Is an expanded manufacturing sales tax exemption adding to Iowa's fiscal woes?

Since July 1, 2016, the sales and use tax exemption Iowa provides for certain computers, equipment, machinery, and replacement parts applies to “supplies” and an expanded list of replacement parts, i.e., certain items used in the manufacturing process. According to some Iowa lawmakers, this recent exemption has contributed to the state’s current fiscal woes.

Beginning July 1, 2016, an exempt “replacement part” is defined as “tangible personal property, other than computers, machinery, equipment, or supplies” substituted for a part of machinery or equipment that is:

• Broken
• Obsolete
• Unable to perform its intended function
• Worn out

Furthermore, the part must:

• Add to the value of the industrial equipment or machinery
• Appreciably prolong the life of the industrial equipment or machinery
• Keep the machinery or equipment in good working order
• Last for at least one year

Beginning July 1, 2016, the definition for exempt “supplies” is “tangible personal property, other than computers, machinery, equipment, or replacement parts,” that:

• Is to be connected to a computer, machinery, or equipment and requires regular replacement because the property is consumed or deteriorates during use; or
• Is used in conjunction with a computer, machinery, or equipment and is specially designed for use in manufacturing specific products, and may be used interchangeably and intermittently on a particular computer, machine, or piece of equipment; or
• Comes into physical contact with other tangible personal property used in processing, and is used to assist with or maintain conditions necessary for processing; or
• Is directly and primarily used in an activity described in Iowa Code section 423.2(47) “a”, subparagraphs (1) through (6), including but not limited to prototype and testing materials.

Exempt supplies include drill bits, cutting fluids, filters, grinding wheels, lubricants, sanding discs, saw blades, and tools (but not hand tools).

This doesn’t mean Jane or Joe Homeowner can purchase saw blades without sales tax. To qualify for the exemption, the items must be directly or primarily used:

• In processing by a manufacturer;
• In maintaining the integrity of products or unique environmental conditions used in manufacturing;
• In researching and developing new products or processes of processing;
• In the processing or storage of data or information by an insurance company, financial institution, or commercial enterprise;
• In the reprocessing or recycling of waste products; and/or
• As pollution-control equipment for a manufacturer.

For additional details, see this Department of Revenue publication and the department’s webpage on Iowa sales and use tax on manufacturing and processing.

Many Republicans disagree that the expanded sales tax exemption for manufacturers is reducing the general fund. Rather, they attribute the decline in revenue to the fact that many online sales aren’t subject to sales tax, and “a sluggish farm economy.”

Whatever the cause, state agencies have had to make budget cuts during the past year, and more than $140 million has been taken from state reserve funds. State lawmakers plan to return that money by the end of the next fiscal year; exactly how they’ll do that remains to be seen.

Sales and use tax exemptions can complicate sales and use tax compliance for manufacturers. Learn more about how sales tax impacts manufacturers at the Avalara Resource Center.