Monthly Archives: June 2013

Identity Theft and Your Taxes

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While most cases of identity theft start outside of the tax system, identity theft can have a substantial negative effect on your taxes.  Identity thieves may use a taxpayer’s identity to fraudulently file a tax return and claim a refund.  The taxpayer may not know anything is wrong until she tries to file a tax return and receives notice from the IRS that she has already filed a tax return for the year.

In other cases, the identity thief may use the taxpayer’s personal information to get a job, and report income from that job under the taxpayer’s Tax Identity Theftsocial security number.

This post will provide some tips on protecting yourself from identity theft and on dealing with identity theft if you are a victim.

Email, Social Media, and Internet

The IRS does not contact taxpayers by email or social media to request personal information or notify taxpayers that they are being audited.  If you receive one of these messages it is likely a phishing technique.  Phishing involves someone using a fake identity to solicit personal information from you. If you receive such a message, forward it to the IRS at phishing@irs.gov

If you discover a website that purports to be the IRS but does not begin with www.irs.gov , forward that link to the IRS at phishing@irs.gov

Traditional Identity Theft

Identity thieves access your personal information by many different ways, including:

  • Stealing your wallet or purse
  • Posing as someone who needs your personal information through a phone call
  • Looking through your trash for personal information
  • Accessing information you provide through an unsecure website.

Identity Thief Uses Your Personal Information to Land a Job

If a taxpayer’s social security number is stolen, another individual may use it to get a job.  The identity thief’s employer may report income by that person to the IRS using the taxpayer’s social security number, thus making it appear that the taxpayer did not report all of her income on her tax return.

If this happens to you, you should contact the IRS to let them know that you never worked for the employer and the income is not yours.  After some questioning, the IRS will update your return to remove the fictitious income.

Identity Thief Uses Your Personal Information to Receive Fraudulent Refunds

Many tax credits are available that are refundable (meaning a refund can exceed the amount of estimated and withheld taxes paid in during the year).  Examples of refundable tax credits include the Earned Income Tax Credit, the refundable Child Tax Credit, and the refundable American Opportunity Credit.  Identity thieves can use your social security number to create fraudulent documents and file tax returns to claim these refundable credits.

These fraudulent returns tend to be filed very early during tax season.  This is done so the fraudulent tax return will be processed before the true tax return and will be less likely to raise red flags with the IRS. When you file your return, you may receive a letter from the IRS that indicates that more than one tax return was filed.  If you receive such a letter, you should contact the IRS (or have your tax return preparer do so) to notify them that you believe your identity was stolen.

Steps to Take with the IRS if You Believe You May Be an Identity Theft Victim

If your tax records are not affected by identity theft, but you believe you may be at risk because of a lost wallet, questionable credit card activity, or other suspicious activity, you may file Form 14039 Identity Theft Affidavit with the IRS.  You will need to submit a copy of your valid government-issued identification, such as a Social Security card, driver’s license, or passport.

You may also contact the IRS Identity Protection Specialized Unit at 1-800-908-4490.

In identity theft situations, the IRS may issue you a PIN that must be submitted with your tax return.  A tax return under your Social Security Number will not be accepted by IRS without the PIN.

How can you minimize the chance of becoming a victim?

  • Don’t carry your Social Security card or any document(s) with your SSN on it.
  • Don’t give a business your SSN just because they ask. Give it only when required.
  • Protect your financial information.
  • Check your credit report every 12 months.
  • Secure personal information in your home.
  • Protect your personal computers by using firewalls, anti-spam/virus software, update security patches, and change passwords for Internet accounts.
  • Don’t give personal information over the phone, through the mail or on the Internet unless you have initiated the contact or you are sure you know who you are dealing with.

 

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Tax Credit for Removing Barriers to Disabled Individuals

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Small businesses are eligible for a tax credit for expenses they incur to make their facilities accessible to disabled individuals.  The credit is equal to 50% of the expenses over $250 and under $10,250.  The maximum credit is therefore $5,000 in any one year.

