Exemption Certificate Management Validation
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
Mike Fleming and Ellie Moffat discuss delve into the critical aspect of exemption certificate validation, shedding light on its importance in ensuring protection against audit scrutiny. Through insightful discussions, they emphasize the significance of thorough validation procedures, ranging from checking for completeness and authenticity to the potential financial repercussions of overlooking this crucial process. With practical examples and expert advice, the podcast equips businesses with essential strategies to navigate the complexities of sales tax compliance effectively.
Here’s a glimpse of what you’ll learn:
Validation Criteria
Impact of Missing Certificates
Importance of Common Sense
Connect with Michael
Episode Transcript - Audio Version
[00:00:00] Intro: Welcome to Sales Tax More, your go-to resource for all things state tax-related. Now, here's your host, Michael Fleming.
[00:00:18] Mike: Hi, Mike Fleming here, founder of Sales Tax More and today's co-host of the Sales Tax More podcast, where we talk about everyone's favorite topic, which is, of course, sales tax. We recently did a podcast about exemption certificate management, and we've got a lot of questions about what exactly is exemption certificate validation. So today, we're going to be talking about validation, but first, let me introduce you to my co-host, Ellie Moffat.
[00:00:50] Ellie: Hey, everyone! Really great to be here. I think this topic is pretty relevant, Mike. It seems like it's come up within our company. So it's great to just be able to pivot and give everyone something really relevant to what's going on. So, for those who don't know Sales Tax and More, we are a full-service consulting and solutions firm. We have a really great team here of experienced tax professionals who are very dedicated to fulfilling any of your state tax or related needs. We do a lot of sales tax returns, sales tax registrations, consultations, research, and like our name states, more. Mike, why don't we jump right in from the beginning? What is exemption certificate management validation besides something that's difficult for me to say?
[00:01:38] Mike: Okay, real simple validation is just making sure that the certificates you collect are going to withstand the scrutiny of an auditor. What's the sense of collecting something if the auditor is going to take a look at it and say, sorry, this isn't going to work. You got a false sense of security. You're thinking you're protected. In reality, if you're not validating these certificates, you could get a big surprise and negative surprise, not the good type of surprise when it comes to an audit.
[00:02:10] Ellie: So why does that matter? Why is that important?
[00:02:15] Mike: A couple of things. Number one, you don't get partial credit. If you don't have a certificate or if your certificate is kicked, it's the same thing. It's a missing or invalid certificate. So, having something is not better than not having anything at all. Let's both look at the same way and why it's really important is, if the certificate is on the right form and completely filled out. And there's a problem with it. You accepted it in good faith. So, therefore, if there are any problems with it, the auditor can't put on their detective's hat. And if there's a problem, they go after the issuer of that certificate usually, and there can be criminal penalties for, the improper use of a certificate. If everything's completely filled out, if it's not completely filled out, if it gets kicked during an audit, if the auditor says, hey, this is not a valid certificate, you get a chance to get it fixed. You can go out and perfect it, in most states in most instances. However, now it's subject to additional verification, and the auditor does get to put on their detective's hat and go digging and see what type of problems there are.
[00:03:39] So you never want an auditor digging. You don't want to give them permission to figure out what's wrong with the transaction, because the more digging an auditor does, the more problems they're usually going to find. So, if you have a valid certificate. Then, you accepted it in good faith. If you have an invalid certificate, you lose your good faith acceptance. So that's what really is why it's so important.
[00:04:07] Ellie: What are some things that people should be checking? How? Yeah, what? What should people be checking?
[00:04:14] Mike: You'd be amazed at how simple some of these things are. Number one, the certificates completely filled out that it's signed, that it's dated. We get so many certificates that we review that just aren't signed or dated. So that's a big one. Just making sure that all of the sections on the certificate that need to be checked or put out. So that's the biggest reason why a certificate would be kicked. It's really when it comes to certificates, a matter of form over substance. In other words, in most sales tax, it's substance over form. What's really going on here? Not so much in certificates anymore. Not since, the last great recession back in 2007, 2008, 2009, it changed, it went from substance over form, what's really going on here. Back then, the auditors gave you a lot of leeway. Not so much anymore. Now, every I has to be dotted, and every T has to be crossed, so making sure it's completely filled out is important. Now, another big thing when it comes to certificates is does it make sense? The example I like to use most certificates it's going to say, the person issuing the certificate; you got to fill in what your line of business is and what you are purchasing. So if you put in there that you're a software developer and you're buying one desk and you're buying it for resale, does that make sense?
[00:05:56] Most people are going to say, no, that doesn't make common sense. They're probably buying that one desk to utilize in their own business. So, the sale for resale exemption should at least be questioned. Now, there's a chance that it could be valid. Maybe this is what, they're going into furniture sales, office furniture sales, and this is the first desk that they're buying, you may find that out after you ask the questions, but there, there is no God-given right to an exemption. And since you are the one who's responsible for paying the tax on that certificate, if you don't accept it in good faith, and if it doesn't make common sense, you cannot accept it in good faith. That's a big part of the test. You need to say, no, this certificate's not going to work. And that's tough sometimes, but we suggest that. Our clients actually reject certificates on a number of occasions because they don't make common sense. So that's a big part of it. Making sure it's on the right form. That's a big part of it also. There are lots of different forms out there. Making sure that the exemption is actually real.
