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Illinois Sales Tax Exemptions on Farm Equipment

tractor in open field

Most states have broad sales tax exemptions for the purchase of machinery and equipment used in manufacturing or farming. Both industries are critical to state economies because they create numerous jobs. Unfortunately, the state revenue agencies aggressively fight such exemptions and make it incredibly difficult for manufacturing and farming businesses to take advantage of them. A recent decision out of Illinois is a recent example of a farming taxpayer being forced to fight for a sales tax exemption that was enacted to benefit his industry and encourage the equipment purchase at issue.

As with most states, Illinois imposes a sales tax on the sale of tangible personal property, like machinery and equipment. Also, like most states, Illinois provides a sales tax exemption for purchases of farming equipment that is “used primarily for production agriculture or State or Federal agricultural programs.” “Production agriculture” is broadly defined to include the raising of livestock, crops for sale, crops for livestock, and several other types of farming activities. At first glance, it appears that the legislature attempted to create a relatively broad exemption to incentivize farmers to remain in Illinois, grow their operations and create jobs.

One of the major reasons that sales tax exemptions exist in farming is the critical nature of the industry to Illinois. In fact, Illinois is one of the top 6 states in the country for cash crop receipts and accounts for nearly 5% of the total agricultural receipts of the entire United States. Illinois’ 72,000 farms generate more than $19 billion annually and employs about 1 million people. Due to their significant impact on the economy, it makes sense to give farmers sales tax incentives to remain in Illinois.

Unfortunately, just as the legislature gives the exemption, the state revenue agencies begin to chip away and make it more and more difficult to qualify for them. For example, the Illinois Department of Revenue enacted a rule limiting the otherwise broad exemption by stating “activities such as clearing of land, mowing of fence rows, and creation of ponds and drainage facilities are not included.” Clearly, the department of revenue does not want too many taxpayers to qualify for the favorable exemption, because it might actually encourage farms to grow, create jobs, and create more products for sale, both within and outside of the Illinois.

Highlighting the ILDOR’s distain for this exemption is a case in which a farmer purchased an excavator without paying Illinois sales tax per the exemption. The taxpayer stated that the excavator remains solely on the farm and is used only when the soil is tilled for planting, during planting time and during harvest. Some of the activities for which the excavator is used includes reshaping fields, filling in ditches, clearing ditches, and clearing beaver blockages. While this seems in line with what farmers do, the sales tax exemption was denied during an Illinois sales and use tax audit because the excavator was used for drainage. The denial was supported with the argument that “including items for the creation and maintenance of drainage would dramatically expand the exemption.”

Following the audit, the case made its way to Illinois’ administrative court / tax court, which is called the Illinois Office of Administrative Hearings. During the hearing, each side made its respective arguments as explained above. Ultimately the administrative law judge (ALJ) agreed with the Illinois Department of Revenue because the excavator was used to maintain drainage which is essentially the same as creating draining ditches. The ALJ also disagreed with the Taxpayer because he did “not use the excavator in tilling the soil, planting, irrigating, or cultivating.” The somewhat obvious fact that you can’t grow crops on improperly drained land was missed, or it was simply ignored in favor of creating a revenue-generating loophole for the state.

This case is yet another example of the Legislature trying to encourage certain activities within its state and the Department making it difficult, frustrating, and expensive to take advantage of it. As the farmer put it, “a person does not flippantly spend $XXXXXX on equipment if it is not necessary for his or her farming operations.” Conversely, these farming and manufacturing sales tax exemptions might serve their purpose of promoting businesses and growth in the state if the agencies granted reasonable claims made under them. Until then, taxpayers are faced with just paying the tax or having a battle on their hands if they chose to fight their case.

More broadly, farming equipment, like excavators should not be subject to sales and use tax. The purpose of a sales and use tax is to tax consumption or business outputs. As such, the final good or service sold by a producer to a consumer is the proper transaction to tax. Included in that ultimate transaction is all of the costs associated with getting that product to market, such as excavators used to create the framing product in this case. It is commendable that the taxpayer aptly fought for an exemption to which he was seemingly entitled to, despite the ultimate outcome.

Given the anti-business climate within the Illinois Department of Revenue, what can be done if you are placed in a similar position when purchasing potentially exempt equipment for your business? You could do what the taxpayer did in the case above and not pay tax, which may result in fighting the issue on audit. Another alternative is to pay the sales tax and seek a refund. You could also seek a ruling from the state either before or after the purchase of the equipment.

Following the agency’s decision of the ALJ’s recommendation, the taxpayer could also continue to fight this issue by appealing to judicial court. Generally, an appeal is due within 35 days of the final agency decision. It will be interesting to see if this taxpayer goes for judicial review and if so, whether the outcome is different. If the courts do not keep the agencies in check, hopefully, the Legislature will act and broaden the scope of such important industry exemptions. Until then, it is critical for taxpayers and their representatives to continue to fight aggressive and unreasonable state agencies.

Our team has handled hundreds of administrative and judicial court cases and can help your company receive the resolution it is entitled to. Contact us to schedule a free 30-minute consultation. Whether you hire our firm or not, we offer a thorough and honest evaluation for free so you can decide how to proceed with knowledge and confidence.

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