To qualify, the small business must:

  • Have gross receipts of $1 million or less OR
  • Employ 30 or fewer full time employees during the prior year

Eligible expenses must be reasonable and necessary:

  • For the purpose of removing architectural, communication, physical, or transportation barriers preventing access to or use by disabled individuals, other than in connection with the construction of a new facility
  • To provide qualified interpreters or other effective methods of making audio materials available to individuals with hearing impairments
  • To provide qualified readers, taped texts, and other effective methods of making visual materials available to individuals with visual impairments
  • To acquire or modify equipment or devices for individuals with disabilities
  • To provide other similar services, modifications, materials, or equipment

A small business that is already in compliance with the American with Disabilities Act may not claim the disabled access credit for the purchase of upgraded or improved equipment.  The small business must have a physical structure into which the public enters to meet the American with Disabilities Act place of public accommodation requirement.

In addition to the disabled access credit, taxpayers are allowed to immediately deduct up to $15,000 of expenses to remove architectural and transportation barriers to disabled and elderly individuals under Section 190 of the Internal Revenue Code.  If an expense qualifies for both the disabled access credit and the Section 190 deduction, the taxpayer can claim the disabled access credit and then deduct the balance of the expenses (up to $15,000) over the amount of the credit that was taken.

Example:  ABC Corp incurs $20,000 of expenses to remove architectural and transportation barriers from its building.  It can claim the full disabled access credit of $5,000 since it had qualifying expenses greater than $10,250.  The $20,000 of total expenses is reduced by the amount of the disabled access credit of $5,000, leaving $15,000 of expense.  This $15,000 remaining expense may be deducted in full in the year it is incurred under Section 190.

 

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

 

IRS Requires Interest on Loans to Family Members

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It is fairly common for family members to loan money to each other.  These loans can be made to help a family member start a business, buy a home or car, or make other large purchases.  These loans can also be made for financial gain.  For example, a parent earning 1% on a certificate of deposit can loan money to a child at 3% interest when the child would otherwise pay 6% on a loan and both parties would therefore benefit.

Make Sure You Charge a Minimum Amount of Interest

It is very important to know that the IRS requires a minimum amount of interest to be charged on related party loans.  A primary concern is that imputed interestthe lender creates a benefit for the borrower in the form of an interest free loan.  The IRS wants to make sure this benefit is recognized as a gift for gift tax purposes.

The minimum amount of interest that must be charged is calculated based on what is known as the applicable federal rate (AFR).  When the interest rate charged in related party loans is less than the AFR, the IRS treats the loan as if it had been made at the AFR and recasts the loan as an arm’s-length transaction.  The additional amount of interest that must be charged is known as imputed interest.

The IRS does this by computing interest at the AFR and comparing it to the actual rate of interest charged, if any.  The excess interest charged under the AFR is imputed interest and is treated as a gift from the lender to the borrower.  This gift may be subject to gift tax.

The borrower is then deemed to make an equal interest payment back to the lender.  The lender will have taxable interest income.  Depending on the use of the borrowed funds, the borrower may or may not be able to deduct the deemed interest paid.  If the borrower uses the loan for business purposes, the deemed interest will be deductible as a business expense.  If the borrower uses the loan to make investments, the deemed interest will be treated as investment interest expense (which is deductible only to the extent of investment income).  If the borrower uses the loan for personal reasons, the deemed interest payment is not deductible.

A Bad Debt Deduction May be Possible

If properly structured, loans from one family member to another are treated as an arm’s-length transaction that entitles the lender to a bad debt deduction if the borrower fails to repay the loan.  In this case, the borrower may have discharge of indebtedness income.

Examples

Example:  Andy loans $200,000 to his son, Opie to start a business.  The loan is interest free.  The IRS requires interest to be charged on this loan.  Based on the AFR rate of 2.8%, the interest for the year should be $5,600.  Andy is deemed to gift $5,600 to his son.  Since this is Andy’s only gift during the year and its amount is under the $14,000 annual gift tax exclusion, it is a nontaxable gift and Andy does not have to file a gift tax return.

Next, Opie is deemed to have paid the $5,600 gift back to Andy as interest.  Andy will have $5,600 of interest income. 

