This blog was last updated on May 19, 2026

Most companies treat use tax as a problem they’ll get to eventually. “Phase 2” of the transformation plan. Meanwhile, auditors, who have gotten meaningfully smarter through technology, know exactly where to look. Manufacturers can find themselves a frequent target. 

When a seller takes a properly completed exemption certificate from a manufacturer, they are largely off the hook. The manufacturer never is. Manufacturers must understand precisely how and where every purchase will be used and must account for the circumstances where actual use differs from intended use. There is no safe harbor.  

The Five Critical Questions That Determine Use Tax in Manufacturing 

Getting the right tax answer for a manufacturing purchase in any given state requires drilling through a series of layered questions, the answers to which can vary depending on the location of the manufacturing facility.  

Q1: Does the activity qualify as “manufacturing” for tax purposes? 

This sounds straightforward until you realize that states define the term differently and that qualifying manufacturing activity may or may not include related activities such as research and development, conveyancing, pollution control, or testing and quality assurance.  

While the rules don’t change too often, any change at all can be enormously consequential. For example, effective January 1, 2026, Texas repealed its sales tax exemption for R&D equipment.  

Q2: What items qualify for tax exemption? 

Raw materials sold to qualifying manufacturers with a valid exemption certificate are non-taxable in most states, as is machinery and equipment. After that, the answers diverge sharply as to whether the exemption extends to items such as tools, repair and replacement parts, consumables, software, energy, and the like. For example, Nevada limits its manufacturing exemption to raw materials only while New Mexico covers ingredients, component parts, and consumables.  

Q3: Does facility type affect use tax treatment? 

States often enact manufacturing exemptions as economic development incentives, as a means of attracting new or expanding businesses to their jurisdiction. This could mean that the exemption may apply only to new facilities, expanding facilities, or the first installation of equipment in an existing plant. Existing facilities or a simple replacement of a piece of machinery may not qualify. Kentucky’s exemption language, for instance, conditions the exemption on machinery being “incorporated for the first time” or installed in replacement of an existing piece of machinery having a lesser productive capacity.  

Q4: How much qualifying use is enough?  

Must an item be used entirely in the qualifying manufacturing activity for the exemption to apply? Take for example a forklift that’s used to move materials within the production line but is also used to transport finished goods to a warehouse. Can the forklift be purchased tax free?  

Again, the answer varies state by state. For example, Massachusetts requires that the item be used directly and exclusively in manufacturing. Wisconsin requires that it need only be used “directly.” Mississippi accepts “exclusively or predominantly” (at least 50%). And in 15 states, you can still claim an exemption even if qualifying use falls below the 50% mark.  

Q5: Does useful life matter? 

It often can, especially for machinery and equipment but sometimes also for any related replacement parts. Florida limits its exemption to items with a useful life of three years or more. California ties it to whether the item is being depreciated or capitalized for franchise tax purposes. Louisiana asks whether it’s depreciable under the Internal Revenue Code.  

The Thorny Question of Software 

Some states include software that is to be used as part of the manufacturing process within the scope of their exemption. If the software is offered as a service (SaaS), it’s also important to know that several states have not (yet) expanded their sales tax base to include SaaS and still others have opted to limit their taxation of SaaS to business to consumer transactions. This places savvy manufacturers in a spot where considerable tax savings may be possible.  

The key, of course, is to know the rules. By allocating software costs across all the places where the software will be used and by leveraging “multiple points of use” exemptions when available, a substantial tax bill can be materially reduced. This strategy is not without risk. Manufacturers must know where multiple points of use exemptions are available and should an auditor ask, stand ready to prove that their allocation method is reasonable and appropriate.  

Macroeconomic Factors Add to Complexity 

The world is conspiring to make the tax landscape for manufacturers even more difficult. Building a new micro factory may make complete sense from a business perspective but if placed in a new jurisdiction, it requires the manufacturer to understand a brand-new set of rates, rules and requirements. The same is true when a manufacturer opts to re-shore activity in response to tariff pressure.  

Likewise, should manufacturers opt to diversify their supplier network as a means of mitigating the risk of global events affecting their production, they must be sure these new vendors understand the scope of exemptions to which they are entitled.  

How Technology Helps Reduce Manufacturing Use Tax Risk 

None of this is a reason to believe that compliance is simply impossible. It may be, however, a reason to revisit a decision that placed use tax compliance “out of scope” of an earlier ERP transformation or tax automation adoption exercise. 

Technology exists today to run batch-based validations across millions of AP transactions and model audit exposure before the state does it for you. Even better, they mitigate the need for expensive “reverse audits” by finding overpayments in near-real time rather than months or years after the fact. The ROI tends to be fast, and the savings/risk reduction meaningful. The only real question is how long you’re comfortable not knowing what you don’t know. 

Managing manufacturing use tax exposure requires more than manual processes and periodic reviews. Explore our tax compliance solutions for manufacturers to see how Sovos can help simplify compliance, improve exemption accuracy and proactively identify audit risk.