THE ULTIMATE GUIDE TO
Exemption Certificates for
Sales Tax Compliance
The Ultimate Guide to Exemption Certificates for Sales Tax Compliance
Contents
Introduction................................................................................................................................................. 1
The Exemption Certificate Challenge............................................................................... 2
The Basics of Sales Tax Exemptions................................................................................... 3
When Exemptions Get Complicated.................................................................................. 4
Best Practices for Managing Exemption Certificates...................................... 5
Soliciting and Capturing.............................................................................................................. 5
Validating and Tracking................................................................................................................ 6
Storing and Systemizing.............................................................................................................. 7
Automating Exemption Certificate Management................................................ 8
Conclusion..................................................................................................................................................... 8
To learn how Avalara can help streamline and simplify the
exemption certificate management process, visit
www.avalara.com or call 877.780.4848.
One of the most problematic parts of the compliance
process is properly collecting, validating and storing
exemption certificates. This highly valuable tax
compliance documentation is the proof you need to
support non-taxed sales. These certificates can be the
difference between a costly assessment and a smooth,
seamless audit.
Unfortunately, properly documenting exemption and
resale certificates can become incredibly complex
when numerous states, entities and variables like
nexus and drop shipments come into play—not
to mention the challenges of properly storing
certificates if your business still relies on paper-based
filing systems. Thorough and accurate exemption
certificate management requires input from various
departments; tax analysts, credit managers and IT
departments all play important roles in the process.
To achieve and maintain sales compliance, it’s critically
important to understand how exemption certificates
work, when to collect them and what steps to take so
they remain valid and up to date.
In this guide, you will learn how to:
Identify the correct certificates for various states
and entities
Determine which exemption certificates to use in
different transactions
Solicit the correct certificates in a timely and
customer-friendly way
Automate manual and paper-based processes to
streamline certificate management
Integrate exemptions certificates with other
software and solutions
1
Achieving sales tax compliance in
today’s complex environment is no
easy feat. There are changing rates to
calculate, evolving requirements to
monitor and a wide array of exemption
certificates to manage. Companies
must handle every step correctly, and
each one is riddled with potential
pitfalls.
Introduction
2
Many of these organizations think they’re fully
documented, organized and adequately prepared for
a sales and use tax audit. Often, it’s not until the audit
notice arrives that a company will realize it should
have had a better process in place to safeguard against
invalid or missing exemption certificates that increase
liability.
The first and most common cause of this pain is the
method of storage: While virtually no business still
relies on pencils and calculators to manually calculate
or file taxes, the same is not true of the tools used to
manage compliance documentation. Many companies
still use filing cabinets, palletized boxes and off-site
storage to manage hard copy documents in systems
that make it difficult to produce valid customer
exemption certificates on demand during an audit.
Meanwhile, credit managers and sales associates
face the stress of customer service issues when valid
exemptions or fillable certificates can’t be produced
in a timely and efficient manner. They may be forced
The Exemption Certificate Challenge
to get numerous employees involved in validating an
exemption status at the point of sale, or they might
be tempted to let the lack of a valid certificate slide in
favor of a verbal agreement that one will be provided
after the tax-free transaction is completed.
Lastly, there are the challenges inherent to
homegrown automation solutions. Unless an IT
team has both the capacity and specialized skillset to
continually code integrations as your business grows,
automating the process in-house can be an arduous
and costly undertaking.
Waiting until an audit notice arrives to correct these
problems is bound to ensure compliance issues.
The sooner you begin to streamline and simplify the
exemption certificate management process, the lower
your audit exposure will be. As an added benefit, many
companies find that exemption certificate efficiencies
also lead to decreases in customer service issues and
increases in loyalty.
The Ultimate Guide to Exemption Certificates for Sales Tax Compliance
Before establishing a new exemption
certificate management process, it’s
important to be aware of potential
pitfalls. Countless businesses spanning
numerous industries stand to be
impacted by improper management
of exemption certificates this year:
retail stores, eCommerce sites,
manufacturers, wholesale distributors,
fuel suppliers...and the list goes on.