Finally, Opie will be able to deduct the $5,600 interest payment since the loan was made to start a business.  If Opie borrowed the money for personal reasons, the deemed interest payment would be a nondeductible personal expense.

Exceptions to the Imputed Interest Rules

Luckily, there are exceptions to the imputed interest rules.  The exceptions are:

  • Loans not exceeding $10,000 between individuals is not subject to the imputed interest rules.
  • A special rule applies for loans between individuals that do not exceed $100,000.  Under this rule, the imputed interest on the loan will not exceed the borrower’s net investment income during the year.  Where the borrower’s net investment income is less than $1,000, the borrower is treated as having no net investment income and will therefore have no imputed interest.

More Examples

Example:  Andy loans his son, Opie, $9,000 and charges no interest.  Since the amount of the loan is less than $10,000, Andy and Opie will not be subject to the imputed interest rules.

Example 2: Andy loans his son, Opie, $90,000 and charges no interest.  Opie has $1,200 net investment income for the year.  The imputed interest based on the AFR is $2,520.  However, since the amount of the loan is under $100,000 the imputed interest is limited to Opie’s net investment income of $1,200.

Example 3: Same facts as Example 2 except that Opie’s net investment income is $900.  Since the amount of the loan is under $100,000 and Opie’s net investment income is under $1,000, there is no imputed interest.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

 

A Different Way to Help Your Child Buy a Home

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When parents help their adult children purchase a home, a usual technique is for the parents to gift money to fund the down payment on the home.

shared equity financing arrangementThere is an alternative technique that parents may use to help their children into a home.  That technique is a shared equity financing arrangement.

How it Works

Under a shared equity financing arrangement, the parents and the child each contribute to the down payment and then each will contribute to the monthly mortgage payments.  They will be co-owners of the home.  Since the child does not own 100% of the home, she is treated as her parents tenant for the portion of the home that the parents own.  The child will pay a fair market rent to her parents for the portion of the home that they own.  The fair market rent can reflect a discount that considers that the child will take better care of the home than a stranger since the child actually owns a portion of the home and is renting the other portion from her family.

The child will be able to deduct her portion of the mortgage interest expense and any property taxes that she pays.  The child’s rent expense will be non-deductible.  The parents will have rental income, and may deduct as rental expenses their share of the mortgage interest and other operating expenses of the home that they pay.  The parents will also be able to depreciate their portion of the home.

Example: Jed wants to help his son, Jethro, purchase a home.  Jed would like to generate some rental income and Jethro needs some help buying a home.  They decide that a shared equity financing arrangement would suit their purposes.  The purchase price of the home is $200,000 and the down payments is $40,000.  Jed and Jethro each pay half of the down payment and each will pay half of the mortgage payments and property taxes.

Jethro may deduct the amounts he pays for mortgage interest and property taxes.  Jed will receive rent income from Jethro for the portion that Jed owns.  Jed will be able to deduct as rental expenses the amounts he pays for mortgage interest, property taxes, and any other rental expenses such as maintenance and insurance.  Jed will also be able to claim a depreciation deduction for the portion of the home he owns. 

A Couple Caveats

Jed’s rental of the home will be subject to the passive activity loss rules.  These rules may postpone Jed’s ability to deduct the rental losses.  Disallowed losses become deductible once the rental property is sold.  However, the sale must be to an unrelated party.  If Jed has suspended losses and sells the property to Jethro, the losses will not become deductible because the sale was to a related party.  It may make sense to adjust the rent payments and down payment (to lower the mortgage interest expense) so that losses are not incurred on the property.

One drawback to the shared equity financing arrangement is that when the home is sold, the parent’s gain will not be excluded under the Section 121 gain exclusion that normally treats up to $500,000 of home sale gain as tax free.  To qualify for the gain exclusion, the owner must own and use the property for two out of five years.  Since the parent does not live in the home, the gain exclusion will not be available.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional be

The Dividend and Capital Gain Tax Rates in 2013 and Beyond

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Beginning in 2013, there are three primary tax rates that apply to dividends and capital gains.  There is a 0% tax rate that applies to taxpayers who are in the 15% tax bracket or lower.  There is a 15% tax rate that applies to taxpayers who are at or above the 25% tax bracket but who have taxable income under $450,000 (for joint filers).  Finally, there is a 20% tax rate that applies to taxpayers who have taxable income over $450,000 (for Dividend and Capital Gain Tax Ratesjoint filers).

