Exemption certificates. This is one area which can be a daunting topic for many companies to consider – to the point where they don’t even want to address the topic. If we avoid the problem it goes away, right?
But poor exemption certificate management can lead to tax exposure where a company could even be liable for their customer’s tax liability. Yes, that means you are paying your customer’s tax for them – and in the case of an audit which happens several years later, you may or may not be able to recover the tax from the customer. There are also rules that many companies simply don’t know about when it relates to what constitutes an acceptable certificate. Without going into the overwhelming detail on various state rules, here are a few of the basics:
How do I know if I need to collect an exemption certificate from my customers?
Let’s just say if you are selling a product, and not charging sales tax to the customer, then you probably need one. There are certain exceptions to this rule since certain items are always exempt, such as sales of groceries in Pennsylvania. Services are nontaxable in most states, but there are plenty of exceptions to that rule as well.
Then there are exemptions based on who you are selling to. Some states have rules that certain types of government entities are exempt, and do not require a certificate. Some states have specific types of exemption certificates for contractors or nonprofits. So just because an entity is exempt from sales tax doesn’t mean that you don’t need a certificate.
Okay, you convinced me, I’ll request a certificate. But wait! There are many other factors still to consider.
What is the difference between an exemption certificate and a resale certificate?
Exemption certificates and resale certificates both tell the recipient that the customer should not be charged sales tax on an order. An exemption certificate gives a reason that the sale should be exempt based on the state’s law such as exempt manufacturing equipment purchased in Pennsylvania. A resale certificate states that the sale should be exempt because the items being purchased are going to be resold to another customer. Some states have two different types of certificates for these, but Pennsylvania has one exemption certificate where an option for resale can be selected. As mentioned before, there are other types of certificates for different types of customers depending on what state is requiring them.
What about blanket versus unit exemption certificates?
Unit exemption certificates only exempt one specific transaction from tax. Blanket exemption certificates are intended to allow the issuer to use the certificate to make multiple purchases tax-exempt. This distinction is often made by checking the appropriate box on the certificate.
Do exemption certificates expire?
It depends on the state. Exemption certificates for Pennsylvania are valid for four years from the date of the exempt sale to which the certificate applies. A good practice is to request updated exemption certificates from customers every three years. Although some states certificates never expire, the type of product you are selling, the reason for exemption, or even the customer business name might change, leaving the previous exemption certificate no longer valid.
Which state requires an exemption certificate?
For the most part, an exemption certificate is needed for the state that the item is shipped to, or the location where the taxable service is being performed. Some states accept a Multistate Uniform Sales and Use Tax Certificate, and some require a specific state certificate. Each state’s rules are different, and as a general rule, in sales tax, it is not a good idea to always apply a “general rule” (see what I did there).
At this point you’re probably reading this and cursing me for promising clarity on the topic and leading to more questions. You’re probably thinking, “Okay so basically you just gave me a bunch of rules, and told me I can’t use the rules.” You might even be ready to give up on the whole topic, and go back to avoiding the problem.
The truth is, exemption certificates matter because they are a low-hanging fruit for an auditor. It is much easier for an auditor to request all exemption certificates for nontaxed sales, and then simply assess all transactions on customers for which no valid certificate is provided. Although the rules are complicated, there are several ways to manage your exemption certificate process.
- Have a process in place. Half the battle is simply receiving an exemption certificate from a customer, so making sure there is a process in place to request and receive exemption certificates is an important first step to reducing liability. This also includes the process for requesting updated certificates. An auditor is much more likely to be lenient on an incorrect exemption certificate than if there isn’t one at all.
- Identify your weaknesses. Although admitting that there might be mistakes can be uncomfortable, identifying possible areas of liability will help take the next step to correcting the issue, and will help avoid surprises come audit time.
- Use a decision flow-chart. A decision flow chart can help staff determine whether tax should be charged on an order, what type of exemption certificate should be received, and many other decisions without having to know the “in’s” and “out’s” of sales and use taxes. An employee simply has to click through the flow chart, answering simple questions to determine how to proceed. McKonly & Asbury’s state and local tax team has prepared many of these in the past, and can tailor a flowchart to your company’s needs.
- Don’t be afraid to contact your resources. It can be very difficult to research sales tax questions on your own since states often do not provide much guidance, and there are all kinds of exceptions to the general rules. It can save a lot of stress to simply ask for help when you need it. McKonly & Asbury’s state and local tax team is available to assist with questions on exemption certificates, state taxability, and other state tax issues.
Thank you for reading, and please contact us if you have any questions!