Joseph Calvanico, National Director for Property Tax and Valuation Services, Crowe Horwath and Dan Megathlin, Director, Crowe Horwath (March 2011)
Reassessment in light of budget shortfalls - Nearly every state and municipality is facing record budget shortfalls, creating tension between the competing priorities of fiscal austerity and long-term growth. In Texas, for example, tax exemptions for businesses were responsible for nearly one third of its budget deficit in 2010. Similarly, local governments across the country lost a total of $235 billion from state property tax exemptions in the past year.
While sales tax revenues rebounded in the last half of 2010, the stimulus funds that have kept some jurisdictions afloat will run out this year. Despite the pro-business agenda of many elected officials, government leaders eventually might be forced to curtail the level of assistance they extend to businesses.
Given this climate, manufacturers would be well advised to devote resources in the short term to understanding where the opportunities lie and how to qualify for them.
Two Primary Sources of Funding
The funds that states make available to manufactures come primarily from two sources. The requirements and processes vary for each, and companies will need to pursue slightly different strategies to take full advantage of them.
Property tax - Manufacturers in all states must pay taxes on their real property, i.e., land, warehouses, factories, offices, and other buildings owned by the business. As with most capital-intensive businesses, real property taxes can make up as much as 25 percent of a company's total property tax burden. Furthermore, approximately 40 states levy taxes on business personal property, which consists of tangible and intangible goods such as manufacturing equipment, furniture, and other assets needed for business operations. Property tax rates for businesses are determined at the local level but remitted at the state level. Since most exemptions are taken in the context of filing corporate taxes, manufacturers should be especially aggressive in looking for savings opportunities when preparing their returns (generally from February to May).
Sales and use tax - In all, 45 states impose a sales tax. In most states, municipalities can add their own sales tax; however, all sales taxes typically are remitted directly to the state, which administers the funds. The combined state and local rates can range from 5 percent to more than 10 percent. During the past decade, states have continued to enact sales tax exemptions for the purchase of materials that are directly used to produce goods for resale. The sales tax is levied at the point of sale, so manufacturers can either qualify for a certificate of exemption or file for a sales tax refund on goods after purchase.
Three Categories of Exemptions
While every state has slightly different definitions for the business expenditures that qualify for exemptions, qualified expenditures can be segmented into three main categories - capital, operational, and growth and development.
Exemptions for capital investments - States provide companies with a range of exemptions on capital expenditures such as equipment, machinery, parts, and supplies used in the manufacturing process. To exempt purchases from sales tax, manufacturers often must issue an exemption certificate to their vendors for purchases of machinery and equipment. In addition, such purchases could qualify for property tax exemptions.
Beyond the core machinery that actually produces goods, other types of equipment also qualify for exemptions. As the public's awareness of environmental issues - and the manufacturing activities that harm the environment - has continued to rise, states have increased exemptions for investments in pollution-control equipment as well as machinery used to recycle waste. Property tax exemptions are also available for buildings, equipment, and land involved in converting waste into new products.
Since companies that invest in permanent new factories are less likely to relocate, a number of jurisdictions offer property tax exemptions for the construction of new industrial facilities. Industrial property tax abatements provide incentives for manufacturers to build new plants, expand existing ones, renovate aging facilities, or add new machinery and equipment.
States such as Indiana, Michigan, and Nebraska make these funds available through exemptions, an industrial facilities tax (IFT), or as part of tax increment financing (TIF). Manufacturers that are considering these types of investments should contact their state economic development department or local authorities early in the planning process to determine what resources are avail able to defray construction costs.
Exemptions for operational expenditures - Companies should recognize that spending for any direct inputs in the manufacturing process might qualify for sales tax exemptions. In general, states are seeking to avoid taxing manufacturers twice - once when they purchase the materials they need to produce goods for retail sale and again when the finished goods are sold. Three types of spending make up a substantial portion of a manufacturer's operational budget.
1. Resale and wholesale goods: In most states, purchases of tangible personal property are exempt from sales tax if the item becomes an integral part of the product being manufactured.
2. Packaging and containers: Materials that house the finished goods for transport and sale at a later date typically also are exempt from sales tax.
3. Energy: Many states provide sales tax exemptions on the use of electricity, coal, gas, fuel oil, or nuclear fuel directly used and consumed in the manufacturing process. In general, energy used in transporting goods or for other activities (such as sales) is subject to tax.