Exemption Certificate Management
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…
Missing, incomplete, or otherwise invalid exemption certificates are generally the leading cause for large audit assessments in companies that are required to collect certificates. Has it always been this way?
It has not. If we go back 10 - 12 years or so, prior to the last great recession, the auditors were very lenient when it came to certificates. Back then it was really a matter of substance over form. This means if the auditor knew it was an exempt sale they would generally make it work. However, during that recession, the states were looking for ways to refill their coffers. They didn't want to raise taxes so they looked at ways to increase revenue with existing laws. They never really enforced any of the certificate rules prior to then, so they said let's start enforcing the certificate rules. And overnight it went to form over substance, which means every "I" has to be dotted and "T" crossed. The auditors began seeing this as low-hanging fruit. And the states made a lot of money. So no it has not always been this way.
Here’s a glimpse of what you’ll learn:
Missing, incomplete, or otherwise invalid exemption certificates are generally the leading cause for large audit assessments in companies that are required to collect certificates. Has it always been this way?
When we start talking about recessions and the states needing to refill their coffers it sounds a lot like today. Do we see any parallels?
We know that certificates will be an issue for many companies, but why are certificates such a big issue in an audit?
Connect with Michael
Episode Transcript - Audio Version
[0:10] Intro: Welcome to Sales Tax and More. Your go-to resource for all things state tax-related. Now here’s your host, Michael Fleming.
[0:28] Mike: Hi, Mike Fleming here, founder of Sales Tax, and More and today's co-host of the Sales Tax and More podcast where we talk about everybody's favorite topic, which we all know of course is sales tax. Today my co-host Ellie Moffat and I are going to be interviewing one of our sales tax analysts, Priya Sorathia about exemption certificates. She's one of the stars of our exemption certificate management service that we offer prior to coming to work for us, Priya actually worked with the state of Pennsylvania and the department of revenue. It was our job to take her from the side of darkness and turn her to the side of goodness and light where she's using her powers to protect those and help keep people compliant. I mean, not get in trouble with the states. Priya, do you want to say a quick hello?
[1:14] Priya: Hello everyone! Thank you for that great introduction, Mike. I'm very excited to be here and I'm very excited to answer questions about resale certificates.
[1:21] Mike: All right, A lot of great information to cover today before we get started, though, I'm going to introduce you to my co-host, Ellie Moffat. Ellie, you want to say hi?
[1:29] Ellie: Absolutely! Mike, I'm really excited for today. Priya, so good to have you on the podcast, before we really get the ball rolling though, I do want to do a quick introduction for Sales Tax and More. Sales Tax and More is a full-service consulting and solutions firm. We have a really great team here of experienced tax professionals who are very dedicated to fulfilling your state tax and related needs. We do a lot of sales tax returns, sales tax registration, consulting, research, and like our name states more. If you have questions about our services or you'd like to work with us, please reach out and ask. We would love to work with you as well. So Mike, back to you.
[2:09] Mike: Okay. Thank you very much, Ellie. For those of you who listened to our podcast on a regular basis or every now and then usually I'm the one who's being interviewed. Ellie's interviewing me or we're having a discussion. Today we're going to flip the script a little bit. I'm going to interview both Ellie and Priya at the same time. Let's start with Ellie. You've heard me say a lot that missing, incomplete, or otherwise invalid exemption certificates are generally the leading cause for large assessments in companies that have a requirement to collect certificates. Has it always been this way?
[2:45] Ellie: Actually Mike, it is not. If we go back just ten or twelve years prior to the last great recession, auditors were very lenient when it came to certificates back then, it was really a matter of substance over form. This means that if the auditor knew it was an exempt sale, they would generally make it work. However, during that recession, the states were looking for ways to refill their coffers. We all know, states also take revenue loss during a recession and they didn't want to raise taxes. So they looked at ways to increase revenue with existing laws. They never really enforced any of the certificate rules prior to then. So they said, let's start enforcing the certificate rules. Basically overnight it went to form over substance. Which means every I had to be dotted. Every T had to be crossed. The auditors began seeing this as low-hanging fruit and the states made a lot of money. No, it has not always been this way, Mike.
[3:35] Mike: Okay, great information Ellie. Priya, do you have anything you want to add to that?
