How To Manage Sales Tax Exemption Certificates

In most states, sales tax is seen as non-negotiable. However, many businesses and organizations can apply for sales tax exemptions utilizing exemption certificates. In this article, we'll dive into types of exemption certificates and best practices for buyers and sellers. 

Understanding Sales Tax Exemption Certificates

In states where sales tax collection is required, businesses must collect and remit tax on all taxable sales. The only exception is when a customer provides a valid sales tax exemption certificate. This certificate is an official document stating that the business is exempt from paying sales tax on its purchase(s).

Sales tax exemption always requires verification and typically only applies to groups like nonprofit organizations, educational institutions, churches and charities, and government groups. Other sales tax exemption certificates apply to resellers and specific types of businesses based on the way they use the items they purchase. Sales tax exemptions vary by state, so a business with nexus in multiple states may have to navigate different exemptions. Businesses are responsible for understanding their tax exemption status and keeping a current exemption certificate. If a certificate is expired or misused, the company or group could be responsible for paying the state's lost sales tax. 

Common Sales Tax Exemptions

There are many reasons why a customer or group could be exempt from paying sales tax. Here are several common types of sales tax exemptions:

• Nonprofit and government exemptions. The most common type of sales tax exemption certificate is for nonprofit and government organizations. The idea is that these groups do good for the community and don’t need to cut into their budgets to pay sales tax. Qualifying for an exemption certificate varies by state. In many states, organizations must be designated as charitable 501(c) 3 or 501(c)4 organizations, which is a separate process from securing an exemption certificate. 
• Resale certificates. Businesses that resell items or materials to make new items can get a resale certificate, which exempts them from paying sales tax on items they plan to resell or rent. The idea is that the end consumer will pay the sales tax. To get a resale certificate, the reseller must register with a state’s tax agency and apply for the certificate by providing specific business information. 
• Manufacturing exemptions. Many states offer sales tax exemptions to manufacturers, meaning these businesses don’t have to pay sales tax on the purchase of machinery, equipment, or manufacturing supplies. In these instances, the goods purchased are essential to creating new items. Each state can have its own definition of manufacturing, which impacts what businesses can apply for the exemption and what purchases are included. 
• Agricultural exemptions. Another industry that is commonly exempt from sales tax is agriculture. In many states, agricultural products and supply purchases don’t require sales tax. Because there is much room for interpretation in many states, what exactly qualifies for tax exemption can vary dramatically between states. 

State-Specific Requirements

Because each state has its own sales tax regulations, each has its own exemption forms and processes. That means businesses operating in multiple states must apply for exemption certificates in each state and understand the state-specific regulations. 

States that don’t collect sales tax for any customers don’t have an exemption process. Other states require more paperwork to grant an exception and require businesses to renew their exemption certificates every few years, while others have a longer statute of limitations and grant exemption certificates that don’t expire. 

In general, groups and businesses still need to apply for a sales tax license in each state they have nexus. From there, they can apply for an exemption certificate if they qualify. 

The following are common requirements for an exemption certificate application:

• Sales tax license and identification number
• Business or organization contact information
• For charitable or religious organizations, verification of tax-exempt or nonprofit status, such as 501(c)3 or 501(c)4 forms
• Current financial statements

The length of the certificate also varies by state and type of certificate. In some instances, exemption certificates expire within one to four years. In other cases, the certificate is valid as long as the information on the application form is valid. Businesses and organizations must understand expiration dates so they can maintain a current exemption certificate. If a certificate is expired or no longer valid, it isn’t effective, meaning the purchaser will be responsible for paying sales tax. 

The only exceptions to the state-by-state rules are the two types of resale certificates that apply to multiple states:

• Multistate Tax Commission (MTC) Uniform Sales & Use Tax Resale Certificate is accepted by 36 states belonging to the Multistate Tax Commission. Resellers must apply for a sales tax license in each state in which they have nexus but can complete a single form to apply for sales tax exemption in all included states. 
• Streamlined Sales Tax (SST) Certificate of Exemption is accepted by 24 states belonging to the Streamlined tax group. Resellers can complete one form and be exempt from sales tax in all included states. 

Collecting and Validating Certificates

Exemption certificates can be challenging because businesses may find themselves on both sides of the transaction as buyers and sellers. Applying for a sales tax exemption certificate is only half the process — sellers and businesses making sales also have to collect and validate the certificates with every applicable purchase. 

For a business to use its sales tax exemption certificate, it must present the certificate when making a purchase. If the buyer doesn’t present the exemption certificate and pays sales tax, that isn’t the fault of the selling business. When verifying an exemption certificate for a purchase, sellers need to check all required information:

• Name and address of buyer
• Reason for sales tax exemption
• Valid expiration date

In general, the process for finalizing a sale with an exemption certificate goes as follows:

• The buyer shows the seller a copy of their sales tax exemption form. 
• The buyer signs and dates the form.
• The seller verifies all required information on the exemption certificate:

• Name and address of buyer
• Reason for sales tax exemption
• Valid expiration date
• The seller retains a copy of the exemption certificate in case of an audit or if the buyer makes a return purchase. 

Sellers need to check that all information on the exemption certificate is current. If a certificate is incomplete or expired, the seller should collect sales tax from the buyer. They could be responsible for the tax if the certificate is deemed invalid by a state auditor. The same applies if the buyer can’t produce their exemption certificate. If the buyer later proves they are exempt, they can request a refund for the overpaid tax.

Certificate Management Best Practices

Aside from verifying sales tax exemption certificate information, the biggest challenge for businesses is collecting and storing them. Depending on the location or business type, a company may have many exemption certificates from customers. Storing these certificates is crucial for compliance and audit preparation. If a business can't prove why its customers didn’t pay sales tax, it could be liable to cover the sales tax. 

What’s the best way to collect and manage exemption certificates for sellers? By leaning into digital storage solutions. 

Technology solutions can integrate into point of sale and sales tax systems to verify exemption certificates and provide a checklist of required information. These systems can produce fields for sellers to complete to ensure that all the required exemption information is collected. Even better, these systems often act as document storage to keep a record of the exemption certificate.

Calculating and collecting sales tax is already complicated without adding exemption certificates to the mix. Automated tools streamline the process and ensure sellers have all the information they need, stored securely in case of an audit. 

Staying Compliant With Exemption Certificates

For businesses or organizations with exemption certificates, staying on top of the paperwork behind the certificate is crucial. Some states don’t place an expiration date on exemption certificates, but some do. IIf a business lacks a current exemption certificate, it must pay sales tax. Then, it must request a refund from the state. To avoid this, businesses should file the proper paperwork with all state sales tax agencies where they have nexus.

Companies should track their sales tax-free purchases. They should regularly audit their records. This ensures they are only exempt on applicable items. For some organizations, like nonprofits or educational groups, almost every purchase falls into the tax exemption category. However, for companies with more wiggle room, like in manufacturing, every purchase might not be sales tax exempt. Understanding the difference and keeping accurate records of all purchases is important. 

Streamline Your Sales Tax Management

Sales tax exemptions are complex and vary by state. It’s helpful to have a sales tax expert. They can assist both purchasers and sellers. Partnering with an expert helps businesses apply for exemption certificates. They also help sellers create efficient systems. These systems can digitally support the collection and storage of certificates from customers. 

If you want to learn more about sales tax and how to prepare your business with a smooth sales tax process, contact The Sales Tax People to get started with a customized sales tax system for your business needs.