December 2007

Reprinted from Nonprofits Legal Update

Note: The following discussion is provided for informational purposes only and is not intended to serve as legal or tax advice. For specific information about sales and use tax exemptions for nonprofit organizations, consult your attorney or tax advisor.

Can Your Organization Benefit?

While nonprofit organizations are acutely aware of their entitlement to federal and state income tax and real property tax exemptions, they may not fully appreciate their entitlement to state sales and use tax exemption.

In certain states, where the combination of state and local taxes are beginning to approach 10 percent, obtaining sales and use tax exemption may be a very worthwhile exercise for a nonprofit organization making significant purchases.

Individual state sales and use tax laws provide exemptions for nonprofit organizations that range from broad and general to limited and quite specific. In this article, we use Maryland to provide some examples of the value and limitations associated with sales and use tax exemptions.

Who Qualifies?

The main nonprofit organizations entitled to Maryland sales and use tax exemption include charitable, educational, and religious organizations; volunteer fire, ambulance, and rescue companies; federal and Maryland credit unions; and nonprofit cemetery associations. Effective July 1, 2006, through June 30, 2009, veterans organizations will also be entitled. For a charitable, educational, or religious organization, exemption is limited to organizations located in Maryland or located in an adjacent jurisdiction that provides services within Maryland or with a reciprocal exemption.

Maryland's courts have determined that an organization may qualify as a charitable, educational, or religious organization even though the IRS has made a determination of qualification under a subsection other than Internal Revenue Code section 501(c)(3). In practice, however, the state comptroller's staff routinely denies applications from organizations that do not possess a section 501(c)(3) determination letter (i.e., a section 501(c)(4) "social welfare organization"), unless the applicant provides documentary evidence to demonstrate that it is primarily charitable, educational, or religious, as defined by the courts. Nonprofit trade associations, business leagues, and similar organizations that may not think of themselves as charitable or educational organizations may qualify for Maryland sales and use tax exemption if the majority of their expenditures is for dissemination of information through meetings, newsletters, Web pages, training classes, and the like.

Value and Limitations

For Maryland nonprofits, the value of the exemption is not limited to the state's relatively low 5 percent sales tax on purchases that the organizations make directly. It also extends to purchases made by real property contractors on behalf of the organization (other than a credit union or governmental entity). Nonprofit organizations need to be alert to make sure contractors pass along this benefit not only on new construction but also on routine plumbing, electrical, painting, roofing, and other realty services and repairs. The exemption also extends to the 11½ percent sales tax applied to short-term car and truck rentals and, if paid directly by the organization, to combined state and local hotel/motel taxes, which can range up to 16 percent, depending upon the jurisdiction.

The exemption is intended for purchases necessary to "carry on the work of the organization." In practice, this limitation is interpreted to mean that the exemption may not be used for purchases for the personal use of officers, employees, or members of an organization or for carrying on an unrelated trade or business as defined in section 513 of the Internal Revenue Code. Vendors can be held personally responsible for permitting an unauthorized exemption. For this reason, some vendors will decline to honor a claim for exemption on products that might be used for personal use if paid for with cash or a personal credit card, even if an exemption certificate is displayed. In addition, federal courts have ruled that the exemption does not apply to charges for hotel accommodations paid for by personal funds of guests, regardless of any reimbursement arrangements.

The practical problems of obtaining exemption are overcome by billing the organization directly or by paying for the charges with a credit card issued directly to the organization. Because vendors document entitlement to exemption by recording the number of the exemption certificate with their sales records, problems at the cash register can be minimized if the purchaser can display the exemption certificate. The Maryland Comptroller's Office will, upon request, issue a reasonable number of duplicate certificates without charge. In a growing number of states, if a vendor raises a question about a particular organization's exemption certificate, its validity can be verified on-line. Maryland's Comptroller's Office has a Web site, which provides this information.

Next Steps for Your Organization

Sales and use tax exemptions can vary widely from state to state. As a general rule of thumb, if your organization has a budget of some size and makes routine purchases of taxable personal property and services, then it may be advantageous to apply for sales and use tax exemption in your state. A good first step in assessing the pros and cons is to consult with your attorney or accountant to see if you can qualify.

Stephen M. Cordi, Ober|Kaler
© 2007, Ober, Kaler, Grimes & Shriver. Reprinted from Nonprofits Legal Update (winter 2006). Reprinted with permission.

Stephen M. Cordi is an attorney practicing in the Tax Group of Ober|Kaler. He is based in the firm's Baltimore office and can be reached at (410) 347-7689 or smcordi@ober.com.