The manufacturing industry is known for having many sales and use tax exemption opportunities – but is your business maximizing on all possible exemptions? In December 2023, The Manufacturing Institute conducted a study of the manufacturing industry alongside Deloitte and found that the industry is experiencing strong economic growth overall.1 In fact, the number of manufacturing establishments in the US increased over 11% between 2019 and 2023 and is expected to continue growing.2 The same study estimated that this new growth could necessitate approximately 3.8 million new employees in the manufacturing industry between 2024 and 2033.3

With these rapidly growing numbers, small and large businesses alike often find themselves unprepared for or unaware of their potential sales tax obligations. Instead of benefitting from a proactive approach, these businesses are left paying tax on items that would otherwise be exempt. Or, even worse, paying penalties and interest on an unknown tax liability that could have been tax exempt with the proper exemption certificate documentation. 

This blog will cover some of the common exemptions that apply to the manufacturing industry, so you can identify areas in which your business may need some extra assistance.

Equipment 

States will often exempt machinery and equipment that is used directly in the manufacturing process. This can include machinery used in your production line, automated assembly systems, or even tools. It can also include machinery or equipment that is used to heat or cool, such as boilers and chillers, or used to produce energy needed for other machinery or equipment, like generators, solar panels, transformers, and more. 

The most important point of this exemption is to be aware of state-specific requirements, as the language of the exemption can change across states. For example, some states require that the machinery or equipment be “used predominately” in the manufacturing process. “Predominate use” may mean a given percentage of usage, usually at least 50%.4 “Direct use” typically means that “the machinery or equipment touches or comes into direct physical contact with the item being produced.”5 However, states can define these terms differently, which may change whether an exemption applies. 

Repairs/Replacements 

In most states, labor services for repairing manufacturing machinery and equipment are exempt from tax. Most business owners are aware of state exemptions for services. But it is less well-known that replacement and repair parts may also be tax exempt. This exemption can apply to repair or replacement parts that are used both for repairs and for upgrades or regular maintenance. 

Utilities 

One of the more significant costs a manufacturer is responsible for can be utilities. Many states offer exemptions or rate reductions for utilities such as electric, natural gas, and water that are used directly in the manufacturing process. These utilities are often also subject to the “predominate use” test discussed above.  

However, some states will allow partial exemptions if you can determine how much of a certain utility is being used for the manufacturing process versus for non-manufacturing purposes. Let’s say, for example, that you own a manufacturing plant with an attached business office. If you can determine the amount of electricity used for your plant versus the amount used to run the business office, the portion of the electric bill used for the plant may be tax exempt or subject to a reduced rate. Some states will even provide formulas to help you calculate this amount, but others may require non-production usage to be metered separately in order to claim the exemption or reduced rate. 

Packaging Materials 

The cost of packaging materials is one area that may seem insignificant, but the costs can add up quickly. Once you have your final product made, items that are used to package the final product may be exempt. Some examples of packaging materials include tape, boxes, shrink wrap, labels, and even pallets used to hold or transport the products. An important reminder for this specific exemption is that it is for packaging materials used for the final product, not packaging materials used for handling the product or storing it – although there may be other exemptions that apply for those materials. 

Tax Credits 

Sales tax exemptions are not the only resource available for companies in the manufacturing industry. Both state and federal tax credits may also apply. One of these credits is the federal Research and Development tax credit, which is available to businesses who are performing qualified research expenses.6 A common misconception about this tax credit is that it is only available for researchers, but in reality, it often overlaps with the manufacturing industry. In fact, research for the US Chamber of Commerce found that less than 3 in 10 businesses who qualify for the Research and Development tax credit actually claim it.7  Some activities that the credit could apply to include developing second-generation products, streamlining and refining existing manufacturing processes or techniques, and making enhancements to existing products. 

Key Takeaways

As a manufacturer, your key takeaway from this blog should be that there are many possibilities for tax-savings in the manufacturing industry, including several that were not covered here. Even large companies struggle to identify all the exemptions, credits, and savings that might apply to them. 

At State Tax Advisors, we specialize in helping you uncover potential tax exemptions, reduce tax liabilities, and simplify your compliance concerns. Contact us today for assistance in maximizing your manufacturing exemptions. 

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1. https://themanufacturinginstitute.org/wp-content/uploads/2024/04/Digital_Skills_Report_April_2024.pdf?utm_source=565934&utm_medium=email.

2. Id.

3. Id.

4. https://www.salestaxinstitute.com/resources/toolkit-for-manufacturing-sales-tax-exemptions.

5. Id. 

6. https://www.uschamber.com/co/run/finance/research-and-development-tax-credit

7. Id.