Decoding Illinois’ Major Sales Tax Exemptions

Keith Staats, JD Executive Director, Illinois Chamber Tax Institute
Deciphering Today's State & Federal Tax Law

Illinois’ sales tax is a combination of four taxes, all of which are imposed on sales of tangible personal property to end users—the Retailers’ Occupation Tax, the Service Occupation Tax, the Service Use Tax, and the Use Tax.

There’s a basic presumption that all sales of tangible personal property are taxable. However, the Illinois Department of Revenue (IDOR) does offer exemptions to this rule (see 86 Ill. Adm. Code 130.120, and 86 Ill. Adm. Code 150, Subpart C). The rationales for the exemptions are avoiding tax pyramiding and to benefit certain sellers or consumers.

Here, I’ll decode the “major” exemptions.

SALE FOR RESALE EXEMPTION

The oldest and most basic exemption is the sale for resale exemption. Items purchased for resale—finished products, or component parts of products to be manufactured or otherwise processed into a finished product—aren’t subject to tax (see Section 130.210). With this exemption, and every other exemption, proper documentation is critical. The best method of documentation is for the purchaser to provide the seller with a resale certificate (see Section 130.1405). In lieu of collecting customers’ resale certificates, a seller who makes all of its sales for resale or can provide “other evidence” that a transaction or series of transactions are non-taxable sales for resale.

Be advised that all methods of claiming a resale exemption are subject to strict IDOR scrutiny. Based on my experience, I generally counsel against a seller attempting to rely on a contention that all sales are for resale unless it can document that 100% of the sales are for resale.

MANUFACTURING MACHINERY AND EQUIPMENT EXEMPTION

One of the most used exemptions in Illinois is the manufacturing machinery and equipment exemption. This exemption for machinery and equipment is used by a purchaser or a lessee of the purchaser primarily (greater than 50%) in the process of manufacturing or assembling tangible personal property for wholesale, retail sale, or lease. The exemption also includes replacement parts for exempt machinery and equipment. Section 130.330 details regulations that define the scope of the exemption. It’s important to know that every word in this definition of the exemption has been litigated, and it’s incumbent upon businesses and their advisors to know the definition. Even though the current incarnation of the exemption is quite broad, there are still traps for the unwary.

ROLLING STOCK EXEMPTION

The rolling stock exemption is another subject of much litigation. A rolling stock exemption consists of motor vehicles, trailers, aircraft, watercraft, trains, etc., that transport persons or property for hire in interstate commerce. While IDOR has rules on the exemption in Section 130.340, be forewarned that the rules haven’t been updated since 2008 and don’t reflect the current law on motor vehicles and trailers.

Under current law, a purchaser of a motor vehicle or trailer claiming this exemption certifies that the motor vehicle or trailer will be used by an interstate carrier for hire who holds an active U.S. Department of Transportation number with the carrier operation listed as “interstate” and classified as “authorized for hire,” “exempt for hire,” or both.

Contrast this with the law in 1990, when I was working as a young IDOR staff attorney, that said “regular and frequent” movement of the motor vehicle or trailer in interstate commerce was required. During that time, I received a phone call from a practitioner asking, quite reasonably, if I could quantify what was meant by “regular and frequent.” I couldn’t find the answer in our files (we only had paper files back then), so I went to my boss and asked the question. He said there was no objective standard—there were only a couple of court cases that described what it wasn’t. He sent me back to tell the unhappy practitioner that the determination was made by the auditors on a case-by-case basis.

Other rolling stock, such as aircraft and watercraft, have a different exemption standard. To claim the exemption, there must be clear demonstration that the rolling stock has carried persons or property for hire in interstate commerce for greater than 50% of its total trips during a 12-month period or greater than 50% of its total miles for that period.

SALES TO EXEMPT ORGANIZATIONS

“Exclusively charitable,” religious or educational organizations, governmental bodies, and schools can be exempt from sales tax. To obtain an exemption, an organization must apply for an IDOR-issued identification number.

Be aware that the “exclusively charitable” standard is a higher standard than the “charitable” definition under the Internal Revenue Code (IRC). Many organizations that qualify as not-for-profit under IRC Section 501(c) aren’t exclusively charitable for Illinois sales tax purposes. There’s extensive case law on what it means to be exclusively charitable for purpose of the exemption. Sections 130.2005 and 130.2007 include rules on this subject.

AGRICULTURAL EXEMPTIONS

Illinois has a strong agricultural industry, so it’s not surprising that there are agriculture-related exemptions. There are exemptions for sales of farm machinery and equipment (Section 130.305), farm chemicals (Section 130.1955), feeds and breeding livestock (Section 130.2100), and seeds and fertilizer (Section 130.2110).

LICENSES FOR COMPUTER SOFTWARE EXEMPTION

The last of the major exemptions worth highlighting is an exemption for certain licenses of computer software (Section 130.1935). I’m highlighting it for a few reasons: (1) I believe it’s unique to Illinois, (2) there are still sellers and purchasers unaware of it, and (3) this was the first rulemaking project that I worked on as a young IDOR staff attorney—and the rule has remained virtually unamended for the past 32 years. A software license may be exempt from tax if the license complies with a five-part test set forth in the rules. Notably, IDOR requires strict compliance with the rules to claim the exemption.

ADDITIONAL EXEMPTIONS

All the exemptions highlighted above equally apply to Illinois’ four sales tax types: the Retailers’ Occupation Tax, the Service Occupation Tax, the Service Use Tax, and the Use Tax. There are also certain exemptions unique to the Service Use Tax and the Use Tax. Section 150.310 details exemptions from the Use Tax that are designed to prevent actual or likely multistate taxation. For example, tangible personal property acquired outside of Illinois by a nonresident and brought into Illinois for their own use while temporarily within the state or passing through the state is exempt from tax. In other words, if an Ohio resident comes to Illinois on vacation and brings their iPhone, Illinois can’t attempt to impose its Use Tax on the value of the iPhone.

Another important Use Tax exemption is the temporary storage exemption for items acquired outside of Illinois that, subsequent to being brought into Illinois, are used solely outside the state or physically attached to or incorporated into other tangible personal property that’s used solely outside the state. For example, a company has offices throughout the United States, including an IT department in Illinois. They buy laptops and software through centralized purchasing from vendors outside of Illinois that are delivered to the Illinois IT department. The IT department loads the software onto the laptops and configures the laptops to company specifications before shipping the laptops off to the other various U.S. offices. Therefore, under the temporary storage exemption, the purchase of the laptops and software that are shipped outside of Illinois for use aren’t subject to Illinois tax. However, if the purchases are made from an Illinois vendor, or purchased from an out-of-state vendor and shipped from an Illinois warehouse, those sales don’t qualify for the temporary storage exemption and are fully taxable by Illinois.

As you can see, sales tax exemptions are important—and tricky to decode. A proper understanding of the scope of the exemptions and proper documentation is always critical.

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