Are Your Exempt Sales Safe From Potential Sales Tax Assessment?

For companies managing their sales tax risk, exemption certificate management is a crucial, yet often-overlooked, consideration that almost always becomes a key focus during a sales tax audit.

Many companies selling tangible products, digital products, or services make tax-free sales when customers indicate the product or service will be used in an exempt manner. When sales of taxable products or services are tax-free based on a usage-based exemption, it is the seller’s responsibility to collect properly completed exemption certificates and maintain them in their records.

Without proper documentation, any transactions that are typically subject to sales tax are at risk of being assessed in a sales tax audit. State tax auditors will often kick off their examinations by reviewing exemption certificates since taxpayers frequently do not prioritize exemption certificate management. While taxpayers feel they can easily collect the certificates later if needed, this is not always a viable option.

While the concept of maintaining exemption certificates is simple, managing exemption certificates is becoming increasingly complex. Implementing a process and tools for validating and storing certificates from tax-exempt customers, known collectively as Exemption Certificate Management (ECM), is an important step in ensuring compliance with tax regulations and reducing the risk of sales tax audits and potential penalties.

Exemption certificates provide legal documentation of certain buyers and transactions being exempt from having to pay sales tax. This, in turn, eliminates the need for sellers to collect the tax.

There are several types of exemption certificates, including:

In addition, some states offer exemption certificates for specific industries or purposes, such as contractors or capital improvements.

State requirements for exemption certificates can vary significantly. Some require a state tax ID number, while others accept a federal employer identification number (EIN). Additionally, certificates may expire in certain states, which makes monitoring expiration and renewal dates important.

Because sellers must ensure certificates are completed properly and accepted in good faith, they must conduct due diligence to confirm the validity of an exemption being claimed by the buyer.

Sellers should also distinguish between single-purchase certificates (which apply to one transaction) and blanket certificates (which cover all transactions with a customer but can introduce risk if some sales with that customer are taxable).

Managing exemption certificates brings several challenges, such as keeping up with state-specific requirements, the time-consuming nature of manual processes, tracking expiration dates, and maintaining secure storage systems.

Effective exemption certificate management involves several core processes:

Performing and coordinating these steps effectively offers numerous benefits to sellers, including reducing audit risk, streamlining sales processes, and enhancing customer relationships.

Keeping certificates organized and retained properly mitigates risks such as losing certificates or forgetting to renew them, which can lead to sales tax exposure that is completely avoidable. Improper certificate management can also strain customer relationships. Asking a customer for exemption certificates related to invoices issued two years ago is never a good situation to be in. For any customers that are no longer in business or are unwilling to provide a certificate, good luck asking for them to reimburse you for the sales tax!

To overcome the challenges inherent in managing exemption certificates, businesses should:

For guidance on implementing effective exemption certificate management processes tailored to your specific business needs, consider reaching out to our State and Local Tax professionals.