3 exemption certificate challenges (and how to solve them)

When it comes to sales tax compliance, document management is a pretty common thorn in the side of accounting departments everywhere. With so many moving pieces and variables to track, it’s a daunting task for even the most detail-oriented, organized professionals.

For many businesses, underestimating the complexity of exemption certificate management is the first step down a rocky path. After all, if you don’t understand the challenges, it’s hard to develop a solid solution.

For instance, many overlook the fact that exemption certificate compliance doesn’t start with collecting documents from your customers — it starts with where you have nexus, or an obligation to register for sales tax.

Even if all of your sales are tax exempt, you can still trigger nexus in multiple states. And while there are a few exceptions, most states require you to file returns regardless of whether you make any taxable sales.

In the case of nontaxable sales, you’ll have to have a valid certificate on file to justify the exemptions. If you get audited and don’t have the proper exemption documents, you could owe the tax, as well as any fees or penalties levied against your business.

Figuring out where you’re obligated to collect tax or exemption certificates is just the beginning. Creating an efficient compliance process means overcoming three key challenges:

Collecting the right exemption certificates
Understanding the rules for exempt sales across jurisdictions
Creating an effective exemption document management process

Challenge #1: Collecting the right exemption certificates

Unfortunately, there isn’t one exemption certificate that works for every exempt sale. You may need to collect a specific type of certificate for certain sales, including:

Purchases made for resale
Purchases made by exempt entities, like churches or nonprofits
One-time purchases
Agricultural equipment purchases
Vehicle purchases
Construction materials purchases

In addition to verifying you have the right certificate, you have to make sure the document is valid at the time of the sale, contains all the necessary information, and is applicable for the type of purchase the customer is making.

And of course, the process for validating certificates needs to be fast, simple, and implemented at the point of sale. If it’s difficult for your customers to get the tax exemptions they’re entitled to, especially if they have to request rebills or reimbursement from the state, they may just decide to shop elsewhere.

Solution
Regarding collecting and validating certificates, technology is definitely your friend. Exemption certificate software can integrate directly with your point-of-sale (POS) system, shopping cart, or invoicing platforms to create a smooth, seamless process for customers.

Sophisticated programs can analyze uploaded documents to determine if they meet the criteria to exempt a sale. By verifying certificates during the purchase, you can reduce the rate of improper tax exemptions or the need to issue credits or rebills.

Challenge #2: Understanding the rules for exempt sales across jurisdictions

As if understanding exemption certificates on their own isn’t complicated enough, the rules differ across jurisdictions. Each state has its own documents and requirements for expiration, statute of limitation, product taxability, and interstate rules.

For example, most states allow qualified nonprofits to make at least some exempt purchases. Other states, like California and Washington, generally tax nonprofits like other businesses. When you sell to multiple states, be aware of each state’s rules, which can and do change.

The Streamlined Sales Tax (SST) program was developed to reduce a lot of the jurisdictional disparity and complexity around sales tax. Member states accept the same exemption certificate, simplifying the document collection and management process.

However, not all states allow all of the SST exemptions. And at the time of this writing, only 24 states participate in the SST program, so remote sellers still need to account for documents from nonparticipating states.

The Multistate Tax Commission (MTC) developed a similar “universal” sales tax exemption form. It’s currently accepted in about 38 states, but as with all things tax, that can change at any time. Each state is also allowed to create their own rules for accepting an MTC exemption certificate. A few fun examples include:

Illinois does not allow the MTC certificate to be used for a resale exemption
Connecticut only allows the MTC certificate to be used for resale exemptions
Kansas does not allow the MTC form to be used for purchasing construction materials

What this all boils down to is: The more states where you have nexus, the more complex exemption certificate management can be — which increases the risk of compliance mistakes.

Solution
Exemption certificate management software stays up to date with changing rules and regulations. It’ll verify that certificates submitted by customers conform with the rules of the governing tax jurisdiction.

Rather than simply accepting whatever form a customer uploads, a robust system can supply the right form for a customer to fill out and submit, reducing delays and improving form accuracy.

Challenge #3: Creating an effective exemption document management process

As far as managing exemption certificates is concerned, it’s important to find a solution that works for your business and build an efficient process around it. Questions to ask yourself when determining how to handle sales tax exemptions include:

How many transactions do you need to account for?
Large volumes of transactions make compliance more challenging across the board. Manually tracking exemption certificates, expiration dates, and customer information can be inefficient, time-consuming, and prone to errors.
Who is responsible for maintaining documents?
Managing exemption certificates can impact multiple departments, locations, entities, and teams, making it difficult to maintain consistent processes and procedures. Without clear ownership, it’s even harder to make sure certificates are accurate and up to date.
Are you ready for an audit?
Audits can be extremely costly and time-consuming. Due to the larger volume of transactions, increases in the average sales price, and complexity of operations, risk grows with the size of your business. When (not if) you’re audited, you must be able to produce a correct, valid form for every exempt transaction, on demand; any missing documents can result in sizable audit penalties.
Are your exempt purchases properly handled?
Ensuring vendors tax your purchases appropriately can be a challenge. Errors can lead to being over- or undercharged tax, each of which creates problems, including potential credit delays or rebills, impacts to cash flow, and audit risk.

Solution
One of the biggest benefits of exemption management software is the support you gain for your internal processes. Choosing a solution with configuration capabilities can help you tailor a solution to your sales volume, industry needs, corporate structure, and regulatory details.

Cloud-based programs in particular give you incredible flexibility, so you aren’t limited to siloed access within a single team or at a specific location. With a secure, central database of documents, authorized employees can pull documents on demand for creating reports or satisfying audit requests.

You can also use document management software to support outgoing exemption certificates. Vendor support makes it easier to supply the right documents to the right sellers, so you can get taxed the right amount.

Get help managing exemption certificate challenges

Avalara has long been in the business of simplifying sales tax compliance. For businesses with complex exemption certificate requirements, Avalara Exemption Certificate Management Premium uses automation to help streamline processes, reduce errors, and gain real-time validation of exemption certificates. Exemption Certificate Management Premium dramatically reduces manual efforts around the entire process.

Some of the key features include:

The most robust database on the market for regularly updated forms and comprehensive and detailed information about tax laws and regulations across different jurisdictions
Tax ID number validation confirms numbers and formats against participating, supported state systems
A centralized management system helps define team responsibility and user roles across departments and locations

Sales tax rates, rules, and regulations change frequently. Although we hope you'll find this information helpful, this blog is for informational purposes only and does not provide legal or tax advice.