While many companies recognize the need for an efficient exemption
certificate management process, nearly half (48%) of accounting
professionals in the U.S. believe an auditor would likely find mistakes like
missing or incorrect compliance documents in the event of an audit.
Source:
Wakefield Research Report
48%
The Basics of Sales Tax Exemptions
When is a sale tax exempt in the U.S.? Generally speaking, there are three main scenarios where a transaction can take
place without sales tax having to be collected:
The buyer is tax exempt by law.
Examples could include government agencies, schools, nonprofit charities and hospitals.
The type of transaction is tax exempt.
The buyer is using the goods in a manner that is exempt, such as reselling or incorporating it into another product.
These transactions are exempt when properly documented by an exemption certificate.
The product itself is non-taxable.
This is often the case with certain types of food, medicine and services.
Each state has its own set of rules on how to handle tax exemptions in each of these
categories. Achieving compliance requires identifying the correct certificates—a
task that is ultimately the responsibility of the seller. If a valid certificate cannot be
produced, the purchase should be taxed or the seller will risk becoming liable for
uncollected taxes in the event of an audit.
3
Did you know?
The average cost of an audit is more than $114,000.
Source:
Wakefield Research Report
4
Many companies, particularly ones that deal with eCommerce and resale, face two common hurdles to overcome
when transactions take place in more than one state:
When Exemptions Get Complicated
Drop Shipments
Sometimes, a seller will accept an order for a product
it doesn’t actually carry. To get it to the customer, the
seller places an order with a third party supplier—
perhaps a wholesale warehouse or manufacturer—
and directs that company to deliver the goods on its
behalf.
If this sounds familiar, your company is in a drop
shipment relationship. Exemption certificates are very
common in drop shipments because they typically
involve resales. However, the rules around what
determines nexus in drop shipment scenarios and
what qualifies as an exemption can vary greatly from
state to state. It’s critically important to become
familiar with these requirements and decide what
types of exemption certificates you will accept.
The Ultimate Guide to Exemption Certificates for Sales Tax Compliance
Nexus
When tax-exempt sales span multiple states, the
exemption certificate process is impacted by nexus.
While each state takes its own approach to this
term, nexus is generally defined as a “presence” in a
state that’s significant enough to require a business
to comply with the state’s sales tax laws. Common
measurements for gauging physical presence include
employees, property ownership and leases. For some
states, nexus is established when a business advertises
or solicits business in the state. In others, using
company vehicles to deliver goods establishes nexus.
For example, consider a brick-and-mortar floral
retailer with several stores located in Cincinnati,
Ohio. The presence in Ohio means the company has
nexus—an obligation to collect taxes—and must be
registered in the state. But what happens when the
florist makes the arrangements it produces in Ohio
available for delivery across state lines to Kentucky
and Indiana? If it begins to ship flowers to customers
in Florida, will it have nexus in Florida? The answers to
these questions will vary from state to state and may
even change as states and courts redefine how nexus
is determined. To remain compliant, it’s important
to become familiar with different state rules and
understand which exemption certificates are required
for tax exempt sales in states where your company
may have nexus.
Soliciting and Capturing
Any time a client or customer claims a sales tax exemption—whether it’s a government agency purchasing products in
bulk or a retailer purchasing items for resale—a valid, up-to-date exemption certificate must be produced. The reason
for this is simple: A company could be 95% compliant, but if an auditor reviews a sample set and identifies records for
the 5% of accounts with incomplete or expired certificates, the business could become liable for the projected tax
liability of 100% of the population of sales. This could translate into an amount much higher than just the uncollected
taxes. Although it’s possible to follow up months or years after a transaction, this approach becomes problematic
when the customer has gone out of business, changed its name or is otherwise impossible to contact.
