What You Should Know About Sales and Use Tax Exemption Certificates
As a State and Local Tax (“SALT”) professional, I assist clients in meeting their multi-state sales and use tax compliance obligations. That of course extends to representation when their filings (or non-filing status) comes under audit. Some of the most frequently asked questions from clients concerns securing exemption certificates from qualifying customers. Each business owner should be concerned about exemption certificates and understand when and why they should obtain them so they can minimize sales tax exposure should the business be audited.
Why are exemption certificates required?
Sales tax exemption certificates are required whenever a seller makes a sale of taxable goods or services, and does not collect sales tax in a jurisdiction, in which they are required to. The certificate is issued by a purchaser to make tax-free purchases that would normally be subject to sales tax. Most state sales tax exemption certificates do not expire and the seller is required to maintain exemption certificates for as long as sales continue to be made to the purchaser and sales tax is not collected. Exemption certificates are not required for items that are not taxable by statute.
Is there a global exemption certificate that can be used in multiple states?
No, unfortunately there are no global rules regarding exemption certificates. Each state has its own set of exemption certificates as well as rules and regulations covering their use. However, some general rules do apply. For example, most states have broad categories of exemptions – resale, government, manufacturing, exempt organizations, telecommunications, agricultural, etc. Since not every state has every exemption in place, local rules and local compliance requirements must be considered.
Do states differ in their treatment of sales made to exempt organizations and governmental agencies?
Yes, states differ in their treatment of sales made to exempt organizations (501 (c) (3) status for income tax purposes) and governmental agencies. A general rule of thumb is that purchases by the Federal government are exempt in every state, but documentation requirements vary. Some states tax state and local government purchases including MN, SC, WA, CA, AZ and HI. States that do exempt state and local governmental agencies generally require the purchases must be for the exclusive use of the exempt entity and the exempt entity must be the payer of record.
Most clients think all sales made to not-for-profit 501 (c) (3) organizations are automatically exempt. This could be a costly presumption. In order for a not-for-profit to be exempt the organization must apply for, and be granted, exempt sales and use tax status in the state(s) in which they conduct business. Don’t be fooled by the organization’s exempt sounding name, ensure you obtain a properly completed exemption certificate if tax is not charged or you may be subject to penalties for not collecting sales tax.
As a seller, how do I know which exemption certificate applies to a transaction?
As noted above, there are no quick and easy rules regarding exemption certificates. Different certificates apply for different exemptions, and there may be unique certificates for specialized property or services. One must research the various tax department web sites or consult with their SALT advisor to determine which form applies. For example, the New York State Department of Taxation and Finance’s website posts a very helpful Tax Bulletin, ST-240 Exemption Certificates for Sales Tax, which explains who may use exemption certificates, how to use them properly and which certificate should be used based upon general sales tax exemptions in the Tax Law. The bulletin can be found at: http://www.tax.ny.gov.
Why can’t a seller simply issue a Multi-Jurisdiction Certificate (MJC) as prescribed by the Multi-State Tax Commission or the Streamlined Sales Tax Agreement Exemption Certificate developed by the Streamlined Sales and Use Tax Governing Board ?
As discussed above, sales and use tax rules vary by state. To help sellers meet their multi-jurisdictional obligations, many states have joined the Multi-State Tax Commission or the Streamlined Sales Tax Project.
The Multistate Tax Commission is an intergovernmental state tax agency working on behalf of statesand taxpayers to administer, equitably and efficiently, tax laws that apply to multistate and multinational enterprises. The Commission has developed a Uniform Sales and Use Tax Certificate that 38 States accept for use as a “blanket” resale certificate (the use of this certificate is not valid in New York State and several others). States however vary in their rules regarding requirements for reseller exemption. Some states require that the reseller (purchaser) be registered to collect sales tax in the state where the reseller makes its purchase. Other states will accept the certificate if an identification number is provided for another state (e.g., the home state of the purchaser). One must check with the appropriate state to determine whether you meet the requirements of that state to be considered a reseller and if one can use the MJC to claim an exemption from sales tax.
