Managing tax-free sales transactions is an administrative challenge for even the most compliance-conscious business. Paper methods that rely on physical certificates will almost always have errors, and even some electronic solutions are prone to mistakes arising from invalid, expired, or altogether missing certificates.
Of course, these errors and mistakes can lead to audit issues, past-due tax liabilities, penalties, and interest if the problems aren’t effectively managed. Here are some of the complexities that make sales tax errors so common and tips on how to manage sales tax exemption certificates to avoid mistakes.
Types of Exemptions
There are numerous complexities to sales tax exemptions and specifics vary by state. However, virtually all allowed sales tax exemptions fall into one of three broad categories:
- Use-Based Exemptions: Use-based exemptions don’t require sales tax because of how the purchased goods and services are intended to be used. Items that are purchased for resale are a common example of exempt purchases.
- Product-Based Exemptions: Product-based exemptions don’t require sales tax because of the good or service itself. Grocery items are a typical example of goods that don’t require collecting sales tax.
- Buyer-Based Exemptions: Buyer-based exemptions don’t require sales tax because of who the purchaser is. Non-profits are common examples of purchasers that may qualify as an exempt organization.
Challenges That Make Tracking Sales Tax Exemptions Difficult
On the surface, tracking a single sales tax exemption is easy enough. Confirm that the purchase qualifies for an exemption, gather the necessary documentation, and file the documentation for a potential audit.
The challenges arise when businesses need to track many sales tax exemptions, especially when those exemptions must be tracked across multiple taxing jurisdictions.
Administrative Burden
First, the simple task of managing multiple sales tax exemption certificates can be overwhelming. Businesses must ensure that certificates on file don’t have any missing signatures, missing issue dates, incorrect addresses, incorrect names, incorrect states, or past expiration dates. Many businesses don’t adequately vet certificates at the time of purchase, and few ever go back through their certificates to check for expirations.
Managed Across Multiple Jurisdiction
Second, the sales tax exemption certificates must be managed across multiple taxing jurisdictions. Different state agencies have different requirements for exemption, and businesses are responsible for navigating all of these variances. Intra-state sales are usually taxed according to the location of the seller, while inner-state sales are normally taxed based on the location of the buyer. As businesses expand and have more customers in more states, this only leads to greater levels of complexity.
Differences Among Varying States
Third, sales tax exemption differences among states aren’t limited only to what transactions qualify for exempt status. The documentation that states accept also varies. Some states accept letters or emails, while other states require official certificates. Even whether a business must officially file to qualify for exempt status can differ.
Additional Sales Tax Complexities
Fourth, a few special circumstances further complicate matters as they overlay all of the complexities noted thus far. Sales tax-free holidays, for example, can make all transactions on a given day tax-exempt regardless of other circumstances. Many states have tax holidays for back to school shopping or other times in the year, but few of them line up together.
The Streamlined Sales Tax Initiative in the United States is a federal attempt to address many of these challenges. But, it still falls short of resolving all the problems businesses face. States approach the initiative differently at points, and a large number of states don’t participate.
Reduce Audit Risk With Sales Tax Exemption Certificate Strategies
Despite the many challenges, several strategies can help businesses better manage sales tax exemption certificates and reduce their audit risk.
At a basic level, a better understanding of sales tax exemptions leads to fewer initial mistakes and better overall compliances. Something as simple as knowing the typical reasons why a transaction might be exempt can help. Employees who take and file sales tax certificates should have a general idea of what items usually need to be on a certificate. Businesses should stress the importance of accepting only valid and complete certificates.
If they haven’t already, all businesses that have multiple sales tax certificates on file should switch to a digital, automated system for managing certificates. Relying on paper certificates kept in filing cabinets is simply too tedious and error-prone. An automated system is more efficient and accurate.
Finally, businesses that have customers in many states ought to consider meeting with a sales tax consultant. A qualified tax consultant who specializes in sales tax will be able to provide guidance on specific questions and help businesses devise a reliable certificate management system. A consultant will also know what automation software will meet a business’ particular needs well.
Contact a Specialized Sales Tax Consultant
If you need the assistance of a sales tax consultant, contact us at FAStec. Our team has worked with many businesses on sales tax exemption matters, and we’re ready to assist you.
We’ll help you implement a management system that will save you administration time, reduce your audit risk, and help you avoid audit-related penalties and interest.