Although managing sales tax exemption certificates may seem like a simple process, anything associated with sales tax proves otherwise. Often times, companies do not spend the proper amount of time documenting and storing certificates. The importance of these tasks is only realized when a company is audited and missing or invalid certificates come to light. While each state has its own complicated set of rules on filling out and accepting exemption certificates, most companies do not realize there are numerous low-cost ways to reduce their risk.
Why Should Sellers Collect Exemption Certificates?
The sale of tangible personal property (TPP) is taxable in most states unless specifically exempt, while most services are exempt unless specifically taxable. However, there are many state rules that make specific services and TPP exempt from sales tax. Certain sales tax exemptions require a certificate to be filled out by the buyer and given to the seller for their records. When a seller fails to collect exemption certificates and does not charge sales tax both the seller and buyer can be liable.
What Are the Consequences of Not Collecting Exemption Certificates?
The consequences of a poor exemption certificate process are not fully understood until a company goes through a sales tax audit. During a state sales tax audit, the company and the state agree to a sample period in order to test if sales tax was properly calculated on the revenue of the company. The sample period can be one month, quarter, or year. The state will request all the sales support for that period, including sales tax exemption certificates. If a company is missing an exemption certificate or the certificate they have s invalid or expired, this will create an exception. The final step is these exceptions are then extrapolated across the entire audit period. We have defended companies where several missing or invalid exemption certificates have resulted in over $50,000 in sales tax due. Sales tax is also a liability that cannot be protected by the ‘corporate veil’ and will result in officer or owner liability.
What Exemption Certificate Should Sellers Collect?
There are hundreds of exemption certificates across 50 states. Knowing which one to collect can be confusing and costly. In general, exemption certificates can fall into three categories:
- The entity purchasing the item or service is a sales tax-exempt entity in their state
- The purchaser will use the item or service in an exempt way (e.g., resell the item)
- The buyer has a specific agreement with the state to be responsible for the sales tax remittance, such as a direct pay permit
Most states place the standard of “accepted in good faith” on the seller. This standard allows a seller to accept a certificate without verifying the information on the certificate. However, from our experience there are exceptions to this rule. For example, a contractor in New York is typically not allowed to purchase materials used in a construction job as a sale for resale. Therefore, he could not issue the New York resale certificate, ST-120. Contractors are only allowed to issue form ST-120.1 when purchasing materials used in a construction project and this form has very specific use case scenarios. In this case both the seller and buyer may be held liable for the sales tax.
Each state has exemption certificates to address the various ways a transaction can be exempt. The certificate should be issued at the time of the transaction before the invoice is sent. States have time limits on when an exemption certificate is valid for a transaction. Issuing a certificate for transactions from years passed is typically not accepted by states.
How Do Sellers Collect Exemption Certificates for Multiple States?
Although there are certain exceptions, a seller must receive exemption certificates from each state they are applying the exemptions to. If a buyer has multiple manufacturing locations, the seller must receive an exemption certificate for each state. Two more common exceptions to these rules apply to drop-shipments and resale exemptions.
Regarding multi-state resale exemptions, sellers can accept the MTC Multijurisidictional Uniform Sales and Use Tax Exemption/Resale Certificate (MTC Certificate). This certificate allows sellers to list multiple states instead of providing a certificate for each state in which they are claiming a resale exemption. Thirty-seven states are covered under the MTC Certificate, making it easier for sellers to manage their client’s certificate requirements. However, there are certain rules when using this certificate as the 37 states listed have their own guidelines on how a form is deemed valid. The seller must also receive separate exemption certificates for the nine states that do not participate in this program.
What is The Difference Between Verify and Validate?
In this guide, we have used two similar terms that we would like to clarify further. Once an exemption certificate is received as a general rule the seller is not required to verify the information, but they are quired to validate the certificate. Verification refers to the information on the certificate such as the tax id number, address, descriptions, or who signed the certificate. In general, the seller can accept a certificate in good faith. However, the seller is required to validate the certificate. Validation refers to the completeness of the certificate based on state-specific guidelines. Here are several steps a company should take to validate a certificate:
- All information on the certificate is completed
- The form is dated and signed
- The name of the buyer matches your customer name
If a seller accepts an unsigned and undated certificate, the liability for the sales tax will likely be on the seller. For example, Texas outlines a “good faith” standard where a seller is not liable for sales tax if:
- the exemption certificate is accepted at or before the time of transaction;
- the exemption certificate is properly completed and legible:
- name and address of the purchaser
- description of the item to be purchased
- the reason the purchase is exempt
- signature of purchaser and date; and
- name and address of the seller
- the seller does not know nor does have reason to know that the sale is not exempt. The seller has a responsibility to know how sales tax applies to their services in Texas.
Source: Texas Administrative Code
Do Exemption Certificates Expire?
Some exemption certificates expire, and some do not. Each state has its own rules on the renewal period of exemption certificates. Also, some certificates are single-use, meaning they can only be used to exempt specific transactions within a limited time frame. For example, Kentucky recommends sellers update certificates on file every four years from the date of issuance. Another state, such as Connecticut, mentions certificates are valid for three years from the issue date. Other states issue exemption certificates to tax-exempt organizations with an expiration date listed. Connecticut typically reissues certificates to organizations that qualify as sales tax exempt every five years. It is expected of sellers to keep track of these expirations and request updated certificates from their buyers. Another example is New York. New York’s blanket certificates do not expire, and sellers are not required to pursue updated certificates.
How Should I Store My Exemption Certificates?
Convert to a software solution. There are some platforms out there that help businesses organize their exemption certificates by storing them online, keeping track of the expiration dates, and seeing which customers have them. In addition, these solutions often allow a simplified validation and streamlined certificate retrieval process from customers. When exemption certificates are kept in boxes, file cabinets, or digitalized in a desktop folder they become easily disorganized as the certificates become numerous. This causes businesses to forget which customers gave certificates, when those certificates were given and when those certificates will expire.
At PMBA, we understand no two businesses are the same. We offer our clients the best-fit services based on their needs and we are ready to assist in implementing solutions. Whether a large multi-national corporation managing thousands of certificates across 45+ states or a small business with exposure in only a handful of states and a few hundred certificates. PMBA will accurately and efficiently handle all aspects of managing all tax exemption certificate needs. If you have questions regarding exemption certificates or if your sales are exempt from tax please contact us at firstname.lastname@example.org.