Most states offer sales tax utility exemptions and these exemptions can reap big sales tax savings for many manufacturers. But the criteria to qualify for these exemptions vary by state. Some states do require utility studies with the state’s own unique parameters.
My advice is don’t walk away from a sales tax utility exemption before researching your state’s qualifying criteria and determining if the exemption could save your company significant tax dollars.
Sales Tax Utility Exemption Overview:
First, let’s review the basic premise of a utility exemption. If energy, including electric, gas, water and fuel, is used during the manufacturing process, many states allow these utilities to be exempt or partially exempt from sales tax. The challenge is determining how much of a facility’s utility usage is for manufacturing. Different states require different percentages.
Utility Study Defined:
Some states require a utility study before the exemption is granted. This is a systematic process of determining where utilities are used at a location and a breakdown of use in manufacturing versus non-manufacturing areas.
Five Approaches to Determine Exemptions:
States typically take one of 5 different approaches when deciding if utilities are used in manufacturing:
- Some states require a utility study.
- Some states require a utility study performed by an engineer.
- Some states require you to meet a certain criteria range then you will receive either 100%, 75%, 50% or 0% of an exemption and you can use any reasonable method to determine the percentage, utility study or square footage.
- Some states allow you to start at 100% exempt and then only subtract the taxable usage while other states require you to identify every taxable and exempt usage.
- A few states say all utilities used at a manufacturing plant site are exempt or at a reduced rate from tax, whether it is used directly in manufacturing or not.
Important Note: While a percentage by square footage may seem to be the easiest it may not be the most accurate. Machines used in manufacturing use significantly more energy than items in your office. We strongly recommend against using just square footage unless your state only require you to meet a certain percentage to get the full exemption and you can easily meet that percentage.
If your state requires a utility study, be sure to look at the state’s guidelines for how to conduct a utility study and what needs to be included. Most states that require a utility study provide specific guidelines for the study.
Examples: New York, Tennessee and Missouri:
In New York, the state gives very specific guidelines and provides formulas on how to calculate an exempt amount for utilities. One formula requires a New York manufacturer to breakdown all kilowatt hours used and identify these hours as either exempt or taxable. This process is time consuming since you need to know how many kilowatt hours are used by each machine, computer, printer, lights, etc. However, the result can lead to huge tax savings.
On the other hand, in Tennessee the state gives a reduced rate to all manufacturers for all utilities used directly in the manufacturing process. Separate metering is the best way to determine what is used directly in manufacturing verse non- manufacturing/ administrative uses.
A third example is Missouri. In Missouri as long as you use 76% of your utilities in manufacturing you will receive 100% of their utility exemption. In Missouri you can use any reasonable method to calculate the exempt percentage including square footage. If your company can qualify for the utility exemption by using square footage to determine the percentage, then calculate it using that method. It’s the easiest way. If not, a utility study may be needed since machines will use substantially more energy than office equipment.
A qualified sales and use tax agency, such as Windward Tax, can help complete your utility study, saving you time and money. Also I recommend conducting a utility study every couple of years to confirm you are still calculating a correct percent. Utility usage often fluctuates with changes in machinery, equipment, square footage and utility rates.
Share your experiences with qualifying for a sales tax utility exemption in your state. What advice would you give to companies seeking this exemption?
Other recent “Manufacturing & Distribution” posts by Lauren Stinson, CMI:
- Manufacturing Purchases: 5 Sales-Use Tax Basics for Purchasers and A/P
- Manufacturing Exemption Misconception: Everything is Tax Exempt!
- Manufacturers’ Utility Studies: 5 Approaches to Utility Exemptions
- Manufacturing Sales & Use Exemptions: Open to Interpretation
- Use Tax Exemptions Case: Non-Traditional Manufacturer in Missouri