[00:07:22] Just because someone sends you a… in a state like Georgia, sometimes North Carolina, sometimes charitable organizations, they need to pay the tax at the point of sale and then go back to the state and get a refund. So you need to collect the tax at the point of sale just because they're an exempt entity doesn't mean that every state treats that the same. Some states you're going to be okay accepting the correct document. A lot of people try to use the form from the IRS. That's not going to work in every state that will allow you to accept it. You got to apply to the state and generally get the specific exempt entity documentation that the state wants you to use. So sometimes it's a letter from the state. Sometimes, it's a specific form, but these are the types of things that you should be checking. Is the exemption actually real? Does the exemption make common sense? You don't have to put on your detective's hat if you looking at this. What's your first impression? Is this real or not? Is this true, or is someone trying to get something tax-free when they should be paying the tax? And then making sure that it's completely filled out. Now, in each scenario, there, there could be a lot more, but those are the big things. You're going to catch 90 plus percent of all of the problems by just doing those things.
[00:08:57] Ellie: Mike, what are the potential consequences of not paying attention to this at all?
[00:09:03] Mike: Oh, that can be financially devastating. Right now, missing or invalid certificates are the number one cause for large assessments. And the reason why it's such a big issue is because most audits nowadays are not itemized; they're done on a sample basis. When you have one missing certificate, it's not just the tax that's associated with that invoice, but it's the error percentage and when you take that error percentage and extrapolate it out over the population, it has an outsized impact. I'll give you an example. This is an extreme example. I was involved in an audit one time and three and a half million dollar audit; roughly 60 percent of the audit assessment was due to, excuse me, it was a three-and-a-half million dollar assessment. Roughly 60% of it was related to certificates. And we found all of the certificates. We did a great job of tracking everything down, but they sold one heavy piece of earth-moving equipment to an individual who said they were going to export it overseas. And we could not find this individual anywhere.
[00:10:25] We even hired a skip tracing company, someone who actually tracks down people who don't want to be found, and we couldn't find them. The company exhausted all of their methods for trying to find them. So we got this audit down to $17,000, except for this one missing certificate. And the $8,000 would have been bad enough, but when you extrapolated it out over the population and Texas would not let us exclude this from the sample. We had done such a good job in the audit that we'd used up all of our favors. They weren't very happy with us. They thought they were getting three and a half million. Now they're getting $17,000. They made us keep it in the audit. So $270,000 impact and the client was still ecstatic. We took a 3.5 million audit down to just under $300,000, but it could have been that much better.
[00:11:24] So even one missing certificate can have a huge impact. Now, most of you are not going to have invoices that would have that much tax on them, but you're also going to have more than one missing certificate, and it's the same concept. When audits are done on a sample basis, these missing certificates have an outsized impact. And I often have to speak to owners or companies or presidents of companies and their salespeople always saying, Hey, this is our best client. Can we… need to waive this. And they'll wave two or three of them after about the third one, our team will come to me and say, Mike, I think we're going to have an issue here. They keep overriding our objections and our recommendations to reject these certificates. And it's usually because they don't understand. They say, okay, the tax on this invoice is going to be $200. We'll eat it, if we have to, because this is a good customer, and we're going to get much more business from them, not realizing. That it's not $200 worth of tax. It's probably a lot more than that because of the audits being done on a sample basis. So after I explained to them how audits work, they usually take our advice on a going-forward basis. So really, really important. Also, if you're not paying attention to exemption certificates, and if you've got your salespeople or anyone on a commission basis who are doing this… very publicized case out there, there was New York and then it was Sotheby's auction house, and Sotheby's was coaching some of the customers on how to use certificates.
[00:13:19] You buy art for hundreds of thousands or millions of dollars. There's a lot of sales tax on that. So they were coaching these buyers, and the state of New York found out about it. They went after the buyer, and they hit him with a $10 million penalty. On the company because they should have known better. They hit him with almost $30 million. So, the improper use of certificates often comes with criminal penalties. So criminal doesn't mean you're going to jail could just be a lot more money that's involved. So you don't want to find yourself in the position of not paying attention and allowing your salespeople or whoever is collecting these certificates, a missing or invalid certificate is bad enough. But if you're coaching your customers on how to not pay tax, that can be a much, much bigger issue. So you got to pay attention to what's going on. Someone's got to be doing the [inaudible] validation. Making sure it makes common sense that it's completely filled out, that it's on the right form, and that it's an actual real exemption.
[00:14:31] And if you take care of all of those things, or you hire someone like us to take care of all those things for you shouldn't have big issues. There's always something that slides through the cracks, but you shouldn't have any big issues. When it comes to exemption certificates in an audit.
[00:14:52] Ellie: Thank you so much, Mike. Anything else you want to add in here?
[00:14:56] Mike: No we we appreciate you joining us today. We hope to see you on future podcasts. Thanks very much.
[00:15:05] Ellie: Yeah, and if you have sales tax needs, we offer a lot of solutions and services. You can reach out directly to me at emoffat@salestaxandmore.com or visit our website. And in addition to our services, we have an entire series of free webinars free resources on our website. And if you have enjoyed what you've heard today. If you've enjoyed our podcast, please like and subscribe. We would really appreciate it. Thank you so much.
[00:15:36] Mike: Bye bye everyone.
[00:15:39] Outro: Thanks for listening. Be sure to hit subscribe and check out all the resources we have out on the web.