3 Key Questions to Ask About Sales Tax Exemptions
One of your small business clients, the owner of a lawn equipment sales and service shop, calls you breathlessly on a Friday afternoon. He just put the final touches on his biggest single sale all summer: eight lawn tractors, eight push mowers, four trimmers, three edgers, and two utility trailers – a nice way to finish the week.
The prices are set, and the premix oil, spare blades, and maintenance contracts have been sold. The retail customer is ready to sign a check but at the last second presents one final slip of paper: a sales tax exemption form. Your client wants to know (right now, by the way) should he accept this paper and exempt the sale or risk losing the sale by demanding the customer pay sales tax just like all his other customers?
A sales tax exemption form – or, in some cases, a resellers certificate – is a document a purchaser provides to a vendor as proof the purchaser is exempt from paying sales tax on a sale. As is often the case with multistate tax compliance, the terms used to describe these types of documents vary, as do the exemptions they can serve as proof of.
The most common type of sales tax exemption is for resellers, or purchasers, who intend to sell the items they purchased to other purchasers. Other common exemptions are for farming, research and development, manufacturing, and other preferred industry types across the states.
Back to your client on the phone … in many sales tax jurisdictions, the taxes due on this transaction could be roughly equivalent to the entire net profit of the deal. Bottom line: This is real money to both parties.
This situation can pop up in almost any retail environment, and although this isn’t a complex issue, the presentation of some proof of exemption by a purchaser should trigger the following three basic questions for vendors:
1. Is the exemption certificate or form presented by the retail customer authentic? States vary on the array of exemption types they provide and the forms they allow vendors to accept. Some states provide only one or two exemption forms to cover all exemption types, while others even allow vendors to accept Multistate Tax Commission exemption forms or perhaps forms from other states. On the other hand, many states provide multiple exemption form types, each designed for specific exemptions, and some states will only accept their own certificates or forms.
In any jurisdiction, under any circumstances, an exemption certificate or form must be the most current version, filled in legibly and completely. It should be signed by an appropriate representative of the purchaser or indicate a valid resellers permit designation. In an increasing number of jurisdictions, it must be current; some of them have expiration dates.
In addition, more and more states provide an online or telephonic resource for vendors to check whether an issuer of an exemption certificate or form is entitled to the exemption based on their own registration status. In states where this verification is possible, it is a responsibility of a vendor to ensure the issuer is entitled to do so. Also, at the risk of restating the obvious, a certificate or form must be presented in a format the state accepts as valid.
2. If your client finds the certificate or form is authentic, does it entitle this purchaser to the exemption he or she is claiming? If the exemption form itself is authentic, acceptable, current, and filled out completely, your client must assess whether the actual exemption claimed applies to the sale.
In the example above, if your client’s purchaser is a company eager to start mowing lawns with their new toys but presents a resellers certificate, it is unlikely the resellers exemption rules apply. However, if the purchaser presents an agricultural or farm exemption form, it’s easier to see that this analysis can become more nuanced.
States vary on how they view misuse of exemption certificates (see question No. 3 below), but the best approach is for retailers to consistently take more than a passing glance as to whether an exemption certificate is applicable for a given sale.
3. If your client determines the certificate on its face is authentic and entitles the purchaser to an exemption, who is on the hook if an auditor someday determines the information on the certificate is false, incomplete, or inapplicable to the circumstances of the sale? The states are not uniform in the approach they take in the misuse of exemption certificates; in fact, isn’t this a recurring theme in every article on sales tax compliance?
Generally, there are two camps:
- Some states find the vendor is on the hook based on a “vendor should have known better” standard.
- Other states look at the purchaser based on a “purchasers shouldn’t lie” standard.
However, every state will look askance at obvious fraud or overt sidestepping exemption rules by vendors.
The use and misuse of exemption certificates is on the radar of revenue authorities. Your retailing clients should take steps to ensure the certificates they accept are authentic, legible, completed, and signed as required. The purpose of the exemption should be compared with the facts and circumstances of a given sale to see if there is a match. And, regardless of the official position a state might take on misuse of an exemption certificate or form, vendors should be diligent about the way they analyze, accept, and manage their exempt sales.
This article is not a complete exploration of compliance challenges related to exemption certificates and forms. Rather, it’s meant to provoke a little thought on a topic that often comes up in the heat of the deal, as our hypothetical lawnmower salesman learned above.
What should you tell the client? Ignoring potential implications related to misuse of exemptions creates audit risk for retailers. Or, put another way, if that slip of paper presented by your client’s best new customer is really only worth a slip of paper and is not valid proof of an exemption, this big deal may turn out to be a big loser if no sales tax is collected.
Shane is a Senior Manager in the State and Local Tax Department at Clark Nuber, P.S. in Bellevue Washington. Shane focuses on state and local indirect tax obligations for companies of all sizes operating across the United States and...