Tax Exemption Certificate Survival Guide
Tax-free sales can put a monkey wrench in the tax strategy of even the most compliance-conscious business. With many businesses still using filing cabinets to hold physical certificates, errors are almost inevitable, and the taxman has noticed: missing, expired, or invalid exemption certificates are the most common cause of sales tax audit trouble.
Fortunately, with the right tools, it’s possible to ensure full compliance with requirements for exemption certificates and sales tax exempt transactions. Using the survival tactics in this guide, you can increase employee efficiency, reduce wasted administrative time, and lower your risk of audit fines and penalties.
For companies selling multiple products and services into multiple states, the validation, management, and storage of exemption certificates can become an administrative nightmare that holds up the sales process. If a tax exemption certificate is invalid, out of date, or missing, you’ll have to pay the tax plus any applicable interest or penalties.
Common Exemption Certificate Errors
- Missing signature/does not include signature of accepted signer
- Missing issue date
- Incorrect claim type/certificate not accepted
- Document (letter, email) not recognized by state taxing authorities
- Includes name or address other than direct buyer and seller
- Showing State ID for wrong state
These five tactics offer a compliance advantage, lowering your risk of audit fines and penalties:
Survival Tactic #1: Understand the nature of exemptions
Sales can be exempt for any of three basic reasons:
- Use-based exemptions are those created by the type of use the product will be put to after the transaction is complete. For example, products intended for resale will generally be exempted from sales tax.
- Product-based exemptions are those that apply due to the nature of the product being sold. For instance, in some states, manufacturing equipment is considered exempt.
- Buyer-based exemptions are those inherent to the type of buyer purchasing the goods or services in question. In some states, government and/or non-profit organizations are exempted from paying sales tax.
As your business expands to multiple states and the number of products you sell grows, you’ll have to contend with tax-exempt customers and transactions more frequently, and keep track of which states apply which exemptions.
- Create systems to track changing tax exemption rules
- Track sales tax holidays
- Track exemptions of all three types: use, product, and buyer
Survival tactic #2: Validate exemption certificates
States participating in the Streamlined Sales Tax Initiative at the federal level have access to a unified exemption certificate form. In some jurisdictions, a company must register to use the form, but other jurisdictions do not have this requirement — it’s important to check with each state department of revenue to verify these rules for every state where you collect sales tax.
Complications arise for businesses selling in non-member states. Some non-SST states accept out-of-state forms, but others do not. Tracking individual form requirements in each jurisdiction is critical to exemption certificate compliance.
To ensure that a customer’s exemption certificate is current and valid, states provide validation via phone or online tools. Check with each department of revenue to learn more about how to validate certificates in the jurisdictions where you collect tax.
What typically needs to be on the form?
- Type of exemption
- Names and addresses of buyer and seller
- Description of goods purchased
- Tax registration number
- Signature of the purchaser
- Review tax exemption certificates for completeness
- Use unified forms for SST states
- Learn non-SST state forms
- Know phone and online tools for exemption validation
Survival tactic #3—Know the rules
Knowing which form to use is only part of the complete compliance picture. In many states, you’ll also need to track sales tax holidays and transaction sourcing.
Every year, a number of states set sales tax holidays (such as “back to school” or “Second Amendment” sales tax free days). Know the holidays as they happen so you’ll avoid under- or over-collecting sales tax.
Whether a transaction is considered exempt also hinges on the location of the buyer and the seller. Most sales within a state are based on the location of the seller, whereas sales made between states are typically based on the consumer’s location. Some taxing jurisdictions determine taxability based on the location of the seller. These “sourcing rules” are not consistently applied in each state and can cause an audit risk if incorrectly exercised.
- Check out Avalara’s map of sales tax holidays
- Learn whether to collect a resale or exemption certificate, and whether one form can be used for both
- Investigate sourcing rules in states where you collect tax
Survival tactic #4: Know exempt products and services
Some goods are tax exempt in one or more states, and some states charge lower tax rates on specific product categories (for instance, groceries). Sales tax used to apply to physical goods only, but today often also applies to services — extending sales tax in this way has become a common strategy to address state budget gaps.
As taxing jurisdictions change their rules about taxability of goods and services, your business needs to be aware of the changes and adjust its accounting systems accordingly. The risk of under- or over-charging consumers sales tax can result in a higher risk of audit, as well as customer dissatisfaction.
- Learn about exempt services and goods in each state where you collect tax
- Keep track of changes to exemptions on department of revenue websites
- Monitor legislation to stay aware of changes on the horizon
Survival tactic #5—Automate
If your checklist is starting to feel too long to handle, you’re not alone. Today, many companies have decided that the complexity of managing exemption certificates across multiple locations in multiple states creates too much risk to manage manually. Instead, these businesses choose to automate the entire process of validating, storing, and managing exemption certificates.
Avalara’s streamlined exemption certificate management software integrates into the accounting software you already use. With Avalara, each exempt transaction is tied to an individual certificate, minimizing audit risk. You can catch invalid certificate numbers before they become a problem, track expiration dates, and keep track of forms in every state, no matter where your business grows next.
- Write down your questions about exemption certificates
- Call Avalara at