[3:50] Priya: Ellie has done a great job explaining, but I would like to add that all of a sudden companies like distributors, for example, who are not generally audited, because the state did not want to waste their time were now getting audited. After all the states thought, why audit them? If they have no taxable sales? But soon companies with no taxable sales were getting audited and none of them were prepared. Again, the states raised a lot of money like Ellie said. You would think after the economy got better, the states would go back to the way it was. But that did not happen. In fact, the trend actually accelerated if anything.
[4:23] Mike: Yeah. I'm starting to hear almost a familiar theme. You know, we're talking about recessions, we're talking about the states needing to refill their coffers. Sounds a lot like today. Are we seeing any parallels, Ellie?
[4:37] Ellie: Yes, absolutely. Historically, as we come out of recession, the state step of their discovery, auditing, collection efforts, and we've really, we've been spreading the word about this for the last year, giving people a heads up and we really are seeing no difference this time. In fact, if anything, it may be worse because of the economic nexus. Research it's being done, and the states know. They know that one in two people are not registered and they should be. Before pandemic closures, many states were gearing up to pursue sellers. Some of that did begin. All of it got put on hold. A lot of things were put on hold as we are all very well aware of. That effort is going to begin again, in addition to the auditing of existing taxpayers. Certificates will play a large role in both efforts.
[5:28] Mike: Sounds like we're in for some troubling times for many companies out there. I mean, the states are coming at them from two different ways. Number one, they're looking for those companies that have economic nexus and are not compliant. The states are going to go after them for all sorts of issues. Then coming out of recession, we have increased audits, whether you've registered, whether you're not registered, looks like times could be very troubling for you going forward. States got to refill the coffers. Ellie mentioned that certificates are going to play an important role and I agree with that, but Priya, can you tell us why certificates are such a big issue in the audit?
[6:10] Priya: Sure Mike. Besides the fact that many companies do not give enough attention to certificates, it's because audits are generally done on a sample basis. When there's a missing, incomplete, or otherwise imbalanced certificate, it's not just a tax on the single invoice that should have been collected that's added to the assessment. Instead, the error percentage of the sample is extrapolated over the entire population in the sample it represents. It has so much oversized impact. I know Mike, in the past, you have mentioned in previous podcasts and me that there's an audit where one missing certificate had over $270,000 impact.
[6:47] Mike: Okay. So you have been listening to me. Yes, Priya. In that particular example, the tax and the invoice should have been $8,000. While most of you, or most of your clients don't have invoices with $8,000 of tax. I think this is one of the greatest examples out there, because when they extrapolated it, that $8,000, which no one wants to play in the first place, was a $270,000 impact and that was just one missing certificate. Now, as I said, most of you, or most of your clients don't have invoices with $8,000. But you're generally missing more than one certificate or have more than one invalid certificate. That's something that you mentioned Priya, an invalid certificate. What exactly is an invalid certificate?
[7:35] Priya: Great question, Mike. Many companies may collect certificates, but they're not validating them. In other words, they're not checking to make sure the certificate would survive an audit. It's not enough just to collect a certificate. It's important to validate it. An invalid certificate is one that would not survive an audit.
[7:53] Mike: Do you have any examples or reasons why a certificate may not be acceptable to an auditor?
[8:00] Priya: Yes. The biggest reason certificates are not complete is because a certificate is not completely filled out. All sections must be completed, dated, and signed. You won't believe how many certificates I see on a daily basis that aren't complete. The next reason is that their certificate is on the wrong form. Either the wrong state or the wrong exemption type, then the third reason is that it does not meet the common sense test. While you collect certificates in good faith, you can't accept them in blind faith. For example, if a customer says that they're in the business of selling furniture and they buy an accountant software from you, does that make sense that they're buying the software for resale? No. It makes more sense that they'll use that software in their own business. So in this case, the seller should reject their certificate and collect sales tax.
[8:45] Mike: Wow. Priya, you mentioned two things in there. I think most of our listeners are going to find it a little bit interesting and perhaps we can get Ellie to expand on that. Ellie, number one, what is good faith acceptance? Number two, can a seller actually reject a certificate from one of their purchases? It turned it down, charged them the tax, even though they provided a certificate?
