How to improve (and simplify) exemption certificate management for manufacturers
To draw and retain manufacturers, many states provide sales and use tax exemptions for equipment, machinery, and other items used in manufacturing. As these exemptions are often fundamental to a manufacturer’s bottom line, properly managing them is essential. Unfortunately, correctly documenting exemptions can be challenging, particularly when multiple states and/or industries are in play.
Why getting exemption certificates right is so important for manufacturers
Exemption certificates prove that non-taxed sales are valid. Without them, states could assume the sales are taxable and hold a manufacturer liable for the uncollected tax — when in doubt, states generally err on the side of taxing. As Michael J. Fleming of Peisner Johnson & Company notes, “Missing or defective exemption certificates are one of the leading causes of inflated sales tax audit assessments.”
It’s important to note that exemption certificates must be correct to be valid, and getting exemption certificates right typically involves multiple departments (e.g., credit managers, IT departments, and tax analysts), oversight, and vigilance. In addition, sales and use tax laws are subject to change at any time; it’s incumbent on each business to stay on top of exactly which equipment, machinery, products, and uses are exempt, and which are taxable.
Top three challenges of exemption certificate management
There are many hurdles to successfully overseeing sales and use tax exemptions, but the top three involve nexus, drop shipments, and certificate management.
- Nexus. In recent years, it has become increasingly challenging for companies to know where they have nexus (an obligation to collect and remit tax). Hungry for sales and use tax revenue, states are broadening their nexus laws beyond the physical presence rule that has long been the standard. Nexus can now be established by frequent and deliberate solicitation, or even installing software (“apps”) and ancillary data (“cookies”), as in Massachusetts and soon in Connecticut.
- Drop shipments. Drop shipping enables retailers to sell products they don’t keep in stock. Instead, they have a third party ship the items directly to the customer. While this has obvious benefits, it can be a sales tax trap. One reason is that exemptions vary from state to state, and drop shipping relationships typically involve more than one state. Another is knowing which forms to use to document the transaction: While both exemption and resale certificates can validate an exempt transaction, relying on an exemption certificate to validate an exempt resale can lead to a negative audit finding.
- Certificate storage and management. Storing and managing sales and use tax exemption and resale certificates can be one of the most challenging and error-prone aspects of compliance. This is especially true for the many companies that rely on paper exemption and resale certificates, and have cabinets (or rooms) full of the things. It’s easy to misfile a piece of paper. Paper certificates become outdated far too frequently, and regrettably, there’s no master list of exemption certificate expiration dates. While in some states, some forms may not ever expire, other states require annual renewal of resale exemption certificates. And in others, the expiration period varies depending on the type of certificate. The final twist: Renewal policies are subject to change at any time. In other words, you may collect an exemption certificate when it has no expiration, only to be found noncompliant during a later audit because the state changed its law and the exemption certificate had expired.
Manufacturers can improve exemption and resale certificate management by refining the way certificates are solicited and captured, validated and tracked, and stored and systemized. Successful strategies include ensuring all required signatures are obtained from the outset, noting and recording expiration dates, staying on top of changes in taxability and nexus laws, and performing a regular inventory of certificates.
Automate. Automating exemption certificate management is the most effective way to improve overall certificate compliance and reduce audit risk. It eliminates errors that result from manual practices, such as misfiling. Furthermore, an automated solution is generally more secure than in-house systems.
Avalara Compliance Document Management keeps certificates accurate and up to date. The system tracks expirations and renewals, and automatically updates to reflect new tax laws and regulations. It also maintains a secure digital library of documents, facilitating analysis and reporting. Certificates are stored in the cloud and are readily accessible, making audits (should they occur) less of a hassle.
Learn more about improving exemption certificate management in The Ultimate Guide to Exemption Certificates for Sales Tax Compliance.
The 2021 sales tax changes report: midyear update
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