On top of these tax rates, there is a new Medicare net investment income tax of 3.8% that applies to investment income such as dividends and most capital gains.  This additional tax applies when a taxpayer has in excess of $250,000 modified adjusted gross income (on a joint return).  Modified adjusted gross income is adjusted gross income (the bottom line number on the first page of Form 1040) increased by the exclusion for foreign earned income (which applies to certain U.S. citizens and permanent residents who live and work overseas).  For most taxpayers, modified adjusted gross income equals adjusted gross income.  This 3.8% Medicare tax begins in 2013.

The 0% tax rate for those in the 15% tax bracket or lower is very generous considering that married filers with taxable income under $80,801 in 2013 are in the 15% tax bracket.  In determining whether the taxpayer is in the 15% bracket or below, ordinary income fills the brackets before dividends and capital gains.

(Note: to make the following examples easier to follow, gross income, adjusted gross income, and taxable income are equal).

Example:  Fred and Wilma file a joint return.  They have wage income of $60,000 and dividends and capital gains of $20,000.  Since their taxable income of $80,000 puts them in the 15% tax bracket, the $20,000 of dividends and capital gains are taxed at 0% (i.e., the dividends and capital gains are tax free). 

Example 2:  Same facts as above except that Fred and Wilma have $70,000 of wage income.  In this situation, the dividend and capital gain income that get Fred and Wilma to the $80,800 limit of the 15% tax bracket are taxed at 0%.  Thus, $10,800 of the dividend and capital gain income are taxed at 0%.  The additional dividend and capital gain income of $9,200 causes Fred and Wilma to enter the 25% tax bracket.  This $9,200 of dividend and capital gain will be taxed at 15%.

Example 3: George and Jane have $200,000 in wage income.  They also have $60,000 in dividends.  Since their ordinary income of $200,000 puts them well beyond the 15% tax bracket, their $60,000 in dividends are taxed at the 15% tax rate.  Additionally, since their modified adjusted gross income of $260,000 ($200,000 wages plus $60,000 dividends) exceeds $250,000, they are subject to the 3.8% Medicare tax.  The Medicare tax is equal to the lesser of (1) investment income of $60,000 or (2) the excess of modified adjusted gross income over $250,000 (which is $10,000 in this example).  Thus, George and Jane would pay the 3.8% Medicare tax on $10,000 of dividend income.

Example 4: Same facts as above except that Jane and George have $400,000 in wage income.  Adding the $60,000 dividend income to their wage income causes their taxable income to exceed $450,000 and a portion of their dividend income will now be subject to the 20% tax rate.  All of the $60,000 dividend income will be subject to the 3.8% Medicare tax.  Additionally, since their wages income exceeds $250,000 they are also subject to the new, additional 0.9% Medicare tax on wages.

 

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Businesses Must Turn Over Unclaimed Property to the State by July 1

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As a business owner, you may have received a notice from the Michigan Department of Treasury advising you to report and turn over to the state any unclaimed property you have.  Many businesses have unclaimed property resulting from normal operations.  Some examples include uncashed payroll checks, uncashed vendor checks, credit balances on accounts receivable, etc.  Any of these assets must be reported and turned Michigan Unclaimed Propertyover to the state if they remain unclaimed for a certain period of time.  For example, uncashed payroll checks must be reported and turned over to the state after one year and uncashed vendor checks must be reported and turned over to the state after three years.

The due date for filing the unclaimed property annual report is July 1, 2013 for property reaching its dormancy period (e.g., one year for uncashed payroll checks) as of March 31, 2013.

Example:  You issue two paychecks.  The first paycheck is issued March 27, 2012 and the second is issued April 3, 2012.  The March 27 paycheck is dormant for one year on March 31, 2013, and must be reported and turned over to the state by July 1, 2013.  The second paycheck issued on April 3, 2012 has not been dormant for one year on March 31, 2013 and must not yet be reported.  If this paycheck remains unclaimed on March 31, 2014, it must be reported and turned over by July 1, 2014.