[9:08] Ellie: Mike, your first question here, good faith acceptance is kind of what it sounds like. Acceptance, it means that you're relying on the purchaser, to tell the truth, and as long as the certificate is on the correct form, it's completely filled out and passes the common sense test the auditor can generally not do any additional digging, and if the purchaser is not eligible for the exemption the state will pursue the seller. However, if their certificate is invalid, you lose your good faith acceptance, and the state can do that additional digging and pursue the seller. So if we haven't made it clear or alluded to this, it is very important that someone is validating certificates. While a state generally allows you to perfect the invalid certificates or procure missing certificates. Any certificate, not valid at the time of audit is subject to additional verification. No good faith acceptance, and as to whether a seller can reject a certificate and required tax, we paid, they must do so. If they have knowledge or suspect, a purchaser is not eligible for the exemption. Mike, we hope that people don't do that, but they also must not do it. Hopefully, that answers both of your questions.
[10:25] Mike: Absolutely! Very important that you're turning down certificates sometimes because most people don't realize that there can be criminal penalties. In addition to the civil penalties, when it comes to the improper use of a certificate, if you're innocent, um, your firm is innocent, then they're generally going to pursue the purchaser. Hit them with additional penalties and potentially, you know, depending on how bad the situation is. Technically someone could go to jail for that. What people don't realize. Is that they can pursue the seller also. There was a recent, very public case about Sotheby's, the auction house.
[11:08] Someone at Sotheby's was coaching one of the purchases of art on how to use a resale certificate. Now they had no intention of reselling that art, but someone was coaching them on it. The state of New York found out, they went after the purchaser and there were extra criminal penalties and everything else. They went after them for $10 million in back tax plus penalties and interest. Went after Sotheby's for almost 30 million. Now, it's the same amount of sales, but they went after Sotheby's a lot harder because Sotheby's should have known better. You know, they're the ones who are responsible for collecting and remitting the tax and what New York said is, Hey! You were complicit in helping this taxpayer evade taxes. Tax evasion, never a good thing. I mean, it's a nice way of saying you committed fraud and as a company or as an individual, you don't want to have that distinction thrown up about when someone is talking about you. Unfortunately, this is something that happens more often than you'd believe it's not just the big names like Sotheby's, we see these issues all the time, whether it's a salesperson who doesn't understand how important certificates are, they don't realize that helping someone to avoid paying tax when they're subject to the tax, how that can actually be a crime.
[12:40] They just don't understand the seriousness of it. You know state comes after you, they're not just coming after that salesperson, they’re coming after all the company and especially the responsible parties of the company. So sometimes it's very innocent. Sometimes, talking about innocence, maybe the salesperson comes crying to the owner of the company and says, Hey, we need this we're going to get so much business and I need you to override the sales tax department on accepting this certificate. I had this conversation a lot, you know, where someone just doesn't realize it's not the tax on that one certificate they're putting at risk because that certificate in a sample, has a much-oversized impact, that's number one. Number two, if you collect a certificate and you knew that the purchaser was not eligible for that exemption, then you could also face criminal penalties. The states don't pursue the sellers. If there's good faith, acceptance there and the seller did not know, but if the seller knew or should have known the state will pursue them and talk about those additional criminal penalties. We offer not only exemption certificate management services, but exemption certificate validation services. It's part of our exemption certificate management services. Having a third party, do these checks. Sometimes could prevent a lot of heartache down the road. At this point, I think that we've covered a lot of ground here. Ellie, let's wrap it up.
[14:19] Ellie: Yeah, absolutely. I did want to say, first of all, Mike, those are really excellent points and great examples for everyone to be aware of. Like Mike was saying, if you have questions about our exemption certificate management services, or really any of the services that we have, you can contact me directly. At Emoffat@salestaxandmore.com. You can also visit our website salestaxandmore.com. We have a lot of valuable information for you. We offer this exemption certificate management service like we've been talking about. We also have an entire series of webinars. We have a lot of free information on our website and paid resources as well. So again, please reach out to us. If you have questions about any of our services or would like to work with us. Anything else you want to add in here, Mike?
[15:15] Mike: Yeah. I want to thank both you and Priya for joining me today and thank you for all our listeners. We look forward to seeing you on our next episode of the Sales Tax and More podcast. Wish everyone a great day. Take care.
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