In the complex world of state and local tax (SALT), most businesses understand the importance of properly charging, collecting, and remitting sales tax. But what’s often overlooked are the many narrow but powerful exclusions and exemptions buried in state statutes and administrative rulings.

For multistate taxpayers, these provisions can represent substantial savings—if they’re known and documented. Yet, many are inconsistently interpreted, poorly understood by auditors, or applied unevenly across jurisdictions.

This article provides a practical guide to lesser-known but legally sound sales and use tax exemptions and exclusions that companies should be evaluating in their compliance strategy, broken down by industry and transaction type.

1. Software: Delivery Method and Usage Still Matter

Sales of prewritten software are generally taxable in most states, whether downloaded or accessed remotely. However, exceptions abound depending on the delivery method, nature of use, and purchaser.

• New Jersey: Electronically delivered software used in a purchaser’s business is exempt, including access to help desk and upgrade services, despite occasional overreach by auditors.

• California: Under Cal. Code Regs. tit. 18 § 1502(f)(1)(D), no tax applies when software is transferred via remote telecommunications and the purchaser doesn’t receive tangible media.

• Pennsylvania: Financial institutions enjoy a special exclusion for software used directly in the business of banking (72 P.S. § 7204(73)). But location matters—remote access is presumed taxable if billed to a Pennsylvania address.

Key takeaway: Source software correctly, preserve electronic delivery evidence, and claim exclusions narrowly tied to business function or industry classification.

2. Digital and Web-Based Services: Beware of Functional Recharacterization

States are aggressively expanding the tax base to capture digital services—especially SaaS, analytics platforms, and subscriptions. Yet, not all digital products are taxable, and statutory carveouts exist.

• Tennessee: Information services are excluded from the definition of taxable digital goods and software access (Tenn. Code Ann. §§ 67-6-231, 233).

• Pennsylvania: While 72 P.S. § 7201(m)(2) includes digital books and canned software in taxable tangible personal property, older DOR guidance excludes information retrieval services if the customer accesses a proprietary database.

• Louisiana: ACT 10 (2024 Extraordinary Session) expanded taxation to digital products, information services, and remotely accessed software, but provides an exemption for digital tools used exclusively in commercial production of taxable goods or services.

Best practice: Segment invoices and licensing agreements to distinguish exempt information access from taxable software or digital content.

3. Resale and Special Resale: Going Beyond “As-Is” Goods

Most taxpayers understand the basic resale exemption. Fewer recognize the opportunity for “special resale”—where items are purchased to be incorporated into other products or consumed in taxable transactions.

• Missouri: Utilities provided to hotel rooms are considered resold to guests and exempt as of 2022. Refunds are available retroactively to 2021.

• Texas and Pennsylvania: Both states exclude TPP from use tax if incorporated into goods ultimately transported and used exclusively out of state.

Resale certificates must match the intended disposition of the property, and documentation is critical in audits involving indirect resale chains.

4. Manufacturing: Scope Varies, But Opportunities Abound

Manufacturing exemptions apply broadly, but every state defines “manufacturing” differently—particularly as to when the process begins, ends, and what’s “directly used.”

• Texas: Tangible property qualifies if it causes a chemical or physical change to a product for ultimate sale, including intermediate steps and packaging (Tex. Tax Code § 151.318).

• Pennsylvania: Exemption extends from the first stage of production through final packaging, with generous inclusion of R&D inputs (72 P.S. § 7201(c)).

• Louisiana: Exemption ends when the last manufacturing activity is completed. Activities like storage or shrink wrapping are explicitly excluded unless integral to sale (47:305.5(3)).

• Illinois: Expanded its exemption to include production-related property used in staging, inventory control, and even safety equipment.

Pro tip: Claim broad exemptions where the statute allows, but prepare detailed process flow documentation to support each claimed input or machine.

5. Packaging and Containers: More Than Just Boxes

Whether packaging is exempt depends on who buys it, who uses it, and whether it’s transferred to the customer.

• New York: Exempts packaging and components actually transferred to the purchaser.

• Texas: Allows a manufacturing exemption for packaging used in shipping products, not just resale exemption for the box itself.

Don’t forget: Returnable containers and packaging for laundry and dry cleaning are separately exempt under many states’ laws.

6. Research & Development: Tax Relief for Innovation

In many states, R&D qualifies as part of manufacturing—but it can also carry its own exemption.

• Pennsylvania: Includes in the exemption any property used in research with the objective of creating a new or improved product or process, excluding market research or admin efficiency (72 P.S. § 7201(c)(5)).

• New Jersey: Broadly exempts any tangible property (except energy) used 100% in R&D, without a production requirement.

Tip: Don’t assume R&D requires a physical product. Tech and software companies often qualify when developing new platforms or methods.

7. Nonprofits and Government Entities: Know the Scope and Limits

Sales to 501(c)(3) nonprofits and government bodies are frequently exempt—but only if the purchase is used for exempt purposes.

• New Jersey, Pennsylvania, Massachusetts: All exempt sales to qualified nonprofits for their mission-related use. Fundraising sales by such groups are also typically exempt.

• Louisiana: Exempts government agencies and allows agencies to designate construction contractors as their purchasing agents using Form R-1020.

Watch out for: Improper use of exemption certificates by third parties or unrelated affiliates, which can result in audit disallowance.

8. Other Notable Exemptions and Opportunities

Some exclusions are industry-specific, yet underutilized:

• Intercorporate Services (Texas): Services between affiliated corporations reporting on a consolidated return are exempt under Tex. Tax Code § 151.346.

• Off-Road Fuel (Illinois): Fuel consumed off public highways is not subject to motor fuel tax—an often-overlooked refund opportunity.

• Aircraft “Fly-Away” (Arkansas): Sales to nonresidents for use outside the state are exempt if the aircraft meets weight or fly-away conditions.

• Capital Improvements (New Jersey): Labor on capital improvements is exempt, though contractors owe tax on materials unless purchased for resale.

• Opportunity Zones (New York): Start-Up NY and other programs offer tax credits and exemptions for businesses operating in designated areas and partnering with state universities.

Conclusion: Spare Change Adds Up

Sales and use tax savings are not always found in the biggest exemptions. Often, the most impactful results come from knowing where the law provides specific, underutilized exclusions—and applying them carefully.

For tax professionals and businesses alike, regularly reviewing the exemptions available by jurisdiction, industry, and transaction type can uncover significant value. More importantly, documenting the basis for each exemption—through contracts, invoices, certificates, and process documentation—is the best defense against auditor skepticism.

In an era of aggressive state enforcement and expanding tax bases, smart businesses don’t just collect the tax—they know when not to.

© 2025 Jeanette Moffa. All Rights Reserved.