Accounting firms and sales and use tax advising: Perfect together?
In our blog last week, we looked at how sales and use tax advisory services might be a good new...
Most states charge sales tax on tangible personal property sold to businesses and consumers. In general, professional and personal services are not taxable unless the state includes specific types of services in their definition of taxable transactions. Examples of taxable services in many states include telecommunications, data processing or information analysis. In most states, services are deemed to be non-taxable unless the statute specifically lists the service as taxable. The taxation of services varies widely among the states.
In certain situations, it is possible to obtain a sales tax exemption that allows otherwise taxable transactions to be sold without paying sales tax. In general, sales tax exemptions are statutory exceptions eliminating the need for the retailer to collect sales tax on a particular transaction or on all transactions with a customer. The most common exemption is “sale for resale,” which allows businesses to purchase products free of tax. In this scenario, the buyer would then assume the responsibility of charging the applicable tax when they sell the item or accrue the use tax if used internally within the business. Other exemptions can apply to special entities, including government organizations and nonprofits. While the Federal Government is always exempt from sales tax, certain state and local governments are not exempt from sales tax depending on the state.
A confusing patchwork of rules and regulations impacts companies that do business across multiple states and jurisdictions. TaxConnex is dedicated to helping businesses untangle their sales tax exemption situation and fully comply with all relevant rules.
In this article, TaxConnex explains sales tax exemptions and the need to obtain and manage sales tax exemption certificates, including what it takes to receive them, how to handle exemption certificate management, and how these exemptions should be treated when filing sales tax returns with the jurisdictions in which you do business.
In its most basic form, a sales tax exemption certificate alleviates a company from collecting and remitting sales tax on certain products and services. In many states, but not all states, the purchase of goods and services by state or local governments or by nonprofits are exempt from sales tax. In the case of other businesses, selected types of transactions are exempt.
The purchaser – not the retailer/business – has the responsibility for determining whether or not a sale is exempt from tax. If the purchaser does not submit a valid exemption certificate to the business, the business has the responsibility to assess and collect the sales tax from the purchaser. The responsibility to determine the validity of the exemption certificate is held by the business. Only valid exemption certificates protect a business from assuming responsibility for the sales tax on the exempt transactions. Failure to obtain an exemption certificate at the time of sales may leave a business with the responsibility to pay the tax to the state if assessed under audit by the state.
Depending on which side of the transaction you are on, the rules for sales tax vary. On the selling side, there are three main types of exemptions:
Certain products and services may be exempt, or partially exempt, in many states. These categories can include clothing, professional services, food, and other items. These types of exemptions vary greatly by state and are sometimes referred to as excluded from the sales tax base. Exemption certificates are not needed when a product or service is deemed non-taxable in a state or jurisdiction - sales tax is just not applied to the purchase.
If you are selling products to distributors who will resell the product, the distributor is the one who needs to provide the resale exemption certificate to the seller to substantiate the exemption. You will need to secure a resale certificate from these distributors in order to not have the obligation to charge sales tax. The responsibility is also on you to validate that the correct information is on the certificate and that it is accurate.
Specific types of customers are exempt from paying sales tax on their purchases. Depending on the state, these may include government entities, non-profits, and schools, to name a few. It is the buyers’ responsibility to provide their exemption certificates in order to not be charged sales tax, and sellers need to keep documentation of these exemptions on file.
On the buying side, if you believe you are exempt from sales tax, it is your responsibility to provide a valid exemption certificate to your vendor. Otherwise, you should expect to be charged sales tax.
As noted earlier, the Federal Government is exempt from paying sales tax. Surprisingly, state and local governments may not be exempt from sales tax depending on the state. Similarly, schools and universities have specific rules from state to state that outline whether they are exempt or not. The factors to consider when selling to educational institutions include whether they are a public or private institution, and also whether they are a K-12 or a college/university. When selling to a college or university, you may also have situations where the item being purchased is used for R+D which could have its own type of exemptions.
Most states carry broad exemptions that absolve non-profit organizations from paying sales tax. Some states that do not exempt nonprofits include Hawaii, South Carolina, and Washington. Limited exemptions are available in states like Maine, Idaho, Iowa, and West Virginia. These same non-profits that may be exempt from paying sales tax will still have the requirement to collect sales tax on applicable sales.
The process of becoming a tax-exempt organization greatly varies by state. In most states, an IRS determination letter starts the process. Most states do not collect sales tax from entities classified under IRS Tax Code 501, as in 501(c)3 nonprofits.
Generally, non-profit organizations only need to apply once for an exemption. In some states, including Florida, Missouri, and Maryland, entities must file renewals every one to five years.
