Understanding Exemption Certificates
Say your company manufactures parts needed for the Boy Scouts’ Pinewood Derby and you sell a bunch of these parts to your local Boy Scouts chapter. You include sales tax in the invoice, and they respond with, “Hey, Boy Scouts don’t ay sales tax!” Can you just remove the sales tax and continue the transaction? No. You have to make sure you have the right exemption certificates on file.
Exemption certificates are documents issued to a purchaser that show the sale is exempt from sales tax. Certificates are typically issued by a state agency, such as a state’s Department of Revenue, though the issuing agency varies from state to state.
Exemption certificates can exempt all of a buyer’s purchases from sales tax or only exempt certain types of purchases, depending on how the sales tax laws apply and what the state agency determines during the application process.
You must accept the exemption certificate in good faith but use due diligence when accepting certificates to ensure their authenticity and validity. Your business can be held liable for uncollected sales tax if due diligence is not done.
You have the right to refuse to accept an exemption certificate, even if it is correct and properly completed. However, if you refuse a certificate, you must charge the purchaser sales tax.
In most cases, you are obligated to keep the exemption certificate for at least three years from the due date of the sales tax return on which the last sale using the exemption certificate was reported. Failure to save exemption certificate documents can result in fines if you are audited. Be sure to check the statutes in any states where your business has nexus to ensure exemption certificates are on file for the period required.
Exemption Certificates And Audits
Due to the complicated and easily misunderstood nature of exemption certificates, auditing these certificates is one of the most common types of tax audits. In the event of an audit, it is not the responsibility of the company or person you sold to to produce these certificates. Rather, it is the responsibility of your company to retain, organize, and produce exemption certificates when asked.
Auditors will often use a sampling technique. Instead of looking through all of your company’s exemption certificates, auditors look at a smaller sample size to create an average number of missing certificates. Missing just one exemption certificate could result in thousands of dollars of taxes owed because of sampling. It is important to make sure your exemption certificates are appropriately labeled and stored in an easily accessed location to avoid this pitfall.
It’s easiest to manage exemption certificates when organizing them by company, both in physical and digital storage. Make it part of your sales tax filing routine to check that all exemption certificates are available and valid.
It is also a good idea to include a digital copy of an exemption certificate in your digital storage. Physical copies can be easily misplaced, destroyed, or lost. Digital copies and good organization can significantly reduce the time and cost an audit can incur.
Problems can arise during an audit if certificates are either missing or deemed to be invalid. The most common reason certificates are deemed invalid:
- Incorrect Form
- Missing Seller Name
- Not Signed
- Incorrect Seller Name
- Not Dated
- Missing Buyer Name
- Incorrect Buyer Name
- Missing Reason for Purchase
- Missing Description of Business
- Incorrect number of digits in permit
Sales Tax Tip: Put a Company Policy in place that exemption certificates must be provided at the point of invoicing and create a checklist that looks for common errors that invalidate a certificate. Agree that the checklist must be completed before accepting a certificate.
When Exemption Certification Is Needed
Exemption certification procedures differ between states and must be assessed on an individual basis. The examples provided may or may not apply to your state and should be regarded only as educational tools. Check with a sales tax expert for advice for your specific situation.
Sales tax exemption certificates are needed to verify that the taxable purchase of items and services are tax-free under certain circumstances. In most states, a properly completed certificate must be obtained within 90 days of the time the sale is made, but preferably at the time of the sale.
Certain sales are always exempt from tax. This means a purchaser does not need an exemption certificate to make purchases of these items or services. However, you should never simply assume that it is the case. For instance, if your company intends to use the product, you cannot use a resale exemption certificate and use tax must be paid.
Who May Use Exemption Certificates?
In some cases, customers may use exemption certificates if they
- Intend to resell the product or service
- Intend to use the product or service for a purpose that is exempt from sales tax
- Make purchases as an agent or employee of tax-exempt nonprofit organizations or government entities
Always remember that while your customers might state that they do not need to pay sales tax for any of the above reasons, without a valid exemption certificate you should collect sales tax in most cases.
Some states do not issue exemption certificates for certain kinds of businesses. If a customer says they are exempt because of a special status, be sure to collect documentation that outlines their status and keep it on file as you would a certificate in case of an audit.
Exemption Certificate Checklist
Sales tax exemption certificates are part of your responsibilities. You are responsible for making sure you are accepting complete, appropriate, and up-to-date certificates. Neglecting to properly document and organize exemptions can result in tax audits and have negative effects on the business relationships.
The exemption certificate must include all the following to be considered valid in most states:
- Date the certificate was prepared
- Purchaser’s name and address
- Seller’s name and address
- Identification number on the purchaser’s Certificate of Authority (in some cases)
- Purchaser’s signature, or an authorized representative’s signature
- Any other information required by state law
Exemption certificates do not have to be overwhelming. If you keep your sales organized and well documented the likelihood of audits can be decreased. A well organized and maintained filing system can also reduce the time and cost of an audit if one does happen.
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