Exemption certificate management and audits

Maintaining current, valid exemption certificates is critical in managing your overall sales tax risk. Under audit, an otherwise exempt sale will be deemed taxable without such documentation from a customer – and just a few missing certificates can result in large penalties and interest.

Properly documenting exempt sales is a hassle and a pain, but it matters. In this blog based on one of our recent webinars, here are how states and other tax jurisdictions are getting tougher with their exemption certificate audits.

Matters of fact

The acceptance of sales and use tax exemption certificates mostly rely on just facts: You either have an appropriate certificate for the sales tax exemption that meets all requirements of the taxing jurisdiction, or you don’t. If you have good facts regarding your certificates, you have a great case in the event of an audit. If you don’t, you could be in great trouble.

Facts to consider:

• Is an exemption certificate on file?
• Is it the appropriate certificate for the exemption claimed? (Is the transaction a sale for resale, is the customer claiming a manufacturing exemption, is the customer a tax exempt entity, etc.)
• Is the certificate missing a signature, date, or other required field?
• Is the certificate expired?

Ensure that all your exemption certificates are easily produced upon audit and proactively review all your certificates for completeness and validity.

A perfect storm

Why should you pay attention to this now? Two reasons: states with budget deficits and the effect of five years ago that opened the floodgates of tax jurisdictions requiring remote sellers to collect and remit sales tax. The combination has resulted in increased scrutiny and assessments on exempt sales – the lowest of hanging fruit for state auditors who know that historically companies have not had good systems to deal with verifying the certificates they have on file.

In a recent survey, for instance, two-thirds of tax professionals reported an increase in the number of sales tax audits, and more than three-quarters expected audits to stay at this level – or increase – soon.

Think of state tax authorities as a business: They have revenue goals, and they rely on audits to generate a certain amount of revenue in a year. The sales tax pie has also gotten bigger than that of use tax in recent years, raising the nebulous standard companies have historically been held to for exemptions and certificate documentation.

In one recent fiscal year, for instance, California’s audit revenue for improperly documented resales exceeded $600 million (in a state with a $37 billion budget deficit), and inadequate records related to exempt sales has been the most-cited reason for tax deficiencies.

Less than proactive

We’ve seen that clients are less than proactive in managing exemption certificates, getting into an audit and then scrambling to obtain certificates for prior periods. What are the risks of this?

Many states require that the exemption documentation be acquired contemporaneously or prior to the sale. Most states have permitted taxpayers even when under audit to go back and acquire certificates – but are scaling back on this opportunity.

Retrieving certificates from past customers can be problematic no matter how much time you have. When you make a sale, you can immediately track down that customer. But as time goes on, those customers may go out of business and their contact information may grow stale. Given the pressures of an audit and the potential erosion of your customer contact information, it’s best to be proactive in securing customers’ exemption certificates.

Next time, we’ll look at best practices for maintaining exemption certificates and documentation.

See our “Expert View - Exemption Certificates Management, Audits, and more!” webinar with CERTifyTax founder and CEO Tom McCarthy and COO Ray Diaz as they discuss best practices in exemption certificate management.

With TaxConnex exemption certificate management service, you can outsource the process and gain easy access to all your certificates online. Contact us to find out if your business could be impacted by exemption certificates and to gain a better understanding of your burden of sales tax compliance.