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I'm considering setting up a sole proprietorship to sell kits (electronics and crafting) that I design. It's my understanding that, in most cases, I would be able to get a exemption certificate that would allow me to buy materials wholesale (without sales tax) and that I would be responsible for collecting sales tax on the kits I sell.

My question is about sales tax on the materials I consume to produce prototypes that won't be sold. Suppose I have a quantity of small motors on hand for kits that require them. If I want to use the same kind of motor in a new kit I'm designing, can I dip into my wholesale stock for use in the prototype or do I have to purchase another motor at retail (paying sales tax)? Perhaps a third option is to sell the motor to myself in order to recognize the sales tax.

I'm in California, USA.

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It may vary from state to state, but my understanding from Minnesota sales tax classes I've attended and a sales tax audit of a client: you would pay the sales tax on the the materials used for prototypes yourself. You can still buy that material wholesale, but since there is no sale to an end customer, you need to pay the sales tax yourself.

I'm suggesting to still buy it wholesale for simplicity, buying everything that way just keeps things consistent. But if you need to buy a specific thing for a prototype that you wouldn't normally otherwise buy, that would make sense to buy retail. But by definition, your prototypes would likely all be built from your regular inventory.

Your sales tax department for the state of California would love to answer any questions, and they probably have classes too - including for new business owners. That's your best bet.

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