An Attempt Must First be Made to Find the Property Owner

Business owners are required to exercise due diligence and send a notice to the property owner at his last known address between 60 and 365 days prior to turning over the property to the state.  This notice will inform the property owner that he has unclaimed property and encourage the owner to claim his property.  If the business owner does not receive a response, the property must then be reported on an unclaimed property form filed with the state.  The business owner must also submit the property to the state.

Penalties for Not Filing or Turning over Unclaimed Property

Penalty and interest may be assessed as follows:

  • interest at 1% over prime per month on the property or the value of the property from the date the property should have been paid and/or
  • penalty at 25% of the value of the property that should have been paid

If the state audits a business for compliance with unclaimed property reporting, the state can go back 10 years.  A concern is that the state is outsourcing its audit function to third party auditors who are paid on a contingency basis based on the amount of unclaimed property they find.  Additionally, third party auditors may only audit a recent period, then extrapolate the value of any unreported unclaimed property over the ten years.  This could result in substantial penalties and interest.

If You Don’t Have Unclaimed Property

If you are certain you don’t have unclaimed property to report and pay over, there is no reporting requirement.

Voluntary Compliance Agreement

The state is providing businesses that have not previously reported or have underreported unclaimed property in the current and past four years with an opportunity to comply with the reporting and payment requirements by entering into a Voluntary Disclosure Program by filing Form 4869.  The program will waive all penalty and interest on property voluntarily submitted to the state.

So…if you have any questions regarding this issue please feel free to contact us.

 

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

IRS Updates Penalty Relief for First Time Errors

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IRS Penalty

 

Not touching upon recent IRS abuses, this post will focus on a policy of the IRS to abate certain penalties.  The IRS has recently updated it First Time Abate Policy that removes penalties for qualifying taxpayers.  This abatement policy is a one-time consideration available only for a first time penalty charge and is based on the taxpayer’s compliance history.

Qualifying for Penalty Relief

The penalty relief applies to the Failure to File, Failure to Pay, and Failure to Deposit penalties.  The taxpayer must:

  • Not have been previously required to file a return or has no prior penalties for the preceding three years
  • Have filed all currently required tax returns (or have filed valid extensions for such returns) and paid, or arranged to pay, any tax due.

Taxpayers will be considered current if they have an open installment agreement and are current with their installment payments.  Additionally, if taxpayers do not qualify for relief because they have not timely filed tax returns or extensions, IRS will provide an opportunity for taxpayers to become current with the filings so taxpayers may qualify for relief.

The penalty relief applies only to a single tax period for a taxpayer.  For example, if a request for penalty relief is being considered for two or more periods of a taxpayer, and the earliest period meets the relief requirements, the penalties associated with the earliest period will be abated, and no relief will be available for the later periods.

This penalty relief is not available for tax returns with an event-based filing requirement.  Examples of such returns include:

  • Form 706: Estate Tax Return
  • Form 709: U.S. Gift and GST Tax Return

The penalty relief will also not apply to Form 1120, U.S. Corporate Income Tax Return.  Penalty relief will not apply to Form 1102S, U.S. Income Tax Return for S Corporation if, in the prior 3 years, at least 1 Form 1120S was filed late, but not penalized.

Even if Taxpayers Don’t Qualify under First Time Abatement, They May Be Able to Have the Penalties Abatement Due to Reasonable Cause

If taxpayers do not qualify for this penalty relief, the IRS will base abatement decisions on whether taxpayers meet the reasonable cause criteria to abate penalties.  Reasonable cause is based on all the facts and circumstances in each situation and allows the IRS to provide relief from a penalty that would otherwise be assessed. Reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining their tax obligations but nevertheless failed to comply with those obligations.  Examples include series illness, death, and being a victim of a natural disaster.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

 

Exemptions from Sales Taxes

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Michigan imposes a 6% sales tax on sales of personal property at retail.  The sales tax does not apply to services, even though Michigan has tried a few times to extend the sales tax to services.  Luckily, there are exceptions to the sales tax.  The exceptions prevent the imposition of sales tax to the sale of certain products, to certain transactions, and to certain purchasers.

