Mission possible: Exemption certificate compliance

Your business is growing. Well done! Sales are up and you’ve opened new offices and distribution centers in new locations to meet customer demand. Maybe you’re even offering new product lines and services. You may be thinking of reaching new markets through a reseller program. 

All of this is great news and worth celebrating. But your sales tax situation has also just gotten a lot more complex. New locations likely mean new taxing jurisdictions, while new products or services can introduce varying taxability. All of this has also made the exemption certificate management process much more difficult.

Poor exemption certificate management processes tend to be ignored or tolerated until a company goes through a sales tax audit. During an audit, the state selects a sample period and requests sales documentation, including exemption certificates. The assumption is that findings for a select sample period represent standard operations for your business for the entire time frame under audit, and penalties are applied as such.

To put that in context, say you had $600,000 in sales for a one-month sample period. The auditor discovers a $15,000 exempt sales transaction for which the exemption certificate is missing or invalid. If the tax rate is, say, 8%, you’re looking at an unpaid tax bill of $1,200. But if the audit is for a 36-month time frame, the auditor will then apply that missing $1,200 in taxes across the entire audit period. Despite being for a single sale, that one missing certificate could end up costing over $43,000 in unpaid taxes!

In 2022, on average, Avalara’s Managed Services Team validated over 56,000 certificates per month; many required correction upon receipt. If not detected and resolved, invalid certificates can result in some serious financial consequences for a business.

So if you want to avoid nasty surprises come audit time, you’ll need to address the three main components of the exemption certificate management process and the challenges involved with each:

• Collecting exemption certificates
• Managing exemption certificates
• Validating tax exemptions during an audit

Yay! Another new customer! But if they’re tax exempt, are you set up to process their order for their specific location, products, or services? Charging sales tax on a tax-exempt sale can create friction with the customer and require resources to process a credit for the tax. 

When you do omit the exempt taxes, it’s important to collect a valid exemption certificate either at the time of sale or before order fulfillment. Not doing so can cause order delays or increase your risk of audit exposure. 

If you fail to collect the sales tax on a taxable order or do not have a supporting exemption certificate on file, you are responsible for paying that tax. If you have multiple internal touch points when processing a sale, set a standard point of collection to ensure a certificate is on hand for each new exempt customer.

Your collection process should include:

• An easy way for your customer to submit their certificate
• Verification that the certificate is valid, properly filled out, and applicable to the sale
• Routing to a secure, accessible certificate database

Once you have a reliable process for collecting and storing exemption certificates, you have to make sure they stay current. That can be … complicated. Some certificates expire after only a year, others are good for three years, and some never expire.

And just because you have a valid certificate on hand for a customer, doesn’t mean it will cover all of their sales. Some jurisdictions have specific certificates for various types of sales. Depending on your product line and the location of the sale, an existing customer may have to supply a different certificate for a new purchase. 

Some questions to ask as you evaluate your exemption certificate management process:

• Can you run reports to easily see the status of outstanding issues?
• How do you track expired certificates?
• What is your process for requesting certificate renewals?
• How easily can you access certificates you have on hand?

Without the proper reporting and visibility into exemptions, your organization will face serious challenges under audit.

It’s not a question of if you will get audited, but when. And for auditors, exemption certificates are easy pickings. If asked to produce copies of exemption certificates supporting exempt sales, how easily will you be able to retrieve them? After all, the longer an audit takes, the more of a burden it can be for your business.

However you structure your exemption certificate process, it needs to be designed with audits in mind. Using a secure, centralized database where any of the designated employees can easily pull reports or find specific documents will help reduce the disruption an audit can cause. Even better: Use a digital database with an auditor portal, so they can just access the information they need on their own.

Avalara uses automation to reduce compliance risk and improve business efficiency. Our exemption certificate management products integrate with Avalara AvaTax or other tax engines so you can:

• Receive customer certificates through a self-service portal, reducing the burden on staff
• Apply automation tools to verify and validate certificates
• Store certificates in a centralized location with quick retrieval, tracking, and reporting options
• Set up automated customer communications to request new certificates when expiration dates are approaching
• Reduce risk and save time while managing the exemption certificate process with automated workflows 
• Access a content and reference library with over 600+ exemption forms, up-to-date tax exemptions content, a tax law search engine, exempt entities library, and more

Avalara is here to help. To learn more about how to streamline your exemption certificate management process, schedule a call today.