the Illinois Department of Revenue, through the “REG-1” form (available online).
Out-of-State Sales - The “Substantial Nexus” Requirement
But what about a nonprofit’s sales to purchasers outside of Illinois? A nonprofit’s sales tax liability clearly arises (absent an applicable exemption) on sales made within Illinois, such as sales made physically in Illinois or sales made online to Illinois residents. But to the extent sales are made to persons or organizations outside of Illinois (including online sales), sales tax liability arises if a “substantial nexus” exists between the nonprofit and the outside state (or states) sufficient to trigger the outside state’s taxing authority over the nonprofit. Such “substantial nexus” is determined according to the extent of the nonprofit’s physical presence in the outside state, such as by the existence of an office, employees, programs, or other regular activities there.
A nonprofit that engages in multi-state sales activities thus should do the following: (a) evaluate whether its physical activities are sufficient to trigger the nexus requirement in other states; (b) if so, determine the availability of sales tax exemptions in other states (as per above for Illinois); (c) if no exemptions are available, register with other states’ Departments of Revenue; and (d) collect and pay resulting sales taxes arising from such non-exempt sales to other states’ taxing authorities.
This legal area can get complicated quickly, with legal compliance traps for the unwary, administrative headaches in evaluating “nexus” sufficiency, and additional complications arising from online sales. Additional guidance is available in our October 2013 blog article.
More Tax Liability? Unrelated Business Income Tax
Another wrinkle is unrelated business income tax, or “UBIT.” UBIT results when a nonprofit engages in (a) a trade or business, (b) regularly carried on, (c) that is unrelated to its tax-exempt purpose. The resulting tax must be reported on IRS Form 990-T, with net revenues subject to federal income tax at regular business corporate rates. Again, the policy implication is clear: to level the commercial playing field, with resulting taxes on commercial activity – even if conducted by a nonprofit.
Consequently, so long as a nonprofit’s sales activities are related to its tax-exempt function, no UBIT should arise. What is “related”? The answer inherently depends on the nonprofit’s tax-exempt purpose. For example, if the nonprofit is engaged in educating teenagers about the benefits of sexual abstinence, then its sales of books about sexual abstinence likely is “related” and therefore not subject to UBIT. Likewise, if a nonprofit’s focus is on training hard-to-employ disadvantaged adults to sew, its resulting sales of finished clothing should not be subject to UBIT (so long as training is the primary focus, not the production of such products). Sales of T-shirts with the nonprofit’s logo similarly should not be subject to UBIT, provided that the focus is promoting the nonprofit itself (related) and not merely to sell clothing (unrelated).
On to Sales Tax Liability in Other States
Having covered Illinois as an example for in-state sales, introduced the “nexus” concept for multi-state sales, and addressed UBIT in case additional taxes may apply, we move on to other states’ sales tax regimes. Evaluating sales tax obligations under other state laws is critical for any nonprofit physically operating in more than one state and engaging in sales tax activities (whether online or otherwise). Nonprofit exemptions from sales tax laws generally can be divided into the following three categories: (a) a small number of states with broad exemption for nonprofits (e.g., Nevada, Missouri); (b) a smaller number of states with no exemption at all (e.g., Alabama, Hawaii); and (c) many states with limited exemption for nonprofits based on limited types and/or amount of sales activities (e.g., Illinois, Michigan, North Carolina, South Carolina). A further sampling of states bordering Illinois provides illustrative examples of the third category.
Indiana provides sales tax liability exemption to nonprofits that conduct sales or fundraising activities for 30 or less days per year. In addition, a nonprofit’s sales qualify for exemption, even if they occur for more than 30 days per year, if such sales are intended primarily to further the educational, cultural, or religious purposes of the organization, such as periodicals, books, or other property (e.g., online sales of materials related to the organization’s tax-exempt mission).
Ohio provides an exemption to nonprofits that engage in sales for only six or less days per year. Notably, if the nonprofit’s sales exceed six days in any calendar year, then all of its sales become subject to sales tax liability.
Wisconsin provides an “occasional sales exemption” if a nonprofit meets all of the following three requirements: (1) its sales occur on seventy-five or fewer days per calendar year, or such sales total $50,000 or less); (2) entertainment is not involved at a paid admission event (and with total payment to entertainers not exceeding $10,000); and (3) the nonprofit organization does not have and is not required to have a seller’s permit.
The Bottom Line
A nonprofit that sells goods should evaluate potential sales tax obligations arising from its sales activities, first by checking its home state’s law for applicable rules and potentially available exemptions. If the nonprofit operates in multiple states with a “substantial nexus” (i.e., more than just an online sales presence), sales tax liability may arise under other state laws too. And to the extent such sales are “related” and regularly carried on, additional UBIT liability may result too. These considerations provide ample reason for careful legal analysis of a nonprofit’s sales activities.