Kirk Low, CPA, Christopher A. Wilson, CPA. Tennessee CPA Journal. March/April 2012.
Diabetes is generally recognized as one of the most costly chronic illnesses in the United States. The American Diabetes Association estimates that medical costs associated with diabetes in Tennessee alone approached $2 billion during 2006. Diabetic patients on average incur nearly two and a half times the annual medical expenses of a person without diabetes, and the daily costs of supplies to monitor and regulate blood glucose levels, as well as to treat the overall effects of diabetes on the body, constitute a significant concern for many diabetics. While the Tennessee sales and use tax exemptions for insulin, insulin pumps, needles and syringes are beneficial in reducing the cost of diabetes, patients nonetheless face increased daily costs, because many items required to live with diabetes are not exempted from sales and use tax.
Tennessee’s application of sales tax on diabetes-related supplies imposes a substantial economic burden on many diabetics in Tennessee, and exempting savings. In a January 2010 article in the Diabetes Forecast, a magazine published by the American Diabetes Association, the author estimated that test strip costs ranged from $104 to $1,820 per year depending on the amount of testing by the patient. Applying the mid-range of Tennessee’s sales tax rates – 9.5 percent – the tax on the test strips would average between $9.88 and $172.90 per year per patient.
Fiscal notes prepared by the Tennessee Legislature also state that exempting test strips from sales tax in Tennessee would result in nearly $3.5 million in annual savings to diabetics. As introduced during the 2010 session of the Tennessee General Assembly, House Bill 2771 proposed to exempt only diabetic test strips, while House Bill 2901 proposed to exempt both test strips and testing equipment. Although neither Bill became law, each the decrease in revenue that would result if such a Bill were enacted as law. The exemption of test strips in House Bill 2771 was nearly a $3.5 million decrease in state and local option sales tax revenue. In regard to House Bill 2901, because the Tennessee Department of Revenue could not determine the total industry sales for all diabetic testing equipment and supplies, the fiscal impact was estimated as exceeding the nearly $3.5 million state and local tax decrease listed for House Bill 2771.
As noted by representatives at the Tennessee Department of Revenue, both sales tax exemption applied to test strips used by prescription in hospital settings. Applying this erroneous assumption, the test strips sold in Tennessee were used by prescription in hospital settings and were therefore exempt. This error likely resulted in a significant reduction in stated fiscal impact of House Bills 2771 and 2901. While Department of Revenue representatives agreed that test strips sold to tax-exempt hospitals for use by such hospitals were exempt from sales and use tax, such representatives opined that no sales tax exemption applied to patient users. The percentage of test strips sold for use by tax-exempt hospitals is recalculated to remove the presumption that 40 percent of test strips sold in Tennessee were exempt, a tax decrease of as much as $5.8 million could result by exempting test strips.
During the 2011 session, House Bills 564 and 1052 were introduced along with companion Senate bills to exempt test strips. The fiscal notes on both sets of bills were identical at a combined state and local revenue loss of nearly $6 million. All of the bills failed to make it out of committee.
Although none of the bills were enacted during the 2010 and 2011 sessions, the Legislature’s adoption of Streamlined Sales Tax Project definitions in the tax code may nonetheless exempt test strips from sales and use tax. Tennessee currently exempts from sales and use tax the sale of drugs dispensed for human use pursuant to a prescription. In 2008, the Legislature adopted the Streamlined Sales Tax Project definition of the term “drug”, which Tenn. Code Ann 67-6-102(35) now defines as a compound, substance or preparation and any component of a compound, substance or preparation, other than food and food ingredients, dietary supplements or alcoholic beverages:
(A) Recognized in the official Pharmacopoeia of the United States, official Homeopathic Pharmacopoeia of the United States, or official National Formulary and supplement to any of them;
(B) Intended for use in the diagnosis, cure, mitigation, treatment or prevention of disease; or
(C) Intended to affect the structure or any function of the body
When purchased by an individual pursuant to a prescription, test strips should constitute an exempt drug for purposes of Tennessee sales and use tax. Specifically, the generally recognized design of diabetic test strips consists of a plastic test strip with a small spot impregnated with glucose oxidase, or some other substance, which undergoes a chemical change when mixed with glucose in a blood sample collected within the strip. Accordingly, a test strip constitutes a drug because it (1) contains a “compound, substance, or preparation, other than food and food ingredients, dietary supplements, or alcoholic beverages” and (2) in regard to diabetics, is obviously “intended for use in the diagnosis … treatment, or prevention of disease.”
Although, as set forth above, test strips should constitute exempt drugs when sold pursuant to a prescription, the Tennessee Department of Revenue has thus far declined to recognize any exemption for test strips. Specifically, after the adoption of the Streamlined Sales Tax definitions, a Tennessee company asked the Department of Revenue if diabetic meters, lancets, lancet devices, diabetic strips and control solution were exempt when “[a]ll of the Taxpayer’s customers are patients with a prescription for the equipment and supplies rented and sold.” In Tennessee Letter Ruling No. 08-15, dated Feb. 27, 2008, the Department stated the following: Lancets, lancet devices, diabetic strips and control solution, are not included in any statutory exemption; therefore, they are taxable for purposes of the sales and use tax. Diabetic meters, or blood glucose meters, are durable medical equipment as defined by Tenn. Code Ann 67-6-102(29); however, a diabetic meter does not qualify for the exemption because it is required by Tenn. Code Ann. § 67-6-314(2) (Supp. 2007). Rather, a blood glucose meter is intended for use everywhere and is meant to be taken with the patient and used in any place the patient goes.
Parties seeking to change the Department of Revenue’s position regarding the application of sales and use tax to test strips have the option of proceeding legislatively or judicially. As recently proposed in the 2011 session of the Tennessee General Assembly, House Bill 564 also seeks to exempt the sale of diabetic test strips, lancets and diabetic urine test strips from sales and use tax. However, successfully lobbying to enact such legislative changes to the current taxation of diabetic supplies will likely be difficult given Tennessee’s current budget constraints as legislation with large negative fiscal impacts are unlikely to gain support. In order to proceed judicially, a retailer would need to either challenge an audit assessment of sales tax on test strip sales or request a refund of sales tax previously collected and remitted to the Department on such sales. However, in instances where the retailer collected sales tax from customers, the tax code requires that the retailer challenging the tax issue tax refunds or credits to purchasers. Thus, a successful challenge through the courts would produce no economic advantage to the retailer. Furthermore, a retailer of test strips who chooses to litigate this issue would also not gain a competitive advantage since all retailers would be exempt if the courts ruled favorably.