When do you need to collect a sales tax exemption certificate?
Sales tax, use tax, transaction privilege tax … whatever your state calls it, it’s been a hot topic since the Supreme Court of the United States overruled the physical presence precedent with its decision in South Dakota v. Wayfair, Inc. in June of 2018. And now that states can tax out-of-state sales, your business may have new sales tax collection obligations.
In the year since the decision, more than 40 states have enacted remote sales tax laws that base a sales tax collection obligation solely on economic activity (economic nexus). If your company sells taxable products into one of these states and you do enough business to establish economic nexus, you’re required to register with the tax authority, collect and remit sales tax, and file returns.
You’re also responsible for validating exempt sales.
Some entities are permitted to not pay tax on their purchases of taxable goods: certain government agencies, buyers purchasing goods to resell, and manufacturers who will incorporate your widgets and whatnots into larger merchandise items. If you sell directly to such businesses, you need to collect a valid exemption or resale certificate from them.
It’s not the most exciting job, but it’s an essential part of doing business in states where you have an obligation to collect sales tax (nexus).
When do I have to collect an exemption certificate?
If you have nexus with a state resulting from physical presence or a remote sales tax law, you’re required to collect an exemption certificate whenever you don’t charge a customer sales tax on a taxable transaction. No exceptions.
Without a record of why the sale went untaxed, your company could be held liable for the unpaid tax.
The exact information needed to verify an exempt transaction varies by jurisdiction and the type of transaction. Yet no matter what the form looks like, you’re required to obtain a certificate when:
- A new tax-exempt customer buys from you for the first time
- A certificate you have on file for an existing customer is invalid or about to expire
Be sure to check that certificates are properly completed when you collect them, especially when the form is lengthy or has numerous fields. If it’s a hassle to collect a certificate in the first place, it’s even more of a pain to go back to a customer for additional information.
When should I ask for a certificate?
There never seems to be a great time to ask for a certificate from a customer; it’s busywork to them because they’re not the ones on the hook for the tax. That said, the best time to collect an exemption or resale certificate is at the point of sale.
It’s tempting to wait — it can sometimes feel like you’re asking for a background check on a first date. However, it’s too easy for you and/or your customer to forget to follow through. And if you don’t have an exemption certificate on file to validate each exempt transaction, you put yourself at risk.
In fact, there’s no good reason not to collect exemption certificates immediately if you’re a retailer. Consumers are used to filling out forms today. If you provide an easy online option that allows quick access to the right documents, they may even thank you.
What’s wrong with waiting?
The longer you wait, the greater your risk of running into trouble: You could end up with incomplete and/or missing exemption certificates come your next audit.
Many states offer sellers a grace period, so you may have up to 90 days to collect a certificate after a sale. But a lot can happen in three months. Your customer could go out of business or change names or locations. More likely, you’ll simply forget to go back and collect a certificate to validate a transaction that took place weeks or months ago.
Don’t wait for an audit to get your exemption certificates in order. State tax departments want to see evidence that your customers had a valid reason to not pay tax on a taxable transaction at the time of purchase, not months or years after the fact.
Are there exceptions?
Not really. However, some flexibility is allowed.
If a customer claims an exemption, promises to send the correct documentation, and doesn’t, you may feel hesitant to push for it. Yet there are ways to encourage customers to send in an exemption certificate while remaining customer friendly. You can give customers 30 days to send in the properly completed form, letting them know you’ll have to apply tax to their next purchase if you don’t have an exemption certificate in hand.
Customers should understand, and they’ll likely appreciate your flexibility — especially as they scramble to come to terms with their own new sales tax collection obligations.
Who should collect exemption certificates?
Tax teams were typically responsible for collecting and maintaining exemption certificates back in the day (i.e., before the internet and automated solutions).
These days, many companies have found ways to streamline the exemption certificate management process by shifting the responsibility to:
- Credit departments that collect new customer information
- IT personnel who set up online shopping carts
- Sales teams that interact with customers one-on-one
Whoever bears the responsibility should be trained to recognize the right time to ask for a certificate. That will make things easier on everyone.
What’s the best way to handle sales tax exemption certificates?
Auditors like to have access to a well-organized stack of properly completed, valid exemption certificates (paper or virtual). It makes their job easier; and the easier their job, the easier they’re likely to go on you.
Of the 45 states (plus the District of Columbia) with a general sales tax, only three have not adopted some form of economic nexus: Florida, Kansas, and Missouri. If your business is on the hook for sales tax in a growing number of states, consider automating exemption certificate management. Avalara CertCapture easily scales to fit growing needs while helping reduce your audit risk.
The 2021 sales tax changes report: midyear update
Your guide to navigating the complicated world of tax compliance and preparing for the future
Stay up to date
Sign up for our free newsletter and stay up to date with the latest tax news.