Going through a sales tax audit can be an intimidating process, in part because the auditors’ requests for documentation are specific, and the process can be demanding. Since sales taxes are so complex, it’s normal for you to worry whether you’ve done everything correctly and whether you have all the right evidence to prove it.
If you sell to customers who are tax-exempt in one or more jurisdictions, one of the first things an auditor will ask for is copies of your exemption certificates. If your sales tax operation is ship shape, you’ll have been collecting and saving these throughout the year. If you haven’t been, you may be in for unpleasant surprises, as your company could be liable for the uncollected tax if you do not have copies of valid exemption certificates.
Read on to learn what you need to know about exemption certificates so you can be ready the next time the auditor knocks on your door.
What types of exemptions are there?
A customer can be tax-exempt for multiple reasons. If a customer is a government entity, non-profit organization, credit union, school, or hospital, they may be exempt from paying sales tax. Each state has its own rules, so it’s important to know the regulations where you are located.
A 501(c)(3) designation may make an organization exempt from sales tax. Legitimate types of exemption certificates include resale certificates and direct pay permits. A multiple points of use (MPU) exemption is another common exemption for SaaS and digital goods, especially when the product is being used concurrently in multiple states.
How do I know if a certificate is valid?
It’s important to know what you’re looking for when you’re validating an exemption certificate. A 501(c)(3) designation does not necessarily mean that a customer is exempt from sales tax, and a letter from the IRS is not a valid form of exemption certificate.
Every state has its own exemption regulations and exemption certificates. Some states, such as Washington, DC, require a Certificate of Exemption be presented. In these states, those validating an exemption certificate need only verify that the name on the Certificate of Exemption matches the name of the customer.
