If a buyer doesn’t have an exemption certificate, who’s on the hook for sales tax?
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 let’s face it — headache-inducing. The same is true with tax compliance; if there’s a kink in your tax compliance machine, you can lose time and money to inefficient manual processes. And if you’re not correctly collecting and maintaining exemption certificates, you’re opening yourself up to taxes owed and costly penalties.
So what are exempt sales, and who qualifies for them?
A sale is exempt when the business making the purchase is exempt from paying sales tax. A sale can be exempt for a number of reasons:
- Sometimes the purchaser is exempt, as is often the case with government agencies
- Sometimes goods are purchased by retailers to resell
- Sometimes, as is often the case with manufacturing, purchases and sales are exempt because the goods will be incorporated into, or used in the manufacture of, a taxable product
Exemption certificate management for manufacturers can be particularly complex since exemptions can apply to goods used in the manufacturing process or goods incorporated into a taxable item. Taxability laws vary by state, and the certificates you need to keep track of also vary by state. If your company sells numerous products to vendors in multiple states, your process just got that much more complex.
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, they 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,” says Colleen. “Once you go into Texas and California, you’re talking hundreds of customers.”
Why does this matter?
Sales tax collections are an important source of revenue, second only to personal income tax collections in most states. Given the possibility of a recession in the coming months, states will be looking for ways to make up the difference in revenue. One way they do this is by conducting audits — missing, expired, or invalid exemption certificates frequently cause sales tax audit trouble for businesses. If you’re in the manufacturing industry, your risk for audits may be higher: In a recent survey conducted by Avalara and Potentiate, manufacturing companies claimed the highest audit rate (18%). One of the top reasons companies are assessed fines during an audit is missing exemption certificates.
Some other common mistakes auditors find (and fine) with exemption certificate management include:
- The certificate is missing a signature or doesn’t include the signature of the accepted signer
- The certificate is missing an issue date
- The certificate lists an incorrect claim type or the certificate isn’t accepted
- The document (letter, email) isn’t recognized by state tax authorities
- The certificate includes a name or address other than the direct buyer and seller
- The certificate includes an incorrect state ID
- Use tax is not properly applied to tax-exempt purchases
The bottom line is, a business always takes a risk when a valid exemption certificate isn’t on file. Businesses can come up with myriad reasons for why they didn’t charge tax on an exempt sale, but from an auditor’s perspective, they’re still on the hook if they don’t have the right documentation.
More vendors, more certificate complexity
Since 2020, many manufacturers have diversified their vendor lists to curb the effects of supply-chain issues on their customers. This means you might have a whole slew of new relationships to manage and new tax information to collect from each company you work with. So how did the team at Limbs & Things manage this complexity when they expanded? They chose an automated solution that supported growth. “When we needed to increase our registrations in response to the Wayfair decision, Avalara took a very, very daunting task and made it achievable,” says Colleen Bremer.
If you’re managing compliance without automation, you could be adding complication to an already complex task. 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 by proactively requesting new certificates. Plus, you can easily manage and automate all of your tax-exempt purchases with Avalara Vendor Exemption Management and add control to your procurement process to reduce use tax liability. Learn more about Avalara solutions for manufacturing today.
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