Sales tax exemptions

Products Exempt from Sales Tax

Sales of the following items are not subject to sales tax:

Food. Food for human consumption, except prepared food intended for immediate consumption, is exempt from sales tax.   Any food purchased under the federal food stamp program is exempt from sales tax.  Prepared food is subject to sales tax.  The following items are not considered prepared food and are exempt from sales tax:

  • Food that is only cut, repackaged, or pasteurized by the seller
  • Raw eggs, fish, meat, poultry, and foods containing items requiring cooking by the consumer
  • Food sold in an unheated state by weight or volume as a single item without utensils
  • Bakery items sold without utensils

The “without utensils’ language is important.  If utensils (including napkins) are included with food sold in an unheated state or with bakery items, the food sale becomes subject to sales tax.  More details about the food exemption from sales tax.

Prescription Drugs.   Drugs for human use that can only be legally dispensed by prescription are exempt from sales tax.  Over the counter medication is subject to sales tax even if it was prescribed.

Medical Devices.  Sales of the following items under a prescription are exempt from sales tax:

  • prosthetic devices
  • mobility enhancing equipment
  • durable medical equipment for home use

Water.  Sales of water through water mains or by deliveries in bulk tanks in quantities of not less than 500 gallons are exempt from sales tax.  Sales of bottled water are also exempt.

Advertising elements.  A commercial advertising element is exempt if the element is:

  • used to create or develop a print, radio, television, or other advertisement,
  • discarded or returned to the provider after the advertising message is completed, and
  • custom developed by the provider for the purchaser.

A commercial advertising element is a negative or positive photographic image, audio or video master, layout, manuscript, copy writing, artwork, etc.

Transactions Exempt from Sales Tax

The following transactions are exempt from sales tax:

Sales for resale.  Property purchased for resale is exempt from sales tax.  The resale exemption applies even where the purchaser is not a licensed dealer, if the purpose for the purchase was resale.  Property purchased for resale does become subject to sales tax if the purchaser does not resell the product and instead uses it personally.

Computers used in industrial processing.  The following sales and uses of computer equipment are exempt from sales tax:

  • computers used in operating industrial processing equipment
  • equipment used in computer-assisted manufacturing systems
  • equipment used in a computer-assisted design engineering system integral to an industrial process
  • there are other exempt sales of computers used in industrial processing

Custom computer software.  Sales of prewritten computer software are subject to sales tax only if the software is available from the seller on an “as is” basis or as an end product without modification or adaptation.  Retail sales of computer software that is originally designed for the exclusive use or needs of the purchaser are not subject to sales tax.

Concrete manufacturing.  Specially designed vehicles that are used to mix and agitate materials added at a plant or jobsite in the concrete manufacturing process are exempt from sales tax.

Motor vehicles used for demonstration purposes.  This exception applies to auto dealers.

Agricultural equipment.

Property in interstate or foreign commerce.  Sales tax does not apply to any sale of tangible personal property is the tax is prohibited by the U.S. Constitution or federal laws.

Exempt Purchasers

The following purchasers are exempt from sales tax:

Federal and state governments

Nonprofit institutions.  Sales TO nonprofit institutions are exempt from sales tax.  Fundraising sales BY a nonprofit institution are exempt from sales tax if the total retail sales in the calendar year are less than $5,000.  Once sales exceed $5,000 in a calendar year, all sales are subject to sales tax (even the first $5,000 of sales).

Agricultural producers.  Property sold to persons engaged in horticultural or agricultural product is exempt from sales tax if used or consumed in the commercial production of horticultural or agricultural products for sale.

Industrial processors.  Property and equipment sold to manufacturers, processors, etc., for use or consumption in industrial processing is exempt from sales tax.

Industrial laundries. Textiles, cleaning products, equipment, machinery, supplies, utilities, and other items sold or leased to an industrial laundry are exempt from sales tax.

 

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

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