Best Practices for Solicitation and Collection
You can stay ahead of these challenges by implementing several best practices:
Best Practices for Managing
Exemption Certificates
Stay updated. If you do business in multiple jurisdictions or are in a drop shipment relationship, determine
where your business has nexus. Review every possible scenario and, if necessary, call upon a specialist who is
up to date on the latest state exemption certificate requirements.
Be thorough. Identify every state exemption certificate your company will need for each type of transaction.
This will make it easier to identify the correct compliance document at the point of sale. A good place to start
is Avalara CertCapture’s free exemption certificate library.
Make it convenient. Develop a system that gives salespeople and credit managers easy access to blank,
fillable certificates for use when onboarding new customers. In addition, ensure they can quickly verify exempt
statuses of existing customers at the point of sale.
Proper management of exemption certificates involves several steps. Each one must
be handled thoroughly and efficiently.
5
6
CONTINUED | BEST PRACTICES FOR MANAGING EXEMPTION CERTIFICATES
Validating and Tracking
As your company collects exemption certificates, it’s important to take a good, hard look at each one and ensure it
contains all the information that will be needed in an audit. Often, all it takes is one small oversight—an overlooked
field, a forgotten signature—to incur penalties. Expiration dates are another consideration. Exemption certificates
have different expiration dates in different jurisdictions; some could be valid in perpetuity and other certificates will
need to be renewed before they expire or, at the very least, before a new exempt transaction takes place.
Best Practices for Validation and Tracking
Avoid surprises during an audit by following these best practices:
Inventory regularly. Have a formal system in place to identify and flag incomplete certificates. Then follow
up with customers in a timely, efficient manner so they can complete their records in the event a certificate
is missing information.
Record expiration dates. How long a certificate will remain valid depends on the jurisdiction, so you must
track these dates and plan accordingly. In many states, certificates need to be renewed every five years. In
others, it’s three. And there are some states where certain certificates never expire.
Stay ahead of deadlines. To avoid confusion in the event of an audit, have a follow-up plan in place.
Providing customers with ample time to update or submit new certificates can greatly reduce risk in the
event of an audit.
The Ultimate Guide to Exemption Certificates for Sales Tax Compliance
Did you know?
Avalara tracks all of
this automatically for you.
Storing and Systemizing
To be adequately prepared for the tax exempt portion of a sales tax audit, your company will need to know several
things ahead of time: what percentage of sales are tax exempt, how many exemption certificates are on file, which
ones have expired and how many are missing information or need to be updated. Having a solution in place to
properly store and index certificates will not only make it easier to extract information requested by an auditor, but
also ensure your company is aware of any potential liabilities well in advance. Equally important is the ability to quickly
locate, verify and store certificates at the point of sale.
Best Practices for Storage and Systemization
Further reduce your audit risk with these best practices for managing exemption certificates:
Index: Ensure all of the exemption certificates you’ve collected are easily searchable and accessible. Since it’s
impossible to predict which certificates an auditor will request, being able to instantly comb through all of
your records and extract the right ones is crucial.
Integrate. Seamless integrations between your exemption certificate process and other solutions will reduce
the amount of time spent matching customer accounts to compliance documents and exemption statuses.
Ideally, exemption certificates should be integrated with any tax determination, point of sale, customer
relationship management (CRM) and enterprise resource planning (ERP) software your company uses.
Automate. Unless your company handles only a handful of certificates each year, automating the exemption
certificate management process will help eliminate manual errors. Automation also reduces the amount of
time and money it takes to manage audits.
CONTINUED | BEST PRACTICES FOR MANAGING EXEMPTION CERTIFICATES
7
Krispy Kreme Doughnuts, Inc. decreased their
audit liability by over 90% using Avalara
Vida Reese
Tax Analyst, Krispy Kreme Doughnuts, Inc. TVID: CAE-B50-5D5
Manually implementing the above steps may suffice at a company that handles a few tax-
exempt transactions each year. However, businesses that deal with multiple jurisdictions
and certificates can be at risk when traditional paper filing processes become riddled
with errors and require a lot of time and energy to maintain. Companies that rely on IT
departments for coding and integrating in-house systems must stay ahead of security
threats that can compromise customer and company data.
