Managing and properly documenting exempt sales — including sales for resale — isn’t easy. But getting it right is crucial for success. As your business grows and evolves, your sales tax obligations may change, including how you manage exempt sales and exemption certificates. If you don’t have a comprehensive plan in place, selling exempt products or services can compound compliance challenges and tax liability. In the event of an audit, you must prove that all your qualified exempt sales are backed up by the right documentation. Failure to do so can result in costly fines and interest payments.

If this all sounds daunting, you’re in the right place. To help you get a handle on how you can properly manage tax compliance for exempt sales, we’ve distilled the process into five steps to help your business stay compliant at every stage of the process. Following each step, you’ll find links to relevant resources where you can learn more.

STEP 1:

KNOW WHERE YOU’RE REQUIRED TO COLLECT AND REMIT SALES TAX AND REGISTER YOUR BUSINESS

Knowing where you need to collect and remit sales tax is the first step in staying compliant. You might not need to register everywhere, so determining where your business has economic nexus (the connection that establishes a business obligation to register, collect, and remit tax or, in the case of exemptions, file a $0 return) is key. Many business activities can create a nexus obligation with a tax jurisdiction, including having physical locations, remote employees, affiliate relationships, or economic activity in that tax jurisdiction. The 2018 U.S. Supreme Court ruling in South Dakota v. Wayfair, Inc. includes provisions that create registration and returns requirements for both taxable and nontaxable sales.

First, you need to understand which business activities can establish a nexus connection, then determine where you might have tax obligations. For businesses with exempt sales, economic nexus can be particularly confusing because it’s established by reaching a threshold based on an amount of sales and/or a certain number of transactions. It can be tricky to determine whether exempt sales should be included in those thresholds, and each state handles exempt sales differently.

If you’re unsure about your current or expanding nexus obligations, a free nexus risk assessment can help. Once you’ve determined where you have a nexus obligation, you’ll need to register with the appropriate jurisdictions.

STEP 2:

DETERMINE WHICH SALES AND WHICH CUSTOMERS QUALIFY AS EXEMPT

After you determine where you have nexus and register to collect and remit sales tax in the appropriate jurisdictions, you need to assess which of your sales and/or customers qualify as exempt from sales tax. There are many reasons sales can be exempt from sales tax, including how or where the goods are used by the buyer. One of the most common reasons for a sales tax exemption is when items are intended for resale.

Rules are different in each state; some states don’t tax services and labor (and therefore don’t require any documentation), but some do. Plus, many states exempt nonprofits and government agencies from paying sales tax, but they’re still required to provide a valid exemption certificate.

As the number and types of products or services you sell grows, so does the likelihood you’ll have more tax-exempt sales and more complexity in maintaining compliance.

Make sure you understand which sales are taxable or tax exempt. Analyze your sales and decide whether to charge sales tax or accept an exemption certificate. Are all your customers exempt or only a small portion? New laws and regulations for remote sellers are increasing the number of customers you must monitor and manage when it comes to exempt sales. This may create an obligation to collect exemption certificates in a jurisdiction where you previously weren’t required to. If that happens, you either need to start charging sales tax to customers or obtain a valid exemption certificate.

In addition, supply chain relationships can trigger a sales tax obligation even if no sales tax is collected. When this happens, you might not have to collect tax, but you need to have a valid resale or exemption certificate for your records. If you can’t produce valid documentation in the event of an audit, you could be liable for paying tax, as well as interest and possibly penalties.

STEP 3:

COLLECT EXEMPTION CERTIFICATES

Once you decide to accept the transaction as exempt, you must collect a valid exemption certificate. Some states have specific requirements when it comes to the documentation needed for exemptions while others are more flexible. With more than 13,000 sales and use tax jurisdictions in the United States, each with varying tax rates and product taxability rules, it can be difficult to know when you’re not required to collect sales tax.

There are many different certificates, and knowing which is the correct one to use can be challenging. But collecting the right one can help improve cash flow by not delaying the sale, and improve customer experience by making it an easy process. If you as a seller have an online purchasing solution for your customers, you may want to integrate automated certificate management.

