Saving Energy and Taxes on Utilities

Whether your business uses electricity, natural gas or other energy sources, one thing is certain: the cost of these commodities is a considerable part of your operating expenses.  Today, most businesses are striving to be more energy-efficient and are considering  “green” energy initiatives in order to save money on energy costs and utility services.  

The need for energy efficiency and conservation is so critical in our country today that the American Recovery and Reinvestment Act of 2009 included over $16 billion in funding for programs, tax credits and other initiatives sponsored by the Department of Energy’s Office of Energy Efficiency and Renewable Energy.  These initiatives go so far as to provide checklists of energy conservation/ efficiency measures that can be implemented at the office, including:

  • Replacing incandescent lights with compact fluorescent lights (CFLs) for desk lamps and overhead lighting. 
  • Using task lighting. Instead of brightly lighting an entire room, focus the light where it is needed to directly illuminate work areas. 
  • Turning off computers and monitors at the end of the work day, if possible. If you leave your desk for an extended time, turn off your monitor. 
  • Using energy efficient ENERGY STAR® products. 
  • Saving paper. Photocopy only what is needed. Always use the second side of paper, either by printing on both sides or using the blank side as scrap paper. 

For the complete checklist, visit: http://www1.eere.energy.gov/femp/services/energy_aware.html

By now, you’re probably asking yourself what this has to do with state and local taxes.  Since most states charge sales tax on energy and utility services used for commercial purposes, the more your business spends on utilities, the more sales tax you may have to pay as well.  As your business starts to implement “green” initiatives and begins using more energy-efficient machinery, equipment, and fixtures, your overall energy consumption will decrease.  What’s more, the amount of energy your business uses for non-manufacturing purposes (typically lighting) may decrease disproportionately to the amount used for manufacturing purposes.

States typically allow sales & use tax exemptions for utilities used or consumed in manufacturing (i.e., production of tangible property for sale) as well as related areas, including research & development and packaging.  While this isn’t exactly earth-shattering news to most people familiar with sales & use tax, what is surprising is the number of businesses that do not take advantage of these exemptions; or, if they do, are relying on inaccurate or outdated utility studies to calculate the taxable versus nontaxable amount of utilities being used throughout the facility.  Utility studies performed for sales tax purposes focus on the amount of energy being consumed by nontaxable machinery and equipment used in “production,” as defined by state tax law.  These studies differ from other types of utility or engineering studies, which typically focus on all energy consumption within a facility, to identify ways for the business to be more energy-efficient in general.    

Most states require manufacturers to do some type of utility study before allowing them to claim an exemption from paying sales tax on their utility purchases.  The nature and scope of these studies differs from state-to-state.  Some states might have strict guidelines, requiring your business to use an accredited engineering firm to perform the study, while other states may only require an engineer to review or certify the results of your internal calculations. There are also those states that don’t mandate the use of an engineer to do the utility study, as long as the calculations are reasonable and can be documented.

States also have different thresholds for the application of these exemptions.  For example, New York requires that utilities be used directly and exclusively in production activities in order to be exempt from sales tax. Therefore, you need to determine the amount of utilities used for production purposes as opposed to administrative purposes, in order to apply the exemption.  Michigan’s exemption utilizes a similar methodology. For example, if an industrial processor is billed a single amount for electricity, only the amount (or percentage) of electricity used for industrial processing would be exempt from sales tax.  Alternatively, Indiana and Maryland are among the states that allow a sales tax exemption for utilities used directly and predominantly (i.e., greater than 50%) in production.  In this case, if the utilities are purchased for production and non-production purposes, majority use determines the taxability of the purchase.  So as long as production use is greater than 50%, the entire charge for the utilities is nontaxable.  

It’s not surprising that the states have differing guidelines for the types of acceptable utility studies, as well as the application of sales & use tax exemptions to utilities used in production activities.  What is consistent among the states, though, is the need for businesses to have up-to-date utility studies that accurately reflect current energy consumption, plant layout, hours of operation, and other relevant conditions that impact utility use.  With increases in enforcement activities by the states, you can expect auditors to scrutinize utility studies to determine if the sales & use tax exemption your business is claiming is reasonable and can be supported. 

In this article, we’ve noted the business community’s growing interest in implementing “green” initiatives to reduce energy consumption “fueled” by tax credits and other initiatives sponsored by the Department of Energy’s Office of Energy Efficiency and Renewable Energy.  Considering the new administration’s focus on energy efficiency, coupled with increased state enforcement activities, now is as good a time as ever to dust-off that utility study that’s been sitting on your bookcase and see if it still reflects your current operational environment, or whether adjustments need to be made.

If you have any questions about this or other SALT issues, please email Tom Mazurek at tmazurek@tsacpa.com.  For additional State and Local Tax insights and resources, or to subscribe to our quarterly newsletter, visit tsacpa.com.

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