Exemption Certificates & How to Reduce Your Sales Tax Audit Liability

by | May 2, 2021

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Ray Diaz

Publish date

05/02/2021

We Minimize Your Sales Tax Exposure Before an Audit Begins.

Properly estimating and accounting for contingent tax liabilities can be a tricky business. Proper accounting involves the application of the government’s complicated, and sometimes unclear, rules to your facts. While the law can be murky, at least your facts are generally easily knowable. After all, they are your facts. But most companies live with a significant tax exposure that is hidden from view. If you make sales to customers who claim a sales tax exemption you may have a tax exposure that you are simply unable to properly estimate. We have developed proprietary software, and assembled a team of highly specialized experts, to solve this exact problem. Whether you are a public company reporting your contingent liabilities according to ASC 450, or a private company concerned about the impact that hidden tax liabilities can have on your balance sheet and cash flow, our team at CERTifyTax can provide you with the transparency you need to properly and accurately estimate your tax exposure related to exempt sales. 

The best part – we can help you minimize your exposure before the taxman shows up at your door. As we said, the tax liability is the intersection of the government’s rules and your facts.

And while we, unfortunately, cannot change the government’s rules, we absolutely can change your facts.

Does your company make sales to customers who are exempt from sales tax?

If so, your team undoubtedly gathers exemption certificates and other documentation supporting the exempt nature of the sales.

But what happens if they collect some but not all the requisite information? What if your customer provides an exemption certificate, but not the proper exemption certificate? What if the certificate is unsigned, or incomplete?

In most states, the burden of taxation is on the consumer (your customer) not the seller (you). This is good. But if your sales to exempt customers are not supported by proper documentation your customers’ tax burden becomes yours. This is bad.

And while all companies understand that undocumented, or improperly documented, exempt sales are bad, the difficult question, in terms of dollars and cents, is – how bad?  

If auditors from every state in which you do business show up at your door, do you know your total potential liability? Do you know which state presents the highest level of financial risk? What customers are responsible for the bulk of your exposure? For almost all companies, these answers are not known. 

At CertifytaxCERTifyTax, we can shine a light on this problem that will allow you to properly estimate this exposure and allow us to put together a comprehensive plan to remediate it.

Why is it so difficult for companies to accurately estimate tax contingencies related to exempt sales?

So, as we said at the start, to understand your risk on any tax matter we need to apply the existing tax rules to your facts. The tax rules are often murky, but your facts are usually known or knowable. Concerning exempt sales, the opposite is true. The tax rules regarding exempt sales, while voluminous, are relatively uncomplicated. Unfortunately, your facts are very likely unknown. and, as a practical matter, unknowable to you.

The root cause of the problem relates to the way companies have historically acquired, stored, and validated exempt sales documentation. Your certificates may have been acquired by your credit department, your accounts receivable department, or at a cash register. If your business is like most others, your exemption certificates are probably stored in a sales tax engine, homegrown document repository, or (yikes!) a file cabinet. You may not have a rigorous validation solution or process in place. Many companies don’t know the extent to which they have undocumented sales and very, very few know if documentation that exists will withstand audit scrutiny. Without software designed for this specific task, manpower, and expertise, a granular, comprehensive analysis of the issue presents a daunting challenge.

How does your company currently estimate potential liabilities related to improperly documented exempt sales?

One (unfortunately!) common way that many companies learn the exact extent of their exposure is to wait for the states to conduct audits. We call this the Wait and See Method. We do not recommend this method any more than we would recommend touching a stove to determine whether it is hot. Audits are never pleasant, but especially if you are flying blind; when you have no way to estimate your potential liability, audits are downright terrifying. State audit teams will select a representative sample of your exempt sales and review your certificates and documentation with a fine-toothed comb. When they identify missing or imperfect certificates, they will extrapolate results and assess taxes, interest, and quite possibly penalties. Although corporate taxpayers will typically scramble to track down old customers to acquire certificates, success is generally limited. In the end, if you have improperly documented sales (and you almost certainly do) you are going to pay the price. Under the Wait and See Method, you find out what that price is at the same time as the taxing authorities. This generally works out very well for the taxing authorities but not so much for taxpayers.

In general, state taxing authorities have become increasingly aggressive in recent years in auditing exempt sales. That trend is very likely to accelerate as a result of the COVID-19 pandemic. Now more than ever, it is prudent to take a proactive approach rather than the Wait and See Method. 

How can the CERTifyTax team help?

For decades it has been frustratingly difficult to estimate and properly reserve for tax exposure related to exempt sales. No longer. CERTifyTax can provide the level of transparency that you need to fully understand and quantify your risk. Better still, our team can develop and execute the perfect plan to remediate to acquire certificates that are missing and obtain or invalid certificates to put you in the very best position for when the auditors inevitably knock on your door.  

At CERTifyTax our dedicated exempt sales team, using our proprietary software, can quickly estimate your total exposure free of cost.

Our software provides transparency to financial executives so that liabilities can be accurately estimated for financial and management reporting purposes. Moreover, we can design an intelligent, data-driven process to remediate your exposure. Finally, our software can efficiently and accurately manage your exempt sales on a going-forward basis so that your future exempt sales will be properly documented from the start. And our team will meet with you quarterly to review your contingent exposure and make sure your exempt sales process remains on track.

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