MOST people in the industry understand that a 12% Federal Excise Tax applies to certain truck-trailer and semi-trailer bodies and chassis and certain truck-tractors — which means that in general, the first retail sale of a taxable article is subject to tax.
However, many are not well-versed in the “bite-sized pieces,” as Mark Sidman and Rose-Michele Nardi termed them in their presentation on tax-free sales to the government.
Sidman is managing member and Nardi is counsel for the Washington DC law firm of Weiner, Brodsky, Sidman, Kider, which has represented the National Truck Equipment Association for more than 35 years.
They said that under Section 4221 of the Internal Revenue Code (Tax-Free Sales of Taxable Articles Based on the Identity of the Buyer), the following types of purchasers can purchase taxable articles on a tax-free basis: purchasers who buy for use in further manufacturing; purchasers who buy for export; state or local governments; nonprofit educational organizations; and qualified blood-collector organizations.
Under 4221(a)(4), no retail tax shall be imposed on the first retail sale of a taxable article to a state or local government for the exclusive use of the state or local government.
So in order to conduct tax-free government sales correctly, Sidman said a company first needs affirmative answers to four questions:
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Is the buyer a qualified government entity?
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Is the sale to the government entity the vehicle's first use?
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Is the sale to the government entity a direct sale?
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Is the sale for the exclusive use of the government entity?
If the answers to all four questions are yes, then a company can make the sale tax-free if it follows the IRS' documentation requirements.
Is the buyer a qualified government entity? Divisions of state or local government qualify. A company can sell FET-free to a city department of public works, state highway patrol, county parks department, or state community college (created, funded, and operated by the state). Entities performing state functions qualify.
However, Sidman said there are some qualified entities that are not a part of the government but perform essential public services under government control. Qualified entities typically funded by the government and non-profit organizations: non-profit volunteer fire departments/rescue squads; humane societies with enforcement powers; and flood-control commissions funded by the state, with members chosen by the legislature, that report to the governor.
“You have to be careful, though,” Sidman said. “There are some that perform quasi-public functions that do not qualify for tax-free sales.”
Non-qualifying entities: private, non-profit hospitals; non-profit community action organizations not controlled by the state; agricultural commodity commissions not controlled by the state.
“If the buyer is a private entity, proceed with caution,” he said. “It is not enough that the entity performs a ‘good’ function and is non-profit. The issue is whether the government would perform that function if the entity did not. It is not enough that the private-entity buyer is under contract with a city or state to perform a function. The issue is whether the government has control over the private entity.
“In general, for-profit enterprises usually will not qualify. The determination over whether a particular purchaser will qualify as a state or local government entity tends to depend on specific operational and organizational facts of the purchaser — facts that often will not be readily available to you or to the IRS. As a result, there is a gray area that could result in an audit risk. Contact a tax advisor before the sale to check to see if any rules have been issued related to any entities similar to the one you are selling to.”
He said the federal government, including the US military, is not qualified to purchase tax-free. However, National Guard units, which are controlled by the states, are qualified.
First-use determination
The next step is to confirm if the sale to the government is the first use. The exemption does not apply to vehicles that have been used prior to sale.
“For example, if you agree with a municipality that you will use a vehicle in your business for six months and then sell the vehicle to the municipality, the exemption does not apply, and your use will trigger a tax,” he said.
A sale to a purchaser that will re-sell the vehicle to a state or local government does not qualify for the exemption (but the initial sale could be done as a tax-free sale for resale). He said it is important to use the correct exemption and the proper paperwork because the IRS strictly construes its requirements for tax-free sales.
Is the sale for the exclusive use of the state or local government? The sale must be for the government entity's exclusive use. If the government entity has an arrangement in place to sell the vehicles to a trucking company after using them for one year, the sale does not meet the exclusive-use test. If the government entity intends to purchase the vehicles and re-sell them to government employees who will use the vehicles in their government jobs, the sale does not meet the exclusive-use test.
Nardi said it is essential that sellers meet the IRS' documentation requirements for tax-free sales to state and local government entities.
“If you meet the four tests for tax-free sales to government entities, but fail to comply with the IRS' documentation requirements, you run the risk of a tax assessment in an IRS audit,” she said. “When claiming a tax exemption, you should expect the IRS to be a stickler for paperwork. You need to have the correct supporting documentation.”
She said the seller must be registered with the IRS for tax-free sales by filing IRS Form 637. The registration must be complete and approved; merely filing the Form 637 is not enough. To check your registration status, use the following link: http://www.irs.gov/app/exciseTax/. The buyer — the government entity — does not need to be registered.
She said the exemption certificate from the government entity is the second piece of necessary paperwork.
“The good news is that there is no need for you or the purchaser to create your own certificate,” she said. “The bad news is that if you create your own certificate, it may not be acceptable to the IRS. This is not the time to be creative. You should just use the form.
“The purchaser may provide a single certificate for multiple sales occurring at different times, so long as all sales covered by a single certificate occur within 12 consecutive calendar quarters, which is effectively three years. This is a nice convenience, but it can also get sellers in trouble because it's easy to forget to replace the expired certificate with a new one. If possible, try to have the purchaser provide you with a new certificate to cover each separate sale. If that's not possible, we recommend adding to the certificate itself the expiration date of the certificate.”
She said that in addition to obtaining an exemption certificate, the seller must include on its purchase order (or on a separate certificate) the following information:
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The vehicle is normally subject to FET under IRC 4051 and is being sold tax-free to a state or local government entity.
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The government entity is acquiring the subject vehicle tax-free for its exclusive use, as stated in the exemption certificate (or equivalent).
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The government entity will notify the seller if the vehicle is used in a manner not consistent with the tax-free sale requirements.
“If possible, obtain a statement from the purchaser stating that, if the IRS determines the sale is taxable, the purchaser will pay the tax,” she said.
“Because the seller is the one responsible for paying the tax, the buck stops with you. If the sale doesn't satisfy the requirements for a tax-free sale, the IRS generally will look to you to pay the tax. Therefore, it is the seller's responsibility to make sure the purchaser provides correct documentation. You cannot just accept whatever documentation the purchaser hands you. You need to review it make sure it satisfies requirements.”