If a buyer doesn’t have an exemption certificate, who’s on the hook for sales tax?

This blog has been revised. It was originally published October 24, 2022.

Key takeaways

• Exempt sales present unique challenges for manufacturers because exemptions can apply to goods that are incorporated into taxable items or used in the manufacturing process.

• Because exempt sales require documentation, manufacturers often find themselves forced to manage exemption certificates for vendors in multiple states — which means having to navigate different rules and regulations.

• Missing exemption certificates is one of the top reasons businesses are fined during sales tax audits.

In the manufacturing industry, the tools and technology required to get the job done need to be in good shape. A flaw in an otherwise well-oiled machine (figuratively or literally) can be expensive, time-consuming, and headache-inducing. The same is true with sales tax; a kink in your tax compliance, such as inefficient manual processes, can cost you time and money (and yes, cause headaches).

For many manufacturers, exempt sales create that kink in compliance.  

A sale is exempt when the business making the purchase is exempt from paying sales tax. A sale can be exempt (or partially exempt) for a number of reasons: 

• Sometimes the purchaser is exempt (often the case with government agencies).
• Sometimes goods are purchased by retailers to resell.
• Sometimes purchases and sales are exempt because the goods will be incorporated into, or used to manufacture, a taxable product

The state isn’t going to take your word for it when you make an exempt sale, though. These sales require documentation — and if you don’t correctly collect and maintain exemption certificates, you’re at risk of owing taxes and facing costly penalties. 

You also need to provide the right certificates to vendors for exempt purchases you make, to avoid overpaying tax and prevent other issues.

Because exemptions can apply to goods used in the manufacturing process or goods incorporated into a taxable item, exemption certificate management is particularly complex for manufacturers. And if your company buys from or sells to numerous vendors in multiple states, compliance gets even more complex — tax laws vary by state, and so do the certificates you need to track.  

Take it from Colleen Bremer, Head of Customer Service and Logistics for Limbs & Things, a company that designs and manufactures medical training models. When the company expanded into more states, it needed a more efficient system for managing exemption certificates. “We had physical records that we’d go and check for expiration dates — it was very rudimentary, and we really could not continue to apply this practice as we grew,” she said. “Once you go into Texas and California, you’re talking hundreds of customers.” 

Sales tax is an important source of revenue; in most states, it’s second only to personal income tax collections. And when states want to boost revenue, often during recessions or in times of rising prices, one key tactic is conducting audits. That’s why missing, expired, or invalid exemption certificates — errors often resulting from trying to manage exemptions manually — frequently cause sales tax audit trouble for businesses.

Manufacturers might even be at higher risk for audits: In a 2021 survey conducted by Avalara and Potentiate, manufacturing companies claimed the highest audit rate (18%). One of the top reasons companies are hit with fines during an audit is missing exemption certificates.

Some other common mistakes auditors find (and fine) regarding exemption certificate management include:  

• Certificates missing a signature or that don’t include the signature of the accepted signer
• Certificates missing an issue date
• Certificates that list an incorrect claim type or that aren’t accepted
• Documents (letters, emails) that aren’t recognized by state tax authorities
• Certificates including a name or address other than the direct buyer and seller
• Certificates with an incorrect state ID
• Tax-exempt purchases with improper application of use tax

It’s always risky for a business to make an exempt sale without a valid exemption certificate on file. Businesses can cite many reasons for not charging tax, but from an auditor’s perspective, they’re still on the hook if they don’t have the right documentation. 

Audit risk isn’t the only way missing or invalid certificates can gum up the works— certificate mismanagement can also cause sales delays, credit/rebills, and other issues for manufacturing businesses.

Since the pandemic, many manufacturers have diversified their vendor lists to curb the effects of supply chain issues. This means you might have a whole slew of new relationships to manage — and new tax information to collect from each company. So how did the team at Limbs & Things manage this complexity? They chose an automated solution that supported growth. “When we needed to increase our registrations … Avalara took a very, very daunting task and made it achievable,” Bremer said. 

If you’re managing compliance without automation, you’re likely making an already complex task even more challenging. Avalara Exemption Certificate Management helps you collect exemption certificates as part of the transaction process, automate document validation, and apply tax exemptions on future sales. It helps you stay ahead of compliance by tracking certificate expirations and proactively requesting new certificates.

Plus, you can easily manage and automate your tax-exempt purchases with Avalara Vendor Exemption Management, adding control to your procurement process and reducing use tax liability.

It’s all part of the purpose-built manufacturing solution from Avalara, which uses AI to power tax compliance and solve common tax challenges across the supply chain. If invalid, expired, or missing exemption certificates are putting your business at risk (or you want to get a handle on them before they do), get in touch to learn more.

If you make exempt sales, yes. But you need to do more than that — you need to ensure certificates are completed correctly so they’re valid, and you should also keep them organized and easily accessible in case of an audit.

Errors are the biggest risk: Missing or invalid exemption certificates are a top reason companies are fined during sales tax audits. Additionally, trying to manage it all manually typically takes more time and effort than relying on an automated solution.

Missing certificates entirely are perhaps the biggest error, but having a certificate that turns out to be invalid can be quite an unpleasant surprise. That can happen due to missing signatures, incorrect names or addresses, the lack of an issue date, and other common issues.

Avalara has a purpose-built solution for manufacturers that allows you to simplify tax compliance at every step — including exemption management with automated document collection, expiration tracking, and more.