Lodging providers beware: Increased eye on sales tax exemption in the state audit

As states struggle to reverse shrinking tax revenues, there have been an increased number of state sales and use tax audits within the hospitality industry relating to the exemption of nonprofits – and the outcome has been costly. One area targeted by sales and use tax examiners has been lodging and services provided to federal, state and local governments; schools; and nonprofit employees staying in hotels.

Auditors are requiring evidence proving that the employee stay was on official business of the exempt organization and/or directly paid for by the entity. Lodging companies not collecting and maintaining sufficient documentation could be vulnerable to penalties as well as additional tax and interest. Here are a few things properties should keep in mind:

  • Don’t assume a federal employee on government business is barred from paying sales tax on hotel charges. In most cases, the hotel charge is only exempt when it is directly billed to the federal agency. This includes credit card paid directly by government. The same holds true for state and local government employees.
  • Many states limit the sales tax exemption to their own state and local government agencies. Therefore, out of state, state and local governmental agencies are taxable on hotel room charges.
  • Another limitation is applied to educational institutions. Again, in many states, the exemption is allowed only for those schools in state. Out of state schools may be taxable unless the school qualifies as an IRC Section 501(c)(3) exempt organization.
  • Without proper evidence of exemption at the time the hotel charge is made, obtaining documentation from an exempt entity after the fact is often difficult. Be sure to retain records of purchase orders, invoices to exempt agencies, certificate of exemption forms, and/or a statement the employee is on official business of the governmental entity, school or nonprofit.

Do not forget about another area of activity - use tax owed on items consumed (i.e., toiletries, etc.) by the hotel. These items generally do not qualify as purchases for resale. Hotel fixtures and remodeling expenses are often treated as purchases of tangible personal property and are therefore taxable on the entire charge of material and labor.