As the pandemic spread throughout the nation, nonprofit organizations became more dependent on technology to complete the vital task of fundraising. Much like their for-profit counterparts, nonprofits shifted to virtual events and required employees to work from home to comply with social distancing restrictions. Fundraising was a part of this transition as events went online to achieve an organization’s stated mission and serve their communities while also keeping everyone safe.
With the pandemic receding, returning to “normal” is unlikely to occur; organizations of all stripes (nonprofits and for-profits) have embraced virtual events and the “work from anywhere” culture, which are likely here to stay.
With this new reality comes tax concerns, as states don’t always play by the same rules.
The new virtual environment provides opportunities for nonprofits to expand where they focus fundraising efforts, removing physical boundaries, and broaden the locations where their employees work, allowing them to retain and hire talent suiting their organizational goals. A caveat to these new benefits is the state and local tax challenges associated with having fundraising activities and employee work occur in new locations, as the location of the fundraising and workforce can impact sales tax collection requirements. Consequently, there may be increased compliance burdens as the nonprofit organizations expand their footprint into new jurisdictions.
Nonprofit Sales Tax Considerations in General
Although nonprofit entities, such as section 501(c)(3) organizations, are generally exempt from federal income tax, states do not automatically exempt nonprofit organizations from sales or use tax. Some states have broad exemptions, allowing organizations with federal tax-exempt status to purchase products and services exempt from sales or use tax, if the purchase is used to fulfill the organization’s “mission” or “purpose.” In other states, the nonprofit exemption rules are more limited and only certain nonprofit organizations exempt by state statute can claim the exemption from sales or use tax.
Also, states treat sales made to an exempt organization very differently than sales made by that same organization. Generally speaking, the exemption for sales made to a qualifying exempt organization can be quite broad, whereas the exemptions for sales made by a nonprofit organization are often subject to limitations and specific fact patterns to qualify for exemption if the item being sold would normally be subject to tax.
The main factor that states look at to determine if sales or fundraising activities are taxable is the frequency of such events and whether a nonprofit could be considered making “regular” or “frequent” retail sales. For example, Minnesota exempts sales from qualifying fundraising events of all nonprofit organizations if the qualifying events do not exceed 24 days per year. Some states even count the number of hours: West Virginia considers “any fundraising event that lasts more than 84 hours” two events, which count towards their limit of six tax-free selling events.
In addition to frequency, states may look at total gross receipts of an event and may not allow an exemption if sales exceed a certain threshold, such as in North Dakota where taxable sales in excess of $10,000 per event are not exempt if the activities are held in a publicly owned facility and no other exemptions apply.
Generally, monetary donations to a nonprofit organization not tied to the sale of merchandise or admission to an event are not going to be subject to sales tax.
Nexus Considerations – Physical Presence
Nexus is a term that is used to describe a minimum connection to a state or jurisdiction. This minimum connection allows a state or jurisdiction to impose a tax on certain out-of-state entities with nexus. From a sales tax perspective, this typically means requiring an entity to register, collect and remit that state’s sales taxes for taxable sales that occur in the state or taxable sales that are shipped from outside the state to customers in that state.
Historically, from a sales tax standpoint, physical presence was the only way an entity could create nexus in a state. Physical presence generally took the form of employees, representatives, property or inventory in a state, either permanently or temporarily. In cases where the physical presence occurs temporarily or infrequently, there are some limitations as to whether a state could consider that activity “sufficient nexus” in a state. For example, in Arizona, having an employee present in the state conducting business on behalf of the company for more than two days per year could establish nexus in that state.
Importantly, during the pandemic many states provided guidance that they will not seek to establish nexus for sales and use tax purposes for out-of-state entities solely because an employee is temporarily working from home due to the COVID-19 pandemic. However, these states may back away from these temporary rules as the pandemic recedes and attempt nexus through the location of remote employees.
Nexus Considerations – Economic Presence
A state’s ability to impose sales tax nexus solely based on physical presence changed in June 2018 with the landmark Supreme Court case, South Dakota v. Wayfair, Inc. This case overturned prior Supreme Court precedent limiting a state’s ability to impose a sales tax collection requirement on a physical presence basis. After the ruling, states can assert nexus if a business or organization crosses a certain defined economic threshold. Typically, the minimum threshold for economic nexus (creating sales tax collection obligation in the current or subsequent year) is $100,000 in sales or 200 transactions per year in that state, but states do differ on how these thresholds are calculated, and some states have higher thresholds.
What does this all mean for a nonprofit organization
Between the various complexities regarding nonprofit exemptions and nexus considerations, sales tax compliance can be a challenging endeavor for nonprofit organizations. There are a few steps that nonprofit organizations can take to improve compliance and potential issues.
Nonprofits need to continue to monitor both their physical presence and economic nexus footprint. For physical presence, this means periodically reviewing where the organization has people, property, and inventory. From an economic nexus perspective, this requires intermittent sales review to see if any sales thresholds have been crossed or are soon to be crossed. For this reason, it is important for nonprofit organizations to plan ahead if they know that a fundraising event or their anticipated online sales could potentially cause sales tax reporting requirements due to either physical or economic nexus.
Additionally, nonprofit organizations must know the rules for items they purchase and sell. Virtual fundraising adds a layer of complexity, as sales from that activity occur simultaneously in multiple states. With proper due diligence, nonprofits guided by their tax professionals can navigate the sales tax laws and continue to fulfill the stated objectives of their organization.
It’s important for nonprofits to know all the sales tax implications. Our nonprofit tax advisors can help simplify the process and maximize your resources.