To document your exempt sales, you need to collect the right exemption certificates, check that the information is accurate and complete, and file them with the transaction information so you can easily track and retrieve that information later. You’ll also need to keep track of when certificates expire or need to be renewed, and you’ll have to do this for every state or jurisdiction where you have exempt sales and tax-exempt customers.

Make sure you understand the certificates and specific forms necessary for different jurisdictions and exemptions. Decide whether you’ll collect certificates from customers up front or at the time of sale. You should also determine whether you have any customers that have been purchasing tax exempt without a certificate on file, so you can back collect exemption certificates for those customers.

Should you need help, Avalara Tax Research offers a comprehensive database of information with easy-to-access, straightforward answers to commonly asked questions. 

STEP 4:

VALIDATE EXEMPTION CERTIFICATES

Regardless of the reason for an exemption, the seller must collect and verify a complete certificate for each tax-exempt buyer to document why sales tax wasn’t collected. Failure to produce valid documentation can be problematic to your business if you’re audited. The inability to produce valid documentation is a common reason for businesses to be assessed tax, interest, and penalties during an audit. Properly managing exempt sales and documentation can help you be better prepared and able to show compliance.

If your business has exempt sales, make sure you have a sound sales and compliance process as well as resources in place to validate exemption certificates at the time of sale. Successfully collecting exemption certificates is a lost cause if they aren’t properly validated and filled out. Be sure you understand the information required for each type of certificate, have a process in place to help you easily identify missing or incorrect information, and follow up if necessary. 

When confirming the accuracy of an exemption certificate, check for the following:

• The name and address are consistent with the company name and address on the invoice 

• There’s a comprehensive description of the items purchased 

• The certificate is complete
  

Finally, the certificate may require the signature of the purchaser or agent and date of completion, since some certificates expire in certain jurisdictions.

STEP 5:

STORE, TRACK, AND MANAGE RECORDS

After you’ve identified your exempt customers and collected certificates, you’ll need to consider how to maintain tax-exempt transaction records, which can take a significant amount of time and resources. Exemption certificate management is not a set-it-and-forget-it process. As new customers come on board, you must repeat the process to check their qualifications and confirm the information on each form is complete. For some states, validated exemption certificates never expire, but you need to make sure they’re signed by an authorized signer. In other states, like Florida, resale certificates expire annually and must be renewed regularly. All of these variations make it difficult to keep your certificate program current and to manage it over time.

To successfully handle exempt sales, you need an efficient way to collect, store, manage, and renew exemption certificates at scale. Many businesses do this process manually, which can be time-consuming as well as risky. Paper documents in filing cabinets can easily get misplaced, misfiled, or forgotten, which makes proving compliance much more difficult. Auditing exemption sales is part of sales and use tax audits, and missing or expired exemption certificates can result in penalties assessed during an audit.

Moving this process to the cloud and automating it with a solution like Avalara Exemption Certificate Management alleviates many of these worries, keeping you organized, up to date, and on track with tax compliance.

Now that you know what to do to manage exempt sales, let’s look at how you can make it easier. Avalara takes the complicated, detailed, time-consuming, and time-sensitive steps involved with managing exemption certificates and automates them into one simple, streamlined, digital process that syncs with your financial systems and business processes.

Avalara Exemption Certificate Management makes it easy to:

• Apply exemptions and collect certificates at the point of sale, creating a better customer purchasing experience
  
• Identify, auto-validate, and verify the accuracy of exemption certificates, reducing the likelihood of incomplete or incorrect information
  
• Collect, track, and manage certificates and tax documents to satisfy compliance requirements, saving time and reducing risk
  
• Avoid tax calculation errors that can result in rebilling and delayed orders
• Be audit-ready with on-demand reporting and easy access to sales data and documents, which are up to date and stored in a secure, central location
  
• Monitor and get alerts about changes to your sales tax obligations so you can stay knowledgeable about compliance requirements
  
• Manage all your sales transactions (taxable and exempt) in one place for greater visibility into your business 
  
• Add exempt sales management to your existing ERP, CRM, and billing systems with prebuilt integrations to most platforms
  
• Identify taxable and nontaxable sales and identify the right certificates with Avalara Tax Research

It’s time to ditch the drudgery and go digital. Talk to one of our tax automation experts about Avalara Exemption Certificate Management and let us help you find the right solution for your business.