Don’t be fooled by sales tax assumptions in manufacturing

Most manufacturers assume their accounts receivable and accounts payable processes are running smoothly and protecting them from undue state tax liabilities, until they realize they’re not. A common misconception in the manufacturing industry is that most transactions are exempt from sales tax. While sales to distributors or wholesalers are typically tax-exempt, failing to comply with proper documentation requirements can lead to significant financial risks.

Additionally, for a manufacturer’s own purchases, there are many tax savings opportunities outside just the traditional notion of “exempt” raw materials. Failing to capture all tax savings opportunities on purchases can impact the bottom line.

One of the most frequent and costly mistakes is neglecting to collect and maintain exemption certificates. If a state auditor requests these documents and they are missing, incomplete, or outdated, the manufacturer—not the distributor or wholesaler—becomes responsible for the unpaid sales tax, along with potential penalties and interest. Without proactive compliance measures, what seems like a minor oversight can quickly escalate in cost.

Common Pitfalls Manufacturers Face with State Sales and Use Taxes

Misconceptions and ambiguity about compliance rules cause many manufacturers to unknowingly expose themselves to sales tax liabilities and put themselves at a competitive disadvantage. Below are three major pitfalls that can lead to financial trouble:

Misunderstanding Nexus Regulations

Many manufacturers don’t realize where they have nexus (where they have tax obligations).  Nexus can be caused by physical facilities, employee location, sales presence, or other business activities. A company may assume it only needs to collect sales tax in its home state and states where they have a physical presence, but many states have aggressive nexus rules that could extend sales and use tax obligations across multiple jurisdictions.

Failing to Collect Tax Exemption Certificates

Even when manufacturers sell goods for resale to wholesalers or distributors, they must collect and maintain exemption certificates to prove those sales are tax-exempt. Without those certificates, a state audit could result in unexpected sales taxes and penalties.

Some manufacturers assume they can just get the exemption certificates later if an audit happens. But this is a risky approach as customers may have gone out of business, merged with another company, or simply refuse to provide the certificate. Without proper records, manufacturers could end up owing significant back taxes.

Being proactive and keeping organized exemption certificates helps avoid these costly surprises.

Overpaying Sales Tax on Component Parts

Manufacturers frequently overpay sales tax on raw materials and component parts, as well as related manufacturing equipment and material handling, due to misclassification errors or lack of awareness about state-specific exemptions. Some states, like South Carolina, offer substantial tax relief for manufacturers, but without a thorough analysis, businesses may be leaving money on the table.

To avoid these risks, manufacturers can benefit from a structured compliance framework that identifies tax obligations, clearly articulates requirements, tracks exemption certificates, and analyzes transactions for potential tax overpayments.

Case Study: How a Manufacturer Tackled an Audit and Uncovered Overpayments

A component parts manufacturer approached Elliott Davis after being audited by the State of Alabama for unpaid sales tax. Concerned about the potential tax liabilities, the company engaged the Elliott Davis State and Local Tax (SALT) team, who applied a four-phased approach to resolve the issue and uncover hidden savings.

Phase 1: Nexus and Compliance Analysis

The first step was to assess where the company had nexus and clarify tax obligations in Alabama and South Carolina. After a thorough exploration of physical locations, operations and sales activities, the Elliott Davis team mapped out the company’s tax footprint and presented leadership with clear guidelines for future compliance.

Phase 2: Sales Tax Liability Analysis

Next, the SALT team investigated the company’s purchases and revenue streams, including:

• Raw material purchases and related products

• Final product sales and customer types

• A 5-year transaction history

By analyzing how different transactions were taxed in each state, the team identified multiple areas where tax liabilities had been misreported or overpaid.

Phase 3: Identifying Overpayments and Securing Refunds

After calculating the company’s total tax liability, the Elliott Davis team uncovered overpayments in South Carolina, a state with favorable tax treatment for manufacturers. The team:

• Determined the exact amount of sales tax due in Alabama

• Identified overpaid taxes in South Carolina

• Worked with the state to recover substantial refunds for the company

South Carolina offers a range of exemptions designed to support manufacturing growth, but taking full advantage requires a clear understanding of what qualifies. Below is a breakdown of key exemptions that could help identify overpayments and secure refunds.

Phase 4: Long-Term Compliance Strategy

To prevent future issues, the Elliott Davis team helped the company implement a clear and practical compliance system, including:

• Proper exemption certificate management

• A streamlined tax reporting process

• A roadmap for ongoing compliance and audit readiness

Results

The company resolved its Alabama audit liabilities and secured a significant refund from South Carolina, transforming what started as an audit crisis into a financial win.

Case Study: How a Supplier Cleaned Up Their Taxes

A supplier operating in five states faced an overwhelming challenge of managing complex, multi-jurisdictional sales tax obligations. Each state had different regulations, exemption rules, and reporting requirements, leading to inconsistencies in tax collection and recordkeeping.

Facing large multi-state sales tax exposures, the supplier turned to Elliott Davis for help. The SALT team worked closely with the company and state tax agencies to:

• Provide accurate exemption documentation to verify non-taxable transactions

• Initiate sales tax exposure mitigation requests through Voluntary Disclosure Agreements (VDAs) in all states with exposure

• Negotiate penalties and interest reductions by proving compliance efforts

• Eliminate historical look-back and exposure via VDAs

• Implement a standardized compliance process for future reporting

Through meticulous documentation and negotiation, the states waived multiple penalties and reduced assessed interest, leading to an estimated total savings of over $400,000.

We Can Help

Sales tax mismanagement in manufacturing can result in substantial penalties, audit costs, and overpayments of sales tax on purchases. Whether it’s managing multi-state nexus rules, reclaiming overpaid taxes, or maintaining compliance in direct-to-consumer (D2C) sales, Elliott Davis specializes in helping manufacturers minimize liabilities and improve tax efficiency. We help clients:

• Reduce audit costs and findings

• Recover overpaid sales tax

• Establish a long-term compliance framework

Contact Elliott Davis today to understand your true sales tax obligations and protect your business from unnecessary financial risks.

The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.