Sales Tax 101: The existential state of New Jersey

Upon learning that someone is from New Jersey, it is not polite to ask, "Oh really, which exit?" Your acquaintance might be a native of far northwest New Jersey, and therefore consider herself on a social par with her neighbors in Duchess County, N.Y. Or your new friend may hail from far southern New Jersey, for example, the land that time forgot, in which case you will cause him embarrassment when he realizes that construction on the turnpike has been completed for decades.

Residents of other states, however, cannot afford to be smug about their differences from residents of the Garden State. ?Take the case of the D.C. suburbs, where employees of the federal government and Beltway bandits alike live in their own existential state of New Jersey; that is, in an economically dependent relationship with a prominent city in another jurisdiction.

Proximity to the federal government, and the economic dependency to which it gives rise, may not carry the baggage of, say, the accent you get when you grow up in Hoboken, New Jersey. But the neurotic urge to imagine that an apartment high-rise on in the suburbs on Rockville Pike has some of the cachet of the Watergate apartments overlooking the Potomac in DC means that we can all, in one sense, be from New Jersey.

This unbalanced relationship is also seen in the distinctive practical operation in most states of a somewhat prosaic state function, the collection of sales and use taxes. (The tax is on the use, such as by lease or license, as well as the actual sale of covered goods and services.) More specifically, managing sales and use tax obligations offers a financial premium to the many firms that conduct business with the federal government.

Feds' exemption

Because the federal government is sovereign, it cannot be taxed. This translates, among other things, into a prohibition on the imposition of a sales tax on sales to the feds. While state statutes typically require vendors to collect sales tax, the tax is, in fact, imposed on the purchaser. When the purchaser is the federal government (or, by the way, the State of Maryland, the Commonwealth of Virginia or a political subdivision of either), there is no requirement that the vendor collect the tax, because none is payable.

I recently quoted a U.S. senator's quip about tax reform amounting to "Don't tax me, don't tax thee, tax that person behind the tree." The prohibition on imposing taxes on sales to the federal government is, after a fashion, a species of behind-the-tree tax reform, in that businesses maneuver in their dealings with the federal government to "qualify" for the sales tax exemption.

The most straightforward technique for avoiding taxes, involving purchases from suppliers for resale to others, applies irrespective of the special rules for sales to governmental entities. Say I have a contract to with the Department of Defense to supply it with toilet seats. Oops, sorry, Reagan left office a while ago. Say it's a fleet of Hummers for the Department of Interior.

When I place my purchase order with my supplier, General Motors, I provide a resale certificate to General Motors. The resale certificate entitles me to buy the goods without paying a sales or use tax. Note, however, that the fact that the government is the intended purchaser makes no difference in this case. Wal Mart and Target get the same resale exemption because the original purchase is not for consumption by the purchaser, because the purchaser is only a middleman. ?

If I'm based in Virginia, and my resale certificate is from Virginia. What if I purchase goods from California to be shipped to Maryland? While Virginia may have sufficient "nexus" to impose an income tax on my Virginia-based company, it cannot collect a sales tax on a transaction that took place entirely outside the state. So what good is my Virginia resale certificate? Do I need a resale certificate for every state in which I sell goods?

It's not necessarily written in the statute, but state taxing authorities generally allow sellers to accept out-of-state resale certificates. It is, after a fashion, a variation on the full faith and credit clause of the U.S. Constitution.

Sales tax 101

Recall that, resale or not, there can never be a tax on a sale to the federal government. That's Sales Tax 101 stuff. Like anything in life, however, and like everything involving taxes, it gets complicated fast.

Take the tax on hotel rooms. If Hilton rents a room to a federal employee on official business, that's really a transaction between Hilton and the federal government, even if the room is put on the guest's credit card, to be reimbursed by the government. Courts split, however, on whether that really is a sale of the room to the feds. In many states, it's exempt, but there is plenty of case law from other jurisdictions reaching a contrary result.

State taxing authorities and government contractors also play cat and mouse over purchases of equipment used in the performance of federal contracts.

If I buy a computer for myself so I can process data for a Department of Transportation study, I am, in the eyes of the relevant state tax authority, the end user, so neither the resale exception nor the exception for sales of goods to the government applies.

A clever Beltway bandit structured a contract for the purchase and use of computers on behalf of the Navy so as to anticipate this kind of challenge from the Maryland comptroller. The equipment which the contractor planned to use in the performance of its contract was delivered to the Navy, inspected by government procurement personnel and made available for use by the contractor only after being tagged with government property numbers. A Maryland Tax Court, oddly indifferent to solid case law favoring the comptroller, ruled for the contractor.

Yogi Berra once confessed that the inspiration for his quip, "If you come to a fork in the road, take it," came from an intersection near his house in Montclair, N.J. We will not presume, however, that when he said, "In theory, there is no difference between theory and practice; in practice, there is," he was thinking of state sales and use taxes.

The truth in that statement does becomes evident, however, when you attempt to impose a self-contained tax regimen on large communities that are, functionally, part of neighboring jurisdictions. Sales, use and income taxes become a trap for the ill-advised or unadvised and an opportunity for the well-coached. As clients of some law firms marvel, good advice pays for itself.

As a famous baseball catcher and noted existentialist who lived in New Jersey but worked in the Bronx once said, "You've got to be careful if you don't know where you're going, because you may not get there."

If you have questions about this issue, or other US domestic or international tax issues, feel free to contact me. David Borinsky. [email protected]