For these reasons, many companies are choosing to automate solicitation, collection and
storage of exemption certificates—and even outsource the entire management of these
processes to exemption certificate specialists. When manual, paper-based and homegrown
systems are replaced by automated solutions:
• Exemption statuses are instantly matched to customer accounts
• Fillable certificates are available at the point of sale
• Expiration dates are tracked automatically and renewal requests are sent before
certificates expire
• Customers can complete certificates in secure web portals and mobile apps
• Auditors can be given access through special audit portals
8 The Ultimate Guide to Exemption Certificates for Sales Tax Compliance
Automating Exemption Certificate Management
Conclusion
In summary, to correctly collect, store, validate and manage exemption certificates for sales tax compliance, you must:
• Understand where your business has nexus
• Stay updated on rules and exemption certificate requirements in each state
• Make it easy for customers to submit certificates during transactions
This process can be very overwhelming for many retailers, suppliers and distributors— especially ones that work in numerous states or handle a lot of drop shipments.
Avalara is designed to handle the entire process from start to finish.
• Empower employees to quickly verify an exemption status at the point of sale
• Regularly inventory for missing or incomplete certificates
• Stay ahead of expiration dates
• Access compliance documentation quickly and easily and respond to audit requests in seconds
• Stay current with new tax laws and regulations with automatic updates
• Track upcoming renewals, expirations and missing documents with automatic updates
• Maintain a secure digital library of documents with nearly unlimited data fields and attributes for effective
reporting and analysis
Optimize Time, Resources and Investments
• Automatically distribute personalized letters, emails and faxes to request new customer forms, and collect
completed forms through scans, faxes, emails or a secure online portal
• Convert paper documents into digital documents at the time of transaction with a new, easy-to-use mobile app
• Add new forms and documents quickly and easily, scaling to meet new business needs
• Deploy and support new client instances quickly and easily
• Maximize existing technology investments by integrating with hundreds of customer management systems and tax
calculation engines through industry standard file and API methods
Delight Customers
Use simple add-ons for point of transaction systems both in-store and online to ensure compliance information is
available where needed to improve customer experience
To learn how Avalara
7
Rest Easy with Avalara
Avalara can integrate with hundreds of customer management systems, retail and eCommerce transaction systems
and tax calculation engines, enabling organizations to provide compliance information at the point of sale – or
wherever it is needed – to deliver a better customer experience while reducing risks.
Be Audit Ready and Reduce Risks
More than 2,000
customers trust Avalara
to securely manage 17
million compliance
documents. By fully
automating a
traditionally inefficient
and paper-heavy process,
Avalara empowers
companies to simplify
and streamline the entire
exemption certificate
management process.
Greg Moosbrugger
Tax Analyst, Northern Tool + Equipment
We no longer have to wait for each store to send in paper certs. Information is entered in
real-time and available immediately, putting us back in control of the process instead of
waiting for information to filter in. With data immediately available, I can pull 300-400
certificates in four hours or less—that’s down from months of work. Avalara has made the
audit process tremendously easier and far less painful.
“
“
About Avalara Compliance Document Management
Avalara helps organizations reduce audit risks and increase compliance by providing
an easy-to-use, cloud-based solution that manages a comprehensive range of tax-
related compliance documents, including sales tax exemption certificates, federal
withholding forms and excise business licenses.
www.avalara.com | 877.780.4848
THE ULTIMATE GUIDE TO Exemption Certificates for Sales Tax Compliance
Achieving sales tax compliance in today’s complex environment is no easy feat. There are changing rates to calculate, evolving requirements to monitor and a wide array of exemption certificates to manage. Companies must handle every step correctly, and each one is riddled with potential pitfalls. To achieve and maintain sales compliance, it’s critically important to understand how exemption certificates work, when to collect them and what steps to take so they remain valid and up to date.
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