The most common exemption is the resale exemption. When a buyer purchases items from a vendor, in some situations they plan to sell the items or services to another business or consumer. This means that the item’s original purchase would be be exempt from sales tax since the tax will be charged during the next or final sale.
Buyers must hold resale exemption certificates to take advantage of this provision of sales tax law. This means that the vendor may avoid charging the tax, but now has the obligation to collect, validate and store the exemption certificate in case of audit.
The rules surrounding sales tax and manufacturing are complex. Each state has its method for determining which sales are exempt, related to the materials and equipment used. In addition to sales tax, use tax calculations are also difficult for manufacturers.
Where use tax is concerned, manufacturers purchase many items used in making goods. Consumables, raw materials, machinery, and equipment are generally exempt, but not all states have equivalent laws on the books. Using a quality service provider like TaxConnex can help your company ensure that you do your sales tax returns correctly and properly handle your exemptions.
Manufacturers’ sales tax provisions are similar to those of wholesalers and distributors. Selected manufacturers sell their products to other manufacturers who qualify for resale exemptions. The overall goal is to avoid the double taxation of multiple materials sold.
Retail sales of tangible personal property are generally subject to sales tax unless exempted. Sellers must default to collecting this tax unless the buyer has a valid certificate of exemption.
As is the case with wholesale and manufacturing firms, goods that the buyer will resell are not subject to sales tax to avoid the problem of double taxation.
Telecommunications represent a special case in sales tax exemptions. Managed service providers (MSPs) and IT management firms often resell telecom services as part of their line of business.
Telecom is a highly taxed and regulated area of business. On top of sales taxes, there are additional taxes and regulatory fees including utility users tax, communications services tax, gross receipts tax, 911 fees, and regulatory fees. Many of these tax “types” and regulatory fees require their own form of exemption. For example, a standard sales tax resale exemption may not be sufficient to relieve taxation of the communications services taxes or the 911 fees.
Telecom’s exemptions can be explained because many telecom companies are in the middle of a supply chain, buying service from a carrier and turning around to resell it to their customers.
Getting telecom taxes exempted is highly complex and requires the help of a dedicated tax expert like TaxConnex if you want to do it right. Going it alone with telecom tax exemptions could create serious problems for your business down the road.
Businesses who believe their purchases are exempt must obtain certificates from each state in which they do business. In some cases, businesses can provide multi-jurisdiction documents covering more than one state at a time.
Another commonly used form is the streamlined sales tax form, an excellent alternative for states involved in the Streamlined Sales Tax initiative. States like Nevada, Washington, Kansas, Vermont, and Rhode Island are part of this consortium.
Most states have their own resale and exemption certificates that apply to purchases within their state.
Client-created certificates are allowed under certain circumstances. These certificates must contain specific information to be considered valid. They must contain state Tax ID numbers, the name of the seller and customer, the type of exemption, and a valid signature and date from the customer. Certificates generally need to be renewed every two to three years, though some have no expiration date and others renew annually as is the case with Florida.
Exemption Certificate Management can be difficult for many companies. Your company needs to keep comprehensive digital files containing your customer-provided exemption certificates. Sellers need to keep track of and validate the information in these certificates to process their own sales tax returns properly.
While sellers are not required to verify every detail on the certificates in most states, they must exercise a level of due diligence and good faith. Some of the information that must be present on the certificate includes the Tax ID number, address, name, date of purchase, position of the signer, and descriptions of the goods sold. Your company must make sure that the forms are filled out completely, signed, and dated and that they have a matching buyer name in your database.
Exemption certificate management always requires the proper storage of certificates. Using a paper system could be rife with errors, meaning that sales tax audits will not come out in your favor. Often auditors only chose a selection of dates and purchases that they audit (referred to as sampling), but if a certificate is found that is not valid, they could apply the error across your entire audit period, potentially costing you a pretty penny. Dealing with an expert sales tax management firm like TaxConnex can help companies avoid problems in this regard.
This article provides a primer on the basics of sales tax exemptions and exemption certificate management, but the field is highly complex. If you are audited, your company’s compliance could rest on having valid certificates of exemption available to the state examining your business. If you are missing certificates, you may be subject to additional tax assessments, plus penalties and interest.
If you pay proper attention to sales tax issues, you can save your company money and ensure that you fully comply with the law where you do business.
Understanding the complicated provisions of sales tax law may require the help of an expert. Contact TaxConnex today at 877-893-5304 for help with sales tax exemption certificates and understanding what is and is not taxable in all of the states where you do business. Working with a service-oriented company rather than a company that feeds your information into an automated database can be a huge advantage for your company.