The Streamlined Sales and Use Tax Project (“SSTP”) is a cooperative effort of 44 states and the business community to simplify sales and use tax collection administration by retailers and states. As a means to make it easier for retailers and remote sellers who operate in multiple states to conduct their business in a fair and competitive environment, the Governing Board of the SSTP developed a multi-state exemption certificate, the Streamlined Sales Tax Agreement Exemption Certificate. The certificate provides a variety of exemptions and is not limited to resale type of transactions. Not all states allow all exemptions listed on this form and states such as New York do not accept the use of this certificate as a valid exemption certificate. Purchasers are responsible for determining if they qualify to claim exemption from tax in the state that would otherwise be due tax on the sale. So, depending upon the rules in a given jurisdiction and their level of participation in the MJC or SSTP different exemptions and filing requirements could apply.
What is meant by a “properly completed” certificate?
In most states a properly completed exemption certificate means the certificate is completed in its entirety by the purchaser, i.e. every line required to be completed is completed by the purchaser issuing the certificate. Most states require that the properly completed certificate be obtained within 90 days of the date of sale and that a seller accept the certificate in “good faith”. Accepting a certificate in good faith means that the seller has no reason to believe that what the purchaser has indicated on the certificate is not true.
What happens if a seller didn’t obtain a properly completed exemption certificate and can’t locate the customer to obtain a new one because they are no longer in business?
In most audit situations a non-taxable sale not supported by a properly completed exemption certificate will be disallowed and sales tax will be assessed against the seller, even though sales tax, in general, is a “consumer tax”. To make matters worse, since most non-taxable sales are reviewed using a “test period audit method” (a limited period is “tested” and an error rate is developed which is projected throughout the audit period) the sales tax due on each disallowed sale will be “projected” throughout the entire audit period. A missing or incomplete exemption certificate can create unnecessary exposure on an audit due to the mathematical compounding of the error rate:
- Say the auditor tests a total of $525,000 worth of non-taxable sales for a one month period. Of that amount, the auditor disallows $12,000 worth of the non-taxable sales in the test period due to lack of properly completed exemption certificates. Assuming an 8% sales tax rate and 36 months in the audit period, the auditor will project additional sales tax due of $34,560 ($12,000 x 8% = $960 X 36 months) as the result of only $960 of additional tax found due in the test period.
In addition to the business being assessed sales tax as the result of missing or incomplete exemption certificates, most states hold “responsible persons” (those under a duty to act for the business) personally liable should the business not fully pay the tax, penalty and interest due as the result of an audit. Consequently, using the example above and assuming the business does not agree or does not fully pay the tax found due on audit, the business owner will have an assessment issued personally for the $34,560 of tax due, plus penalty and interest. Personal assessments can severely affect credit ratings and will certainly cause unnecessary financial hardship.
What can one do to avoid or minimize exposure on audits when obtaining exemption certificates?
The following best practices can help minimize or eliminate exposure on audit of your business’s non-taxable sales:
- Become familiar with exemption certificates in the states where you conduct business and design an exemption certificate policy that everyone in your company must adhere to, with no exceptions.
- Obtain a properly completed exemption certificate at the time of first sale. Too often a seller is told by their customer, “I’m exempt, don’t charge me tax, I’ll send you an exemption certificate”, and of course the customer never sends it. Charge sales taxes on all taxable sale transactions until you receive a properly completed exemption certificate.
- Ensure that exemption certificates are maintained for the required time period to support the non-taxable status of exempt sales. Your file may need to be retained for a long as you continue not to charge a certain customer sales tax or the period of the statute of limitations in the state(s) where you do business, whichever applies. And remember, it is not enough to simply get the certificate; you must also maintain it and make it available during an audit.
- Centralize the receipt and storage of all exemption certificates. A decentralized filing system can lead to gaps in proper internal control over exemption certificates. Decentralized certificate retention often leads to lost or incomplete certificates. Don’t spread the responsibility throughout your business. Costly errors often occur when exemption certificates are obtained by salespeople, store managers, store clerks, etc. who may not be properly trained to identify what is a properly completed certificate or the correct certificate to obtain.
- In businesses where there are many exemption certificates on file, a good idea is to maintain certificates electronically. Specialized software is available which can reduce audit exposure and increase productivity by centralizing exemption certificate management.
Whether you sell taxable products or services and don’t collect sales tax, or you purchase items without paying sales tax, you must know the sales and use tax consequences of your activities in each state you do business in. Be sure to obtain exemption in states where nexus has been established, then focus on the type of exemption being claimed to insure the correct exemption certificate is obtained.
Seek the advice of a Marcum SALT professional so that you can avoid, or at the very least, minimize unnecessary tax exposure on audit of your non-taxable sales or purchases due to issues with exemption certificates.