Sales Tax FAQs #8: Exemption Certificates
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
Mike Fleming and Ellie Moffat answer some of your frequently asked questions about sales tax.
Here’s a glimpse of what you’ll learn:
What can an exemption be applied to?
How do you obtain an exemption certificate?
Who is and isn’t a good fit for STM’s exemption certificate management service?
Connect with Michael
Episode Transcript - Audio Version
[00:00:00] Welcome to Sales Tax and More your go-to resource for all things state tax related. Now here is your host, Michael Fleming.
Michael Fleming: Hi, Mike Fleming here, founder of Sales Tax and More and today's co-host of the Sales Tax and More Podcast where we talk about everybody's favorite topic, and I do mean everybody's, sales tax. And today we're gonna go over some of the questions that we've been asked during some recent webinars.
But first let me introduce you to my co-host Ellie Moffat.
Ellie Moffat: Hey, everyone, great to be here. My favorite subject is absolutely sales tax, so it's an honor to be on the podcast. And
[00:01:00] you know what, today these are webinar questions that we divided out to talk a little bit. Specifically about exemption certificates.
So before we do that, I'll do some introductions first for Sales Tax and More. We are a full service consulting and solutions firm, and we have a really great team here of experienced tax professionals who are very dedicated to fulfilling your state tax and related needs. So we do a lot of sales tax returns, sales tax registrations, consultations, research, audit defense, exemption certificate management, and like our name states more. So if you have questions about our services, please reach out. We'd love to hear from you, and we'd love to work with you. And while I am asking things please like and subscribe to this podcast as well. So Mike, now you're in the hot seat. What can an exemption be applied to?
Michael Fleming: Stuff.
Ellie Moffat: There you go folks. That's the podcast today. Thanks for joining us.
Michael Fleming:
[00:02:00] Alright let's get serious. And by the way, I was being a little bit sarcastic there right before this. I was on a call and the gentleman was telling me that he absolutely hates sales tax, but he knows it's something that he needs to pay attention to.
So that was my emphasis on why it's everybody's favorite topic. Very few people love sales tax. You gotta be a sick individual like myself in order to love sales tax. But all right. Getting back to this, what can exemptions be applied to? Really there, there's a number of different types of categories that exemptions can be applied to.
Exemptions or exclusions, maybe it's for a specific item like groceries. Groceries are gonna be taxable in some states. They're gonna be exempt in other states. If there's no tax on groceries, you don't have to worry about exemption certificates. There's nothing to manage because everybody gets to buy the groceries for free.
So it can be by item. Exemptions can also be by use. Type of
[00:03:00] exemption certificate you've all probably heard of is a resale certificate. So if you're buying something for resale, that's a specific type of use. And there's an exemption for that. The manufacturing process items used or consumed in the manufacturing process are very often exempt.
So therefore you can have an exemption. That's a type of use, something that's being used in the manufacturing process. So it can be by item type or entity type. It could be by entity type. Lots of nonprofits or the federal government. That's not a good example, but state governments, let's use those are often exempt from paying taxes on their purchases.
It can be by entity type. When we're talking about contractors, maybe it's by project type, maybe they're working for an exempt entity and therefore that project is gonna be exempt, but the contractor may do the same exact type of work for someone who's not an
[00:04:00] exempt entity, and that project is not exempt.
There are agricultural exemptions. There are so many different exemptions out there. And most of them you do need some type of certificate or documentation proving that it was an exempt transaction. So some states have general exemptions that you can use one certificate for everything.
Other states have very specific exemption certificates. But the biggest ones out there are your manufacturing your resale, your agricultural. These are ones that we're going to see on a daily basis. And like I said if it's exempt for everybody, you don't have to worry about documentation.
If it's not exempt for everybody, then you gotta worry about documenting that transaction because if it's not documented correctly, then the state will most often, not very often, but most often not recognize it as an exempt transaction. And you'll
[00:05:00] have to pay the tax on it if you ever get audited.
So you gotta make sure that you are collecting the right type of certificate, making sure it's on the correct form. Not just collecting the certificate, making sure that the certificate would actually survive an audit if an auditor looked at it. Which means is it on the right form? Is it completely filled out?
Is it signed? Is it a type of exemption that's actually available? You don't have to play detective and see if your customer was actually eligible for that exemption, but it's gotta be a real exemption. You can't be accepting a certificate for a make believe exemption. State's gonna come after you on that.
Does that sort of answer the question? Ellie, I know we started out fooling around here, but I'm trying to be serious at this point. Was that decent?
Ellie Moffat: No, I think that does answer the question and I, and it leads us really, it leads us into the next question as well, which is also about exemption certificates.
Mike how do you go about obtaining one, how do you obtain an exemption certificate?
Michael Fleming: We get this
[00:06:00] question a lot. People call us up all the time and say, I need an exemption certificate. It's really a two part answer. And it depends on whether you have nexus in a state, and it depends on what state it is.
So if you have nexus in a state, in general the way that you get a certificate is you gotta be registered. So you gotta get registered and as part of the registration process. They get you an exemption certificate and now you're responsible for collecting and remitting tax in that state. That's how you would generally get it if you have nexus.
Now, if you don't have nexus, and nexus is just a fancy word that means link or connection. And when we talk about taxes, it's the link or connection with a state where the state can say that, "Hey, you have enough of a connection with us that you need to collect and remit our sales tax". So if you do have this link or connection with the state if you don't have it, we already
[00:07:00] talked about if you do have it, if you do have it, the state wants you to get registered in order to issue a valid certificate.
If you don't have nexus, there are 40 or so states out there. Maybe 37. 'Cause there are 10 tough states and there are really only 47 states slash jurisdictions that have some type of sales tax. If you don't have this nexus, then there's alternative documentation. You may not have to be registered in order to issue a valid certificate.
Sometimes you can use your home state certificate, so if you're registered to collect tax in your home state, the state may accept that. Maybe it's a state like Pennsylvania, which will accept a no nexus statement. And in a no nexus statement, you simply write on the certificate, you check one box.
Is this for resale? And why you don't need a certificate is I don't have nexus in the state of Pennsylvania. That's what we call
[00:08:00] alternative documentation. And alternative documentation can only be used if you don't have nexus in that state. And states never make anything easy. Each state has their own idea as to what can or cannot be accepted in lieu of the normal state's exemption certificate.
Different states as we talked about earlier a resale certificate is a type of exemption certificate. But most states have a separate resale certificate from an exemption certificate. And when it comes to exemption, some states have a general exemption certificate. Some states have very specific certificates.
How you obtain one it really depends on whether you have nexus or not, what state it is, and then the other thing would be what type of exemption are you looking for? Now, there are 10 tough states out there that I mentioned that even if you don't have nexus, you
[00:09:00] cannot issue a valid exemption certificate unless you're registered California.
Perfect example. You cannot issue a valid certificate in the state of California unless you're registered there. So some companies will say, you know what, I don't need to be registered in California. But if I'm not registered in California, I gotta pay my vendors a lot of tax 'cause they're charging me all of this tax.
And I don't wanna pay that tax anymore. So even though there's a cost to getting registered, I'm gonna voluntarily register in the state of California so I can issue a valid resale certificate. So I don't have to pay my vendor the tax anymore. So lots of different ways on how to obtain a certificate. In general though, you need to be registered with the state in order to issue a valid certificate if you do have nexus.
Ellie Moffat: All right. Thank you so much.
[00:10:00] Michael Fleming: I was just gonna say, we have lots of information out there about this. We even have a great chart. Now it's not on a free portion of our website. A lot of time, effort, and energy goes into number one, creating it. It's a proprietary chart. I don't know of anyone else who has it.
And we keep it updated. So it's in our SALT Vault and a lot of other great tools in our SALT Vault. But if you're doing a lot of drop shipping, especially it tells you what type of alternative documentation each state will accept, which states will not accept anything, which states will accept home state certificates, no nexus statements, home state numbers. And by the way, if it's a state that will accept no nexus statement or a home state number. Like New York accepts the home state number. You don't have to go and register for that. You just go online and download the certificate. And when you're filling it out, it'll say there's two parts and you skip part one.
Part one is if you
[00:11:00] are registered in the state of New York. And part two, you gotta assert that you don't have a need to register because you don't have nexus in the state of New York. And therefore you gotta give them your home state number or your home country number, like a GST number or something like that in order to get that certificate.
But that can just be downloaded off the internet. But if you do have nexus, and nowadays more and more companies do have nexus because of this economic nexus. Then, you generally have to be registered in order to issue a valid certificate.
Ellie Moffat: All right. Thank you. Thank you so much, Mike. And last question we have here. We have an exemption certificate management service.
Can you explain to people who would be a good fit? Who would need a service like this and who is not right for a service like ours?
Michael Fleming: This is a really tough question because we have some really small clients
[00:12:00] out there and we have some really large clients. Exemption certificates have such an outsized impact on audits because audits are now done on a sampling method that even one missing certificate or invalid certificate can have a huge impact. I use an example this was a larger company, but they sold a heavy piece of earth moving equipment. It should have had $6,000 worth of sales tax on it.
And they sold it to an individual who was supposed to be selling it overseas. And they had about a three and a half million dollar audit. 60% of that three and a half million dollars was related to certificates. They hired us for audit defense, and we got that number down. We found every single certificate.
We found a couple of refunds we could put in there. We got a lot of the issues overturned in the audit. We got this three and a half million dollars down to $17,000. Client was ecstatic with us. But we still had the
[00:13:00] issue of this one certificate. Nobody could find this individual and they just never thought to get a certificate.
So when we're going to businesses, we were very successful in clearing up all of the other certificate issues. But we even hired a skip tracing company. Skip tracers are people that track down people who owe money. And we couldn't find them. The company themselves couldn't find them. So this one invoice we tried to get excluded from the audit, you know, get it detailed. We'll just pay the tax on this one invoice, which was $6,000, which a lot of money, no one wants to pay that. However, the state wouldn't do it. We already had used up all our favors in this audit, got it down from three and a half million to $17,000.
They said, "Absolutely not. This is staying in the sample". And when they extrapolated it out over the population, this $6,000 turned into over a $270,000 error. The error percentage turned out to
[00:14:00] $270,000 in assessment. Except for this one certificate, they would've had a 17,000.
Now they're just under 300,000. Still very happy with us. We get it from three and a half million down to 300,000 just about. So they're real happy, but one missing certificate had over $270,000 impact on this audit. Now, most of you are saying my invoices don't have $6,000 worth of tax on 'em.
How's this apply to me? You're absolutely right, but you probably have more than one missing or invalid certificate. And it's the exact same concept because audits are done on a sample basis. They generally have an oversized impact on any assessments that you do have. Because it's not dollar for dollar, it's what that dollar represents.
What's the ever percentage, what's being projected out, extrapolated over the population there? So that's why it's real important. So even small companies if you don't collect a
[00:15:00] lot of certificates, this may be important to you. Now if you don't collect a lot of certificates and the certificates are for large amounts, this is something that you may want to use. If you're selling mostly to consumers out there, individuals, and they don't have a lot of exemptions. There aren't a lot of certificates to worry about. So you're not a good candidate for this program. Why pay for something you don't really need? But if you're collecting a lot of certificates. If you have a lot of exempt customers out there, or if you have a lot of exempt dollar amounts, maybe it's not a lot of certificates, but it's a lot of money that's being exempted then you're a good candidate.
So it doesn't matter what industry you're in, it doesn't matter, if you've got a lot of certificates to collect. If you have a responsibility to collect exemption certificates and the dollar amounts or
[00:16:00] the certificate amounts are large, you really need someone managing your certificates and not just collecting the certificates.
Someone who's validating them, making sure that they would survive the audit, making sure they're on the right form, making sure they make common sense, making sure that they're completely filed out, making sure that there's a real exemption that is available to the company out there.
So this can be done internally if you have the right people for it. They just need to be trained properly or you can outsource it to a company like us. But you gotta do it one way or the other. It's that important. This is the number one reason for large assessments in companies that have a requirement to collect certificates.
'Cause if it's not properly documented, state's gonna treat it as a taxable transaction.
Ellie Moffat: Thank you so much, Mike, and we have more information
[00:17:00] on this exact thing. All these questions on our website too. If you wanna delve in, you can give us a call. You can work with us. We'd love to hear from you about that.
And if you have other sales tax needs, we offer many solutions and services. You can reach out to me directly. My email is emoffat, that's E-M-O-F-F-A-T at salestaxandmore.com. You can also visit our website, salestaxandmore.com. And yeah, thank you so much for joining us.
Michael Fleming: Thank you everyone hope that this was beneficial to you and we hope to see you on the next installment of the Sales Tax and More Podcast. Bye-bye.