Managing communications tax exemptions can be particularly challenging
Managing sales tax exemption certificates is a challenge for any business but managing communications tax exemptions can be even more complex than synching your smartphone to play your favorite songs on your smart speaker, and not your smart thermostat.
That’s because communications services are subject to a much broader range of federal, state, and local taxes, fees, and surcharges as well as sales tax. Customers are rarely exempt from everything.
That makes it essential, and also really complicated, for companies doing business with tax-exempt customers to stay on top of which customers are exempt from what taxes, and which taxes they’re still liable for.
Sales Tax Exemption 101
First, let’s review sales tax exemptions in general.
There are basically two primary categories for sales tax exemptions: one for resellers and producers of components that are going into a finished product that will then be sold — and one for charities, nonprofits, and/or government agencies.
When a business does a transaction with a tax-exempt supplier or customer, it needs to document the exemption to show future auditors why it didn’t collect and remit the sales tax usually required. This is typically done by collecting a tax exemption certificate from the exempt supplier or customer.
Managing exemption certificates can be challenging, requiring an accounts receivable department to spend many hours to prove they have valid and current certificates on file for every tax-exempt transaction. You can learn more about managing sales tax exemptions by reading our Ultimate Guide to Sales Tax Exemption Certificates.
Exemptions for communications services
The greatest challenges surrounding exemptions for communication services billing stem from the fact that a large volume of the items at the bottom of the bill aren’t taxes at all, but fees or surcharges. For example, 911 fees are typically paid in exchange for access to a government service and Universal Service items are usually recovery surcharges through which the seller is passing on their own obligations to the buyer. Scenarios in which the transaction becomes exempt from either can be extremely limited.
There can be many instances where a communications company is making sales to certain customers that are tax exempt under various laws: charities or government agencies, for example.
The laws governing these exemptions vary from state to state. Most states, for example, allow schools to make tax-exempt purchases. However, North Carolina doesn’t — unless the educational institution is part of the state government. Similarly, California doesn’t exempt cities from having to pay sales tax, although many other states do.
And while many states exempt charities from having to pay sales tax, those exemptions don’t necessarily apply to all the different taxes that can be levied on communications services. In fact, when it comes to fees and surcharges, like 911 and Universal Service Recovery charges, there’s rarely any exemption for the types of entities that typically claim sales tax exemption. Your nonprofit customer may object to paying these items but most likely they’re still subject to 911 and if you don’t recover the carrier surcharges, your receipts are likely still going to be subject those items; you’ll just be paying out of pocket with a margin that likely doesn’t make up the difference.
And even if the buyer is exempt from paying local communication taxes too, you’re going to need to collect documentation from them — in the form of a local tax exemption certificate — to show why you didn’t collect and remit. That’s in addition to the state sales tax exemption certificate you collected.
Getting tax exemptions right in these situations can be tricky. Florida, for example, issues paper exemption certificates for various categories of tax that look very much alike. (This is totally aside from all the complexities introduced because Florida has 481 local entities charging communications services taxes at rates that range between 0.3% and 7.6%).
Whatever state you’re selling into, it’s up to you to ensure your customer isn’t providing you with a sales tax exemption certificate for a transaction that requires a communications tax certificate, or just providing you with one when you actually need both.
It’s also extremely common for communications services to be offered for resale. This can present a completely different set of exemption problems. If you’re selling to smaller reselling communications companies, you may well find that their registration and compliance for the full range of taxes and charges is far from complete. Perhaps they have documentation of a sales tax registration but haven’t registered for regulatory fees or vice versa. Or perhaps they’ve registered in some of the relevant jurisdictions but not others. You may have to be nimble enough to pick and choose when and where they’re treated as a wholesale buyer versus a retail buyer.
Potential problems — and solutions
Given all the headaches and potential delays that can arise from managing exemption certificates, there’s a strong temptation to plunge ahead with a transaction before the paperwork is in place, just to ensure that deals don’t get lost.
While that might be understandable, it’s a significant risk: When state auditors come around, one of the first things they’ll look for is whether you’ve got documentation to back up your claims of tax-exempt sales.
And in this era of COVID-19, you could also face a second risk: Some of the organizations you did business with at the start of the pandemic may no longer exist. If you didn’t secure an exemption certificate from them at the time the transaction occurred, it’s too late to go back to do it now.
Automating your communications tax compliance processes can remove much of the headache and delay. To learn more, check out our guide on untangling communications tax complexity.